Does France deserve to lose its AAA status?

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

By:
Euromoney Skew
Published on:

France loses its coveted AAA status, with the ratings agency Standard and Poor's taking action against 16 countries

So, Standard & Poor's has taken the plunge and snatched France's AAA status away, as well as taking action against 15 other countries:


RATINGS LIST

                                    To                                                                            From
Austria (Republic of) AA+/Negative/A-1+                                                   AAA/Watch Neg/A-1+
Belgium (Kingdom of) (Unsolicited Ratings) AA/Negative/A-1+                  AA/Watch Neg/A-1+
Cyprus (Republic of) BB+/Negative/B                                                         BBB/Watch Neg/A-3
Estonia (Republic of) AA-/Negative/A-1+                                                    AA-/Watch Neg/A-1+
Finland (Republic of) AAA/Negative/A-1+                                                   AAA/Watch Neg/A-1+
France (Republic of) (Unsolicited Ratings) AA+/Negative/A-1+                 AAA/Watch Neg/A-1+
Germany (Federal Republic of) (Unsolicited Ratings) AAA/Stable/A-1+     AAA/Watch Neg/A-1+
Ireland (Republic of) BBB+/Negative/A-2                                                     BBB+/Watch Neg/A-2
Italy (Republic of) (Unsolicited Ratings) BBB+/Negative/A-2                       A/Watch Neg/A-1
Luxembourg (Grand Duchy of) AAA/Negative/A-1+                                  AAA/Watch Neg/A-1+
Malta (Republic of) A-/Negative/A-2                                                            A/Watch Neg/A-1
Netherlands (The) (State of) (Unsolicited Ratings) AAA/Negative/A-1+     AAA/Watch Neg/A-1+
Portugal (Republic of) BB/Negative/B                                                           BBB-/Watch Neg/A-3
Slovak Republic A/Stable/A-1                                                                        A+/Watch Neg/A-1
Slovenia (Republic of) A+/Negative/A-1                                                       AA-/Watch Neg/A-1+
Spain (Kingdom of) A/Negative/A-1                                                              AA-/Watch Neg/A-1+

N.B.--This does not include all ratings affected.



But what catches our eye, is France's position.

Ratings agencies have been warning the markets and governments for months over a possible French credit-rating downgrade . Moody's warned France in October of an official negative outlook, which could lead to a status downgrade, while S&P said in December that Germany, France, Austria, Finland, the Netherlands and Luxembourg were the AAA rated countries under review.

The latest ratings action from S&P also reveals that:


The outlooks on the long-term ratings on Austria, Belgium, Cyprus, Estonia,
Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal,
Slovenia and Spain are negative, indicating that we believe there is at
least a one-in-three chance that the rating will be lowered in 2012 or 2013
.
The outlook horizon for issuers with investment-grade ratings is up to two
years, and for issuers with speculative-grade ratings up to one year. The
outlooks on the long-term ratings on Germany and Slovakia are stable.



During the last year, many market participants have exclaimed how France was unlikely to be downgraded – not because it doesn't deserve to be, but mainly because of the political implications behind this.

Furthermore, a conflict of interest has been called into question, which led many to say that having a country like France being downgraded would be very slim.


“There is a general market perception that at times there can be a conflict of interest because the companies or sovereigns who want to be rated are paying the agencies to grade them. This obviously includes auditing their accounts.”



Dismissing this idea was not helped by the fact that S&P fell into hot water with French politicians when it "accidently" placed France on the downgrade watch list:



[Reuters]

Standard & Poor's mistakenly announced the downgrade of France's top credit rating on Thursday, frightening investors already anxious over Europe's worsening debt crisis.

The erroneous alert, which S&P said was sent to some of its subscribers, fed concerns that Europe's debt problems had engulfed the region's second-largest economy. It contributed to the worst day for France's government bonds since before the euro was launched in 1999.

In a statement issued nearly two hours after the fact, S&P said the message resulted from a technical error and not from any action it intended to take against France.

French policymakers and regulators reacted quickly, worried that their efforts to maintain the credibility of France's finances were in jeopardy.



The reaction by French politicians at that time will be a good indicator for the type of rebuttal France will unleash during the next month or so:



[Reuters]

"We will not allow any negative message to pass" to the market, French Finance Minister Francois Baroin said on the sidelines of an economic conference in Lyon. "We have a strategy, a commitment in terms of deficit reduction."



Of course, the French government hit back at such a notion that they should lose their AAA status - and politicians fought tirelessly to try to prevent rating agencies becoming involved with rating sovereigns. This idea collapsed shortly afterwards.

In November, the European Securities and Markets Authority approved the four largest ratings agencies to continue to issue ratings on countries within the European Union, having initially proposed to prohibit them from rating sovereign countries if they were in the middle of negotiating a bailout.

However, as previously reported by Euromoney and Euromoney Country Risk, comparisons have been drawn over whether the UK should also retain its AAA status, in comparison to France.

At the beginning of January, Panicos Demetriades, professor of financial economics at the University of Leicester, said:



French public finance statistics have improved in 2011, more so than those of the UK. One, therefore, has to have a certain degree of sympathy with French officials who recently argued that it is the UK that should lose its triple A rating and not France.

However, any serious analysis of the eurozone crisis reveals that it is now less of a sovereign-debt crisis and more a crisis of confidence in the single currency. The UK has a proper currency and a proper central bank. France – and all other eurozone countries – do not have a normal currency and do not have a proper central bank. Moreover – this is the worst part – the French and German governments have failed to grasp the fundamental flaws in the design of the euro.

The main problem with the ECB is that it is not allowed to lend to governments of member states. Eurozone governments are therefore forced to resort to financial markets to (re)finance their debt.

This would not have been much of a problem if markets were able to price all risks efficiently. This is frequently not possible, not just because markets are subject to psychological biases, herding, fads, bubbles, etc, but also because certain events are rare and do not lend themselves to risk analysis.

Relying on markets to (re)finance sovereign debt when uncertainty and ambiguity aversion are rampant goes beyond placing too much faith in inefficient markets. It is sheer madness. Reluctance to turn the ECB into a normal central bank is, therefore, an act of recklessness that can further undermine confidence in the euro.

I would therefore not be at all surprised to see France – and even Germany - losing its triple A rating soon.



Meanwhile, Nicholas Spiro, managing director, Spiro Sovereign Strategy, said:



Perceptions of the creditworthiness of the UK and France have been strongly influenced by the deepening crisis in the eurozone. While France has suffered because of its banks’ heavy exposure to southern Europe, in particular Italy, and doubts about its fiscal credibility, the UK has benefited from its autonomous monetary policy and its steadfast commitment to fiscal austerity.

...

The UK’s triple A rating is more secure, mostly on qualitative grounds. However, Britain’s fiscal position and its private sector balance sheet are in a far worse state than France’s. If it wasn’t for the UK government’s fiscal credibility and its independent monetary policy, the UK’s triple A rating would be much more at risk.



S&P said the reason for France's downgrade, as well as others, is "primarily driven by our our assessment that the policy
initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone", and continued:


In our view, these stresses include:

(1) tightening credit conditions
(2) an increase in risk premiums for a widening group of eurozone issuers
(3) a simultaneous attempt to delever by governments and households
(4) weakening economic growth prospects
(5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.


 

- Euromoney Skew Blog