UPDATE 2-Fitch cuts French credit rating on budget, economy woes

Fri Jul 12, 2013 3:01pm EDT

* France has lost AAA with all three major rating firms

* Fitch cuts rating by one notch over debt, economic outlook

* Govt says committed to reform, welcomes stable outlook

By Luciana Lopez and Ingrid Melander

NEW YORK/PARIS, July 12 (Reuters) - France lost the last of its major AAA ratings on Friday in a blow to President Francois Hollande as his government battles to rein in public finances and kickstart the stalled economy.

Fitch cut France's credit rating by one notch to AA-plus, citing a deteriorating debt outlook and an uncertain economic environment as the euro zone crisis risked flaring up anew.

The euro zone's second-largest economy, which fell into a shallow recession in the first quarter of the year, had already lost its prized AAA ratings with S&P and Moody's last year.

In explaining its cut, Fitch cited a slew of causes for concern including a weaker economic output, a jump in the French unemployment rate, budget deficits and subdued external demand.

Risks to fiscal projections "lie mainly to the downside," the rating agency said in a statement, keeping a stable outlook on its new rating.

"A debt ratio that is higher for longer reduces the fiscal space to absorb further adverse shocks," it said.

Fitch raised its estimate for how long it will take France to shave down its debt, forecasting it would peak at 96 percent of gross domestic product next year and still be as high as 92 percent in 2017.

The government projects its efforts to whittle down public spending will have cut its debt to just over 88 percent by then.

Standard & Poor's rates France at AA-plus with a negative outlook. Moody's rates it Aa1 with a negative outlook, meaning both agencies see another rating cut likely.

The euro zone's three-and-a-half-year sovereign debt crisis has strained the monetary union as even major economies such as France continue to feel the pain of stalled growth.

French GDP, flat in 2012, is expected to drop 0.3 percent in 2013 before expanding 0.6 percent in 2014, according to the median forecast in a Reuters poll this week.

"WAKE-UP CALL"

Although long anticipated, the downgrade is grim news for Hollande two days before the country celebrates its national Bastille Day with a military parade through Paris and as he is grappling with dismal approval ratings over his failure so far to pull the economy out of its slump.

Analysts downplayed the likelihood of any major market impact of what Nicholas Spiro, managing director at Spiro Sovereign Strategy, called a "belated" downgrade, after investors shrugged off other rating cuts over the past months.

But they said this was a reminder to France that it must press ahead with tough structural reforms to regain competitiveness.

"If Italy's debt market was able to shrug off this week's sovereign downgrade, then France's is even less likely to be affected," Spiro said.

"However, if there's one country in which a downgrade ought to be a wake-up call for politicians to step up the pace of fiscal and structural reforms, it's France," he said.

Despite its economic woes, France has been enjoying low borrowing rates over the past months, with the 10-year benchmark bond hitting record lows of under 1.65 percent early May.

The yield has crept back up to over 2 percent since early June, increasing along with other benchmark bonds over worries over the impact of the U.S. Federal Reserve's plans to taper its stimulus policy. It stood at just under 2.2 percent on Friday.

In the face of weaker-than-expected growth, Paris has won an extra two years to bring its deficit in line with the EU ceiling of 3 percent of GDP in exchange for pushing through ambitious reforms of its pension system and labour markets.

A series of indicators including business sentiment surveys and consumer spending data have pointed to a slight improvement in the economy, which may have pulled itself out of recession in the second quarter.

Finance Minister Pierre Moscovici said in a statement that the Socialist government was committed to cutting its public deficit and restoring jobs and growth.

He noted that Fitch had kept a stable outlook on the credit rating and said that reflected France's efforts to reform its labour market and pension system, and the reduction in the banking sector's risk exposure.

FILED UNDER: