Moody's warns France on possible negative outlook

France's President Nicolas Sarkozy and Economy and Finance Minister Francois Baroin at the Elysee Palace, September 26, 2011.

NEW YORK (Reuters) - Moody's warned on Monday it may slap a negative outlook on France's Aaa credit rating in the next three months if the costs for helping to bail out banks and other euro zone members stretch its budget too much.

The warning comes as European Union leaders are discussing measures to protect the region's financial system from an expected Greek debt default. Those measures should include injection of capital into banks with exposure to Greek debt.

France and Germany are the two strongest economies among the 17 euro zone members, and they are spearheading a plan to be presented at an EU summit on Sunday to help resolve the region's debt crisis.

France's progress on crucial fiscal and economic reforms as well as potential adverse developments in financial markets or the economy will also be taken into account under the review, Moody's said.

A negative outlook would be a sign that Moody's could downgrade its rating on France in the next couple of years. Moody's had placed the United States's Aaa rating on negative outlook in August.

"The deterioration in debt metrics and the potential for further contingent liabilities to emerge are exerting pressure on the stable outlook of the government's Aaa debt rating," Moody's said in a statement.

France, it said, has less room now to stretch its finances than it did during the financial crisis of 2008.

France may face a number of challenges in the coming months, such as the need to provide additional support to other European countries or to its own banking system, Moody's said.

For the country to maintain a stable outlook on its rating, it will need to prove its "continued commitment to implementing the necessary economic and fiscal reform measures," the ratings agency said.

The government will also have to show "visible progress in achieving the targeted sustainability improvements" in its debt ratios, Moody's said.

France's debt metrics are now among the weakest of its Aaa peers, the agency said, but they are still supported by a favorable debt affordability, or a relatively low interest burden in relation to government revenues.

But the ability to finance very high levels of debt "rests on investors' confidence in the government's ability and in its willingness to tackle unforeseen challenges," Moody's said in the report.

(Editing by Leslie Adler)