June 11, 2014 / 12:25 PM / in 4 years

RPT-Fitch: French Region Reform Does Not Alter Near-Term Challenges

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June 11 (Reuters) - (The following statement was released by the rating agency)

The French government’s proposal to reduce the number of French regional governments to 14 from 22 does not alter the near-term challenges facing the regions, which reflect constraints on both revenue and expenditure flexibility, Fitch Ratings says. Over the longer term, the proposal could result in savings and greater liquidity for the fewer, larger regions that would result.

The amalgamation proposal is part of plans to save around EUR10bn over the next three years by eliminating overlaps among local and regional governments (LRGs). It would support the aim of giving the regions a bigger role in economic development, innovation and training by transferring some responsibilities down from the departments or central government.

However, the trend towards increasing the regions’ responsibilities has not been, so far, matched by an increase in budget revenue. The changes come at a time of heightened financial pressure due to national efforts at fiscal consolidation. State transfers to all LRGs will be cut by EUR1.5bn per year in 2014 and 2015. LRGs are required to contribute to further expenditure savings worth EUR50bn planned by the national government by 2017.

The 22 French regions are already facing budgetary challenges following tax reform, sluggish growth, and increasingly rigid spending commitments in recent years. They have almost no tax leeway (there is only one direct regional tax), while automatic increases in staff salaries, and commitments made in previous years in areas such as high-speed rail have made it hard to contain operating and capital expenditure. We expect the regions’ aggregate current balance to deteriorate in 2014-2015.

Another key measure to monitor is the Territorial Reform Act (or Act III), due to be debated in parliament later this summer, which will update the regions’ budgetary framework. It may ease revenue constraints, by replacing state grants with tax revenues such as an increased share of value-added tax (cotisation sur la valeur ajoutee des entreprises, or CVAE) or other tax revenue to the regions, or by reducing the planned grant cuts. Without additional revenue, borrowing will accelerate. However, the regions’ debt level is still relatively low, with a healthy payback ratio of around four years at end-2013. Stronger equalisation mechanisms have given some support to the weaker regions, while co-financed projects with central government can help fund capex. The French regions should continue to benefit from the strengths of the subnationals institutional framework, including strong supervision by the central government.

Over time, reducing the number of regions could be credit positive in helping the remaining larger regions achieve economies of scale and improved bargaining power with suppliers. Bigger regions with larger borrowing programmes - more comparable with Germany’s Laender or Spain’s autonomous communities - may also be better placed to tap a wider range of funding sources, for example via the commercial paper and bond markets and bank liquidity lines, and enjoy improved access to European development funds.

The potential benefits of amalgamation are highlighted by the fact that Franche-Comte and Burgundy had requested permission to merge voluntarily, before the government’s proposal. Nevertheless, full integration between any two or more regions and the associated cost savings may be politically difficult, while positive structural effects will take time as long as most of the regions’ operating expenditure is inelastic.

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