INCRA France Rating Report 2015

Rating: 7.7 (AA)

France

Negative outlook

Rule of Law

Economic Fundamentals

Transparency and Accountability

Public Sector Fiscal Policy 8.4 7.6 7.4

Monetary Policy

7.6

Social Cohesion

8.9

10

8

6

4

7.7

2

8.1

2

4

6

6.8

8

Future Resources

7.4

7.7

• Stable, vibrant democracy

• Strong tradition of rule of law • Highly developed social safety net

7.8 7.6

• Strong track record of swift decision-making and execution of fiscal policy, underpinned by a highly qualified and competent civil service

• Low interest-to-revenue ratio

10

7.2

External Sector

• Diversified, wealthy and highly productive economy characterized by good performance in research and innovation

• Broad and deep revenue base

7.0

Capital Markets and Financial Risk

Strengths:

Strategic Capacity

Weaknesses: • Rapidly rising debt-to-GDP ratio

Crisis Management

Implementation Adaptability

8.0 Macroeconomic Indicators

• Rapidly rising debt-torevenue ratios • Poor real and nominal GDP performance

Forward-Looking Indicators 7.5

Summary The French government presides over one of the world’s richest countries in terms of both accumulated assets and ongoing income generation. Given this wealth, the government has at its disposal more than adequate resources to meet its financial requirements today and in the future. At the same time, France’s political traditions mean that the French people have come to expect a wide-ranging social welfare system, which is increasingly costly to maintain in a globalized world. Membership in the eurozone, by definition, constrains public policy actions. Sometimes this is to a country’s benefit, but at other times it reduces government flexibility, thereby complicating crisis management. For France at present, this combination of

• Ongoing primary deficits • Actuarially unsound public retirement schemes • Significant contingent liabilities emanating from the financial system • Significant contingent liabilities emanating from eurozone bailout programs • Problems integrating the country’s growing minority population

1

factors results in relatively low sovereign credit risk associated with an AA+ rating.

However, as discussed below, the country faces important challenges going forward.

The Economy For a number of years, economic growth in France has been relatively anemic. Since GDP contracted by 2.8 percent in 2009 in the wake of the global market crash, real growth has remained weak ever since.

After increases of 2.0 percent in 2010 and 2.1 percent in 2011, growth slowed even more. In 2012 it was a mere 0.3 percent, followed by 0.3 percent in 2013 and 0.4 percent in 2014. As the eurozone sovereign debt crisis has deepened, it has triggered recessions in many eurozone member countries, which are also major trading partners for France, dampening demand in those markets for French

exports. Exports have been growing despite this, providing an important boost to an otherwise weak GDP growth rate. However, although exports grew in the first quarter of 2015, imports rose even faster, causing net exports to be a significant drag on the overall growth rate equal to -0.5 percent. The overall economy grew by 0.6 percent in the first quarter of 2015. Since domestic demand accounted for all the growth in the first quarter, and since imports rose at a relatively fast pace, it is possible that import growth in the first quarter of 2015 was caused by a domestic economy on the mend. Nonetheless, the economy should get a boost in 2015 from the export sector given the recent sharp drop in oil prices as well as the sharp depreciation of the euro against the dollar and other world currencies. Yet overall, the eurozone

Real GDP Growth (%) 3 2 1 0 -1 -2 -3 -4 2008

2009

2010

2011

2012

2013

2014

2015

crisis has caused significant stress, not just on French consumer and business confidence, but in practical terms on the French financial sector.

Because French banks hold significant positions in eurozone sovereign debt, any further deterioration in sovereign risk in member states beyond Greece would represent heightened risk for the banks.

Such risk remains an important potential contingent claim on the government.

Unemployment and Labor Law Weak economic growth, not surprisingly, has been associated with high unemployment, which reached a rate of 10.3 percent in 2013 and was at 10.4 percent in December 2014. Most observers expect unemployment to remain relatively high.

Even if GDP growth is positive for the year 2015, the growth rate is not likely to be robust enough to generate a sharp fall in unemployment. Of key concern given the associated social risk is the fact that youth unemployment is approximately 25 percent. Unemployment is especially high among immigrants and their Frenchborn children.

France has tried to spread employment more widely by legally limiting the number of hours that can be worked in a week. Unlike Germany’s scheme of burden sharing, where workers and employers collaborate to determine the most efficient way to spread employment among employees, France’s government-imposed system has often caused unanticipated inefficiencies, or even prompted employers to move jobs abroad, particularly in financial services and high-tech. Even excluding

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The Current Account: A Measure of Competitiveness

Unemployment Rate (%) 12 10 8 6 4 2 0 2008

2009

2010

2011

the workweek regulations, the Organization for Economic Co-operation and Development (OECD) notes that France would still have one of the most highly regulated labor markets. Labor market rigidities are likely constraining employment growth.

In 2013 and 2014, reforms were made to French labor law, but these have not

2012

2013

2014

2015

thus far proven effective. In February the government met with labor unions and representatives of business to attempt to further streamline labor laws. Given the nature of France’s civil society, however, it is doubtful that such reform will approach the steps undertaken in the last decade in Germany, despite the fact that the government has indicated that it is seeking to follow the German model.

Current Account Balance to GDP (%)

0 -0.5 -1 -1.5 -2 -2.5

2008

2009

2010

2011

2012

2013

2014(f)

2015

Although the current account balance does not have the same meaning for a country in a monetary union as opposed to one with an independent currency, it can still provide a snapshot of the monetary union member’s overall competitiveness. Early in the last decade, France regularly reported current account surpluses. However, since 2005 the country has regularly recorded annual deficits between 0.5 percent and 2.2 percent of GDP (2012). The current account deficit-to-GDP ratio was 1.3 percent in 2013 and is estimated at 1.1 percent for 2014. These deficits are not excessive, but are indicative of a slow but steady deterioration in the country’s competitive position. However, given the recent rise in export growth – which until recently was caused, according to the IMF, by weak domestic demand — the country should see a boost to its competitiveness in 2015 from lower energy prices and the euro’s depreciation.

Fiscal Policy When discussing fiscal policy, it is important to make a distinction between advanced industrial economies and emerging markets. The former are able to carry much more public sector debt than the latter, given that wealthy countries usually have highly developed domestic financial markets or easy access to such markets in other countries. Another important distinction is that highincome countries usually have more diversified income streams as well as more accumulated assets, either at home or abroad. This is one reason that we compare countries to their income peers.

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being transformed into real claims.

Examples of this are government-funded bailouts of financial institutions or other companies. In the case of France there is a concern that French banks might need the government to bail them out if the eurozone’s sovereign debt problems worsen, forcing another eurozone sovereign to restructure its debt. Because French banks have sizable sovereign portfolios, a restructuring, similar to that of Greek banks, could prove costly to the French banks and therefore to the government.

General Government Debt to GDP (%) 100 90 80 70 60 50 40 30 20 10 0

2009

2010

2011

The 2015 Budget In December 2014, the government passed its budget for 2015. When it was initially proposed, this budget caused concern within the EU over the size of 2015’s anticipated deficit. Earlier, the French government committed to reducing its budget deficit to 3 percent of GDP by 2015, in adherence to eurozone fiscal criteria. Instead this year’s budget, despite maintaining relative austerity, will only result in the budget deficit declining from 4.5 percent of GDP to 4.1 percent in 2015.

The austerity program poses the same risk as witnessed elsewhere. With French GDP growth close to zero, cutting the deficit by 0.5 percent of GDP will act as a drag on economic activity, but one that is easier to bear than the measures that would have been needed to conform to the EU rules, which would have required a decline in the deficit of several percentage points. (The IMF, likewise, indicated that

2012

2013

2014

2015

reducing the deficit by only 0.5 percent annually appeared appropriate in order to maintain a reasonable level of GDP growth.)

Debt Ratios France’s general government debt-toGDP ratio has risen steadily since 2008, when it was 68.2 percent. The debt-toGDP ratio rose to 81.5 percent in 2010, to 85.0 percent in 2011, and to 89.2 percent in 2012. In 2013 the ratio stood at 92.2 percent, and it is estimated to have reached 94.5 percent in 2014. Not only is this ratio higher than that of many of France’s peers, but it is expected to continue rising, albeit more slowly, for the foreseeable future.

Contingent Claims Although deficit figures are important in gauging how high a debt-to-GDP ratio may become, another important reason for sudden increases in government debt is related to contingent claims suddenly

Another concern is the growing cost of eurozone sovereign bailouts. If the existing bailout funds, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), are able to obviate the need for further sovereign bailouts, then the French government’s debt will be containable using ongoing budgetary restraint.

However, if keeping the eurozone stable requires greater injections of funds than already allocated, France’s contribution would likely push the country’s debt-toGDP ratio to levels consistent with an even lower rating.

Eurozone Contagion Since the Greek government first faced financial difficulties five years ago, eurozone governments have been plagued by ongoing market access concerns. Countries on the so-called periphery of the eurozone, including Greece, Ireland, Portugal, Spain, and Cyprus (Italy is also sometimes grouped with these countries), have all faced major bouts of investor angst. In Greece, investors suffered significant losses as the country’s government debt was

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restructured, causing massive losses on principal. Given that background, private sector investor concern has risen.

France faces two problems caused by the eurozone crisis. The first is that the government has already had to contribute to the EFSF, and will soon need to fund its portion of the ESM. If both Italy and Spain were to require bailouts, this could prove costly, potentially requiring additional French contributions to any future bailouts beyond that. The second problem is that, although France is viewed by investors as part of the eurozone’s core, it is also viewed, in terms of government finance, as one of the weaker members of that core. As such, to keep financial contagion from affecting its own interest rates, the French government must be particularly vigilant.

Antecedents to Contagion What could cause investor concern about France to rise? Any sign that the French government is unable to deliver upon its pledge to stabilize its debt over time. Possible signals include if the government is not able to implement its recently passed budget or if economic growth is significantly below the rate assumed in the budget.

Consequences of Contagion The consequence for the French government of a loss in investor confidence would be that interest rates on government debt would rise, making any solution to France’s fiscal challenges all the more difficult. Significantly higher interest rates on French government debt would negatively affect the government’s credit rating.

Forward-Looking Indicators (FLI) Given that France is among the most highly developed countries in the world, it is not surprising that it performs well with regard to FLI. This is particularly the case in terms of rule of law, citizen approval of political institutions and procedures, stakeholder involvement, political communication, and institutional learning. However, France is slightly weaker in unemployment, social security, and the government’s ability to set strategic priorities.

Although France remains both willing and able to repay its debt, the country is plagued by a variety of worrisome issues, and the trends appear to be largely negative. Growth is slow, and opinions are mixed on how well or how soon it will recover. The lack of social mobility is a very serious issue, with strong differences persisting across class and educational divisions. Country committee participants agreed that the French government must implement a series of reforms, but saw the prospects for these as difficult given the extreme differences in the population’s needs.

Moreover, as the economic situation remains poor, many are turning to the extreme right-wing National Front party.

Rule of Law France has a long and well-respected tradition of rule of law. Except for a brief period during the Nazi occupation during World War II, the country has maintained a democratic, law-based system of government since 1870 that has served it well. France also has a strong tradition of an elite civil service, whose high-ranking members enjoy notable prestige. Such

a professional and well-qualified civil service is able to implement policies effectively and in a timely manner.

Transparency and Accountability Transparency and accountability have long histories in France and scored well in the country committee’s assessment.

Media pluralism is reasonably guaranteed by a complete set of constitutional, legislative and administrative rules, such as the press freedom law, which dates from from 1881 and was amended since.

With regard to print media, the diversity of newspapers and opinions mirrors the political diversity of the country.

The French political culture and tradition mean that parliament and government, legitimized by democratic elections, hold the monopoly to express the people’s “general will”, whereas economic and social associations are seen as lobbies motivated by self-interest. Therefore government officials tend to have distant relationships with associations, which do not play a major part in the formulation of policy proposals in France.

In the decision-making process, however, the arm’s-length relationship between government and associations has given way to more cooperation. In the last decade, new rules have stipulated that relevant associations must be consulted before presenting a bill covering social policy. Still, not all associations are able to exert a real influence on policymaking, other than by proposing new ideas and concepts that are taken up from time to time by politicians.

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Some relatively formal consultative bodies do exist. For example, the various economic, social and ecological interest groups are represented, together with experts, in an official Economic, Social and Environmental Council (Conseil économique, social et environnemental, CESE), which has constitutional status but remains purely consultative.

Future Resources France has a rather good overall performance with regard to research and innovation. According to the EU Innovation Scoreboard results for 2014, France is ranked 11th (out of 27 EU countries) with respect to innovation capacity, performing just above the EU average. These weaknesses include a relatively low private resource mobilization for research and development (R&D), low innovative behavior of companies, especially smalland medium-size businesses, and a rather weak collaboration between the private and the public sectors. France spent 2.26 percent of GDP on R&D in 2012, a ratio that has not risen since 2000. With this level of R&D spending, France is slightly below the OECD average of 2.28 percent and far below the common European target of 3 percent of GDP. Despite high overall spending and several new measures, French labor market policy has shown rather poor results.

Since the 1990s, France has faced a high unemployment rate, which has reached 10.4 percent in 2014. The main problems are joblessness among youth and elderly workers, as well as the difficulties French citizens with a migrant background encounter when seeking to enter the labor market. The insider-outsider

divide, linked to strict regulation and exclusionary job protections, compounds the problem.

Social inequality with regard to access to education and qualifications is a sensitive topic in France. The leading orientation of the national education system is to promote quality and social advancement. But formal equality — which tends to advance all students, regardless of their social background, on strictly meritocratic criteria — has not prevented social inequality.

By international and European standards, the French welfare state is very generous and covers all aspects of collective and individual welfare, not only of nationals but also of foreign residents, and keeps poverty at a comparatively low level.

Redistribution is high and above the OECD average.

Social cohesion and inclusion on the other hand are weak. France struggles to keep the oldest and youngest workers employed and to address social problems in urban zones.

Strategic Capacity Coordination of government action and communication is assured in a hierarchical manner. The key problem behind these communication problems of the Francois Hollande administration is the president’s lack of strategic and decision-making clarity. Forced by the country’s economic malaise into a supplyside policy, reforms, and budgetary discipline — a policy approach that is contrary to his campaign announcements and therefore meets strong opposition within his own Socialist party — Hollande

was reluctant to clearly assume his policy shift and to explain its necessity.

Although the country has appeared more adaptable recently, its ability to learn from the implementation of policy has been largely “accidental”, not strategic.

The French government relies on abundant expertise from more than 600 standing committees, councils, and observatories representing various advisory institutions. While this broad and deep expertise is available, it is unclear how much it is put to use in France’s strategic planning.

France has a tradition of strong political and ideological polarization, and open consensus building between government and opposition parties remains very difficult. The national unity seen after the terrorist attacks against the journal Charlie Hebdo in January 2015 is an exception to the rule. Even moderate opposition parties see no interest in helping the government to build consensus on controversial yet vital reforms; they would prefer to see the government fail in order to win the next elections.

Implementation and Adaptability Over the past three decades, France has had to learn from its own policy failures as well as changed European and global conditions.

President Hollande, who has been faced with both internal and external pressures, has needed some time to adapt his policies. Whereas he seemed to prefer a moderate social democratic policy in line with his campaign promises— more

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growth, more social justice, more jobs, maintaining of the welfare state — this approach soon proved inadequate to cope with the economic crisis and with growing structural economic problems, as well as with European rules and commitments, such as the requirement to stabilize the budget deficit. Hollande first tried to minimize the policy changes he introduced at the end of 2012, but failed to convince his supporters.

There was some criticism from some members within the country committee about the president’s “zigzagging” on election promises. It was suggested that the uneven reception of reforms by government officials and society at large is rooted in the failure to clearly communicate their details and goals.

Despite the larger concerns about the government’s ability to prioritize and

execute reforms, the concentration of political power (a strong executive, together with a centralist state organization), with nearly no institutional veto players, facilitates rapid political decisions and their prompt implementation if necessary.

Track Record of Past Crisis Management Since the 2000s, under the pressure of globalization, European monetary integration, industrial competitiveness problems, and growing financial deficits, France has been under new pressures that have challenged its capitalist economy and its growth model. It faces the growing decline of its industry, economic stagnation, and the rise of unemployment, while the deficits in public administration and social security have deteriorated. The call for structural

reforms has become omnipresent in the public debate. France needs state and administrative reforms to reduce the high ratio of public expenditure-to-GDP, which stands at 57 percent, the highest ratio in the OECD. Furthermore, it needs to reform its labor market as well as its tax and social contribution system that is penalizing business, among others.

The previous administration of Nicolas Sarkozy was unable to address these challenges sufficiently, and Hollande’s administration seems likewise limited.

Reforms in the social security system (mainly pension reform) and some supplyside measures for competitiveness only scratch the surface of what needs to be done. France still needs to prove its capacity to master this challenge as it did in the past.

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Rating Committee Average Scores by Indicator Macroeconomic Indicators

8.0

Capital Markets and Financial Risks

8.1

Economic Fundamentals

7.6

Domestic Credit / GDP (%)

9.2

Real GDP Growth %

6.5

Domestic Credit (% Change)

7.8

GDP per Capita

8.4

Overall Strength of Banking Sector

7.5

Real Exports (% Change)

7.3

External Sector

7.8

Real Imports (% Change)

7.5

Current Account

7.8

Gross Domestic Investment / GDP (%)

7.9

External Debt

7.8

Gross Domestic Savings / GDP (%)

7.9

Inflation-CPI (%)

8.2

Forward Looking Indicators

7.5

Population Growth (% Change)

6.8

Political Economic and Social Stability

7.5

Public Sector / Fiscal Policy

7.4

Rule of Law

8.4

General Government Debt / GDP (%)

6.6

Legal Certainty

8.4

Nominal GDP Growth (Local Currency %)

7.2

Independent Judiciary

9.0

Separation of Powers

7.9

Property Rights

8.4

Transparency / Accountability

7.6

Corruption Prevention

7.3

Independent Media

8.1

Civil Society Participation

7.4

General Government Debt / General Government Revenue (%) General Government Interest / General Government Revenue (%)

8.0 8.2

General Government Primary Balance / GDP (%)

6.7

General Government Fiscal Balance / GDP (%)

7.0

General Government Revenue / GDP (%)

8.2

General Government Expenditure / GDP (%)

7.4

Monetary Policy

8.9

Accommodative Monetary Policy

8.9

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Social Cohesion

7.0

Implementation

7.7

Social Inclusion

7.2

Government Efficiency

7.8

Trust in Institutions

6.9

Resource Efficiency

7.7

Societal Mediation

6.8

Adaptability

7.4

Conflict Management

6.9

Policy Learning

7.1

Future Resources

6.8

Institutional Learning

7.8

Education

7.2

Crisis Management

7.6

Research and Innovation

7.1

Historical Evidence of Crisis Management

8.1

Employment

6.6

Crisis Remediation

7.1

Social Security

6.3

Signaling Process

6.8

Environmental Sustainability

7.2

Timing and Sequencing

7.6

Steering Capability and Reform Capacities

7.5

Precautionary Measures

7.7

Strategic Capacity

7.2

Automatic Stabilizers

8.1

Prioritization

6.4

Policy Coordination

7.3

Stakeholder Involvement

7.3

Political Communication

7.6

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macroeconomic indicators I. Economic Fundamentals

2008

2009

2010

2011

2012

2013

2014

2015

Nominal GDP Growth (%)

2.5

-2.8

3.0

3.0

1.6

1.2

1.2

1.5

Real GDP Growth (%)

0.2

-2.9

2.0

2.1

0.3

0.3

0.4

0.7

Unemployment Rate (%)

7.5

9.1

9.3

9.2

9.8

10.3

10.0

10.0

Real Exports, Goods (% Change)

-0.6

-11.3

9

6.9

1.1

2.2

3.4

4.8

Real Imports, Goods (% Change)

0.6

-9.4

8.9

6.3

-1.3

1.7

3.1

3.2

Nominal GDP (bn. US$)

2,937

2,700

2,651

2,865

2,688

2,807

2,902

2,935

GDP per Capita (US$)

47,273

43,234

42,249

45,430

42,415

44,098

45,383

45,690

GDP per Capita (PPP basis: US$)

35,169

34,836

35,896

37,350

37,347

37,555

38,162

Inflation - CPI (%)

3.2

0.1

1.7

2.3

2.2

1.0

0.7

Population Growth Rate (% Change)

0.6

0.5

0.5

0.5

0.5

0.5

Gross Fixed Capital Formation / GDP (%)

23.6

22.0

22.0

22.4

22.5

22.1

21.6

Gross Domestic Savings / GDP (%)

22.3

21.3

21.9

23.2

22.7

22

22.4

22.1

II. Public Sector Policy

2008

2009

2010

2011

2012

2013

2014

2015

General Government (GG) Debt / GDP (%)

68.2

78

81.5

85.0

89.2

92.2

94.5

95.1

GG Revenue / GDP (%)

49.8

49.6

49.6

50.8

51.8

52.9

52.7

52.2

GG Expenditure / GDP (%)

53.0

56.8

56.4

55.9

56.7

57.2

57.1

56.5

0.9

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GG Financial Balance / GDP (%)

-3.2

-7.2

-6.8

-5.1

-4.9

-4.1

-4.4

-4.3

Primary Balance / GDP (%)

-0.5

-4.9

-4.5

-2.6

-2.4

-2.1

-2.3

-2.2

GG Debt / GG Revenue (%)

134.6

157.2

162.8

166.1

171.2

173.4

180.7

187.1

6.2

5.4

5.4

5.8

5.5

2008

2009

2010

2011

2012

2013

2014

2015

5.4

4.6

2.7

-1.3

3.6

GG Interest / GG Revenue (%)

III. Capital Markets & Financial Risk Domestic Credit Growth (YOY) Domestic Credit / GDP (%)

120.4

125.2

128.6

129.4

132.5

130.8

IV. External Sector

2008

2009

2010

2011

2012

2013

2014

2015

-1.7

-1.3

-1.3

-1.7

-2.2

-1.3

-1.1

-1.0

Current Account Balance / GDP (%)

Sources: OECD, World Bank, IMF, Author’s Calculations

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About the Bertelsmann Foundation The Bertelsmann Foundation, established in 2008, is the North American arm of the Germany-based Bertelsmann Stiftung. The Foundation is a think tank that spurs debate and discussion on political, economic and social issues and it is committed to promoting the freedom of individuals and societies and international understanding. The Bertelsmann Foundation develops, creates, and implements its own projects and programs. The Bertelsmann Foundation develops “Global Ideas and Transatlantic Action” and we serve as an international window in the US capital, providing a showcase for global best practices and a venue for thought leaders to exchange ideas for confronting society’s greatest challenges.

The INCRA project was launched at the Bertelsmann Foundation’s 2012 Annual Financial Conference, which has developed a reputation for being the go-to event on the sidelines of the International Monetary Fund World Bank Group Spring Meetings. The Bertelsmann Foundation sees INCRA as an important contribution to the debate and discussion on new rules for international financial- and economic-policy governance. Therefore, the Foundation seeks to explore and support all avenues to turn the INCRA concept into reality.

About INCRA The Bertelsmann Foundation developed its INCRA (International Non-profit Credit Rating Agency) proposal following the 2008 financial crisis and the subsequent criticism of the practices of the leading credit rating agencies. The INCRA blueprint presents a new model, both in its institutional setup and its methodology, for developing a credit rating agency to assess sovereign risk in an alternative way. INCRA is based on an operational business model funded by a sustainable endowment.

Since publishing the original model for INCRA the Bertelsmann Foundation has assembled a team of international sovereignratings experts to produce sovereign ratings based on INCRA’s transparent methodology. INCRA has developed a comprehensive new methodology that evaluates a country’s ability and willingness to repay its debt. In its sovereign debt assessments INCRA uses forward-looking indicators in addition to traditional macroeconomic data. These indicators are highly qualitative, mirror a country’s socioeconomic development and include factors like governments’ crisis management and reform capacities as well as investments in education and infrastructure. INCRA defines sovereign ratings as “public goods”, available to all citizens and correspondingly all detailed rating reports are available online for free.

Contact Annette Heuser, Bertelsmann Foundation, (202) 384-1990 annette.heuser@bfna.org Anneliese Humpert, Bertelsmann Foundation, (202) 384-1995 anneliese.humpert@bfna.org Bertelsmann Foundation North America, 1101 New York Ave NW, Suite 901, Washington, DC 20005 www.bfna.org www.incraglobal.org

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