PARIS France would have limited room to absorb any new shocks to its public finances without endangering its AAA status, Fitch Ratings said on Wednesday, in the latest sign that the euro crisis could rob France of its cherished top-tier rating.
In a special report on French public finances, Fitch said France's debt and deficit were consistent with a AAA rating but said shocks such as a further economic slowing or provisions for banking sector support could put the rating in peril.
The report kept upward pressure on French borrowing costs after Moody's warned on Monday that a sustained rise in yields coupled with weaker growth could harm France's ratings outlook.
"Similar to the situation of other major 'AAA' sovereigns, the increase in government debt has largely exhausted the fiscal space to absorb further adverse shocks without undermining their 'AAA' status," Fitch said.
"The principal concern with respect to France is that the intensification of the euro zone crisis will generate contingent liabilities that will be crystallized onto the sovereign balance sheet."
The Fitch analysis followed reports, denied by France and Belgium, that a restructuring deal for Franco-Belgian bank Dexia may have to be renegotiated, with Brussels pressing Paris for more funding guarantees.
French 10-year bond yields were little changed on the Fitch note, having already risen as high as 3.73 percent earlier in the day on the Dexia report, following several days when traders have pushed French yield premiums over German Bunds to new highs.
Fitch did not hint at putting France on a negative outlook, saying: "France's public finance metrics remain consistent with retaining its AAA status."
But it added: "Under a stress scenario in which the euro zone crisis intensifies with adverse consequences for growth and crystallization of substantial contingent liabilities from its exposure to the peripheral nations, France's AAA rating would be at risk."
It said the threat of bigger liabilities over financial support for the banking sector was a particular concern.
FALTERING ECONOMY WEIGHS
The head of France's AMF securities markets regulator acknowledged the market was focusing on the country's AAA rating, but he said other top-rated euro zone countries were also in the same position.
"It is for reasons which seem irrational to me because the fundamentals have not varied more here since the spring than they have in United Kingdom or the United States," Jean-Pierre Jouyet told Les Echos newspaper.
"France's AAA is a European bet because it shapes the stability of the EFSF (euro zone bailout fund)," he said.
France's maximum exposure through the EFSF is 158.5 billion euros ($214 billion), equivalent to 8 percent of gross domestic product, and if all that had to be used, France would have little fiscal space left to absorb other liabilities, Fitch said.
"France has lost its status of safe haven in the euro zone," said Diego Iscaro, senior economist with IHS Global Insight.
"At the moment it is not that worrying. Yields are still relatively low. The problem is ... will this deteriorate?"
Stress scenarios aside, Fitch sees France's debt peaking at 90 percent of GDP, similar to Britain and less than in the United States, and it praised France's commitment to debt reduction.
Faltering growth has, however, prompted President Nicolas Sarkozy to announce two waves of cost-cutting measures. Further measures would be politically difficult with a presidential election in April.
The government recently cut its 2012 growth forecast to 1 percent from 1.75 percent, a level many economists still see as optimistic. Given the likelihood of France entering a recession next year, many investors have already discounted a rating downgrade for the No. 2 euro zone economy.
Fitch saw France's public deficit at 4 percent of GDP in 2013 and said the country's 3 percent goal for that year would require additional fiscal measures.
The head of France's debt management agency, Philippe Mills, said in an interview with the daily Les Echos on Wednesday that a rating downgrade would be costly and could take years to repair.
($1 = 0.7410 euros)
(Reporting by Catherine Bremer, additional reporting by Geert De Clercq; Editing by Ruth Pitchford)