PARIS France is now braced to lose its AAA credit rating, with a downgrade largely priced into financial markets and President Nicholas Sarkozy saying it would be manageable, but a two-notch cut would deal a blow to public finances.
Ratings agency Standard and Poor's dropped a bombshell last week when it placed 15 euro zone countries on negative review, warning it could downgrade their sovereign ratings if Europe failed to resolve its deepening debt crisis.
Of the six triple-A rated euro zone countries, France was the only one singled out for a possible two-notch downgrade, and while a one-notch cut would be fairly easily swallowed, a two-notch cut would be more painful.
France is paying historically low levels of interest on its 1.3 trillion euros of outstanding debt, and a one-notch cut is unlikely to move market yields significantly, analysts say.
But a two-notch cut, particularly if France were the only country to be hit, could push up annual borrowing costs by several billion euros just as France is scrabbling to make budget cuts so as not to miss its deficit targets.
"A two-notch downgrade would be the start of a real nightmare and could open up a Pandora's box," said an analyst at a major bank who refused to be named.
Analysts at fund manager Amundi calculate that a 100-basis-point rise in the premium investors demand to hold French bonds over safe-haven German debt would push up borrowing costs by some three billion euros a year, raising the threat of even further downgrades over the long term.
A one-notch cut might only push up French 10-year rates slightly above today's level of 3.3 percent, and if they stayed below or at 3.6 to 3.8 percent, that would be "completely manageable", Dexia Asset management credit strategist Nicolas Forest told Reuters.
France has paid an average of 4.14 percent interest on its medium- to long-term financing since the start of the euro in 1999.
Sarkozy has made holding onto France's top-tier AAA rating a point of pride, but he appeared resigned to losing it this week, telling the daily Le Monde in an interview that he would face any future downgrade with a cool head.
"It would be one more difficulty, but not insurmountable," Sarkozy said.
Markets have also factored in a cut to France's rating, which is seen by many as overdue given the pressure on the government's deficit-cutting plans from faltering growth and the risk of shocks from debt-laden banks and the raging euro crisis.
French 10-year spreads over German bunds have settled around 120 basis points, after hitting a euro-life high around 200 basis points in late October, and many analysts are pointing out that a sweeping downgrade by S&P would just mean AA+ becoming "the new AAA".
A move that punishes France more than its peers could hurt the corporate sector, however, Natixis credit strategist Badr El Moutawakil said, hurting French companies' ability to find funding.
"Everything depends on the size of the downgrade. If France's rating is cut and that of the other AAA sovereigns isn't, then corporates will have a hard time escaping the rise in risk aversion that will hit France," he explained.
Forest said markets were more jittery about the work left to do to set up a legal basis for treaty change in Europe than about France's rating.
The 26 EU states that backed new rules on fiscal discipline will not ratify them until March, and between now and then the euro crisis risks raging on, with some 100 billion euros worth of euro zone bonds set to fall due over the next three months, he said.
"Markets hate uncertainty, and there's too much of that at the moment," he said.
(Writing by Vicky Buffery; Editing by Catherine Bremer and James Dalgleish)