PARIS Moody's, the second credit-rating agency to strip France of its top triple-A rank, told Reuters it will downgrade the country's debt further if the government fails to implement reforms such as a labor market overhaul.
Dietmar Hornung, Moody's lead analyst for France's sovereign rating and author of the downgrade statement, said a sustained loss of competitiveness in Europe's second biggest economy and its failure to tackle structural problems prompted the decision to cut France by one notch to Aa1 with a negative outlook.
France has one of the world's highest levels of public spending at 56 percent of gross domestic product (GDP). Moody's said it was worried about the country's fiscal situation and its exposure to the euro crisis.
"We would downgrade the rating further in the event of an additional material deterioration in France's economic prospects or in a scenario in which there were difficulties in implementing the announced reforms," Hornung said on Tuesday.
He cited a plan to enable companies to hire and fire more easily - which is currently bogged down in talks between unions and employers - as a key factor for France's creditworthiness.
French debt markets on Tuesday shrugged off the widely-expected downgrade, even though it is the second after Standard & Poor's removed France's AAA in January. Some investors require their best assets to have top ratings from two of the three major rating agencies.
The yield on French bonds crept up slightly to 2.1 percent, from around 2.08 percent on Monday.
Hornung said France remained vulnerable to shocks from the euro zone crisis, particularly given its disproportionately large exposure to some of the euro zone's most troubled debtors via trade and its banks.
"If there are substantial economic and financial shocks from the euro area debt crisis, that would also exert downward pressure on France's rating," he said in a telephone interview.
Hornung welcomed France's 2013 budget, which included 30 billion euros ($38 billion) in deficit-cutting measures, and a competitiveness pact unveiled this month aimed at reducing companies labor costs as "significant steps".
"These announcements are credit supportive and led to our decision to limit the downgrade to one notch," he said. "But we still think the 2013 budget and the medium-term budget plan is based on too optimistic growth assumptions."
France's growth forecast of 0.8 percent for next year, which underpins its plan to meet a public deficit target of 3 percent of GDP, has been widely questioned by economists given that the euro zone's economy has slipped back into recession.
FRANCE FIGHTS BACK
Finance Minister Pierre Moscovici, leading the government's response to the downgrade, said Moody's had failed to recognize the boldness of recent decisions. The cut strengthened the Socialists' resolve to press ahead with reforms, Moscovici said.
Hornung, however, said Moody's believed the scope of the structural challenges facing France - from its rigid labor, goods and services markets to high levels of public spending - required a comprehensive package of policy measures.
"The track record of France in implementing structural reforms and fiscal consolidation is somewhat mixed. That is why we are on the cautious side," he said. "Some of these structural challenges here have been built up over a long period of time."
Hornung acknowledged that France remained a large, wealthy and well-diversified economy and said Hollande's efforts could ease the strain on public finances. Public debt is forecast to top 90 percent of GDP this year.
"There is certainly a chance over the medium term that, if properly implemented, these measures could address some of the structural rigidities and could also have a beneficial effect on the debt dynamics of France," he said. ($1 = 0.7803 euros)
(Reporting By Daniel Flynn; editing by Mark John/Ruth Pitchford)