The first big sign that the credit markets would not fret about Moody’s downgrade of France’s sovereign paper was the lack of movement in the country’s most widely followed stock index. It barely sold off 0.4%. At 3,426, the index sits just below its 52-week high of 3,600. In contrast, fiscal cliff anxiety has taken a much greater toll on U.S. markets. Global capital markets investors knew France could not sustain its ratings as GDP improvement slackened. In other words. the downgrade was “priced into” French debt. And the old “safe haven” rule applies to France’s paper, as well. Investors who actually want exposure to Europe have few relatively safe places to put their capital.
A careful reading of Moody’s comments when it dropped France’s rating from Aaa to Aa1 shows that the ratings agency remains relatively optimistic. Moody’s explained that:
France remains extremely highly rated, at Aa1, because of the country’s significant credit strengths, which include (i) a large and diversified economy which underpins France’s economic resiliency, and (ii) a strong commitment to structural reforms and fiscal consolidation, as reflected in recent governmental announcements, which may, over the medium term, mitigate some of the structural rigidities and improve France’s debt dynamics.
The agency added:
Given the current negative outlook on France’s sovereign rating, an upgrade is unlikely over the medium term. However, Moody’s would consider changing the outlook on France’s sovereign rating to stable in the event of a successful implementation of economic reforms and fiscal measures that effectively strengthen the growth prospects of the French economy and the government’s balance sheet. Upward pressure on France’s rating could also result from a significant improvement in the government’s public finances, accompanied by a reversal in the upward trajectory in public debt.
France’s president, François Gérard Georges Nicolas Hollande, says he remains bound and determined to improve the financial position of his government, although the resistance to his plan by other politicians has been aggressive. Hollande has pressured large employers and unions to set plans that would minimize job losses as France’s gross domestic product flatlines. He continues to press lower corporate taxes and higher ones on the rich, based on the theory that the rich can afford additional contributions, and that businesses will hire and expand spending if they can improve margins via lower government tolls. Hollande has remained committed to cutting the government’s deficit to 3% of GDP by next year. However, this could be a stretch if France enters a long recession.
France has the economic diversity and GDP size, at $2.7 trillion, to maneuver in ways that neighbor Spain cannot. France’s GDP is almost twice Spain’s. And France does not have the crippling trouble of bad banks, 25% unemployment and a housing market that has collapsed. Capital markets investors already know that. Even with the Moody’s downgrade, they seem ready to give France the benefit of the doubt.
Douglas A. McIntyre