Moody's Warns on France's Rating Outlook

Moody's warned France on Monday that a sustained rise in its debt yields coupled with weakening economic growth could harm its ratings outlook, fuelling concern the euro zone's second largest economy might lose its AAA status.

Worries about a high fiscal deficit and banks' exposure to other troubled European sovereign debt have drawn France into the firing line of the bloc's crisis, despite the government's insistence it would do everything necessary to protect its top rating.

Moody's announced in mid-October it could place France's AAA rating on negative outlook in three months if the costs for helping to bailout French banks and other euro zone members overstretched its budget.

On Monday, the rating agency said that a worsening in the French bond market -- amid fears the sovereign debt crisis was spreading to the euro zone's core -- posed a threat to its credit outlook, though not at this stage to its actual rating.

"Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications," Senior Credit Officer Alexander Kockerbeck said in Moody's Weekly Credit Outlook dated Nov. 21.

The premium investors charge on French 10-year debt compared to the German equivalent was up around 20 basis points at 163 bps following publication of Moody's report but remained well short of the 202 bps hit last week, a new euro-era high.

Moody's said that at last week's record level, France pays nearly twice as much as Germany for long-term funding, adding that a 100 basis point increase in yields roughly equates to an additional three billion euros in yearly funding costs.

Many investors have already discounted a downgrade to France's AAA rating, given expectations its economy will enter recession next year.

"In the current environment, people are expecting France to be downgraded," said Olivier Bizimana of Morgan Stanley, saying it appeared likely Moody's would revise down France's stable outlook if nothing changed. "The fiscal position is probably worse than other triple A countries and on top of that you don't have the back up of a central bank."

CAUGHT IN A TRAP

France's AFT debt agency said on Monday that, despite a recent increase in the spread of French yields over benchmark German debt, its average medium- and long-term financing cost remained close to historically low levels.

"For the first 11 months of the year, it stood at 2.78 percent, its (second) lowest level since the creation of the euro, after 2.53 percent observed in 2010," AFT told Reuters in a statement.

Economists, however, said that France risked being sucked into a "fiscal trap" where slowing growth necessitated more austerity measures which in turn slowed growth even further.

"If on top of that you have interest rates which are increasing it means you have a vicious cycle where it's almost impossible to stabilise the trajectory of the debt and that could add pressure on the ratings," Bizimana said.

France's government recently cut its growth forecast for next year to 1 percent, from 1.75 percent, but most private economists still consider that far too optimistic.

Budget Minister Valerie Pecresse said the government would not take further austerity measures, after announcing a 65 billion euro package of cuts this month, saying a budgetary buffer of 6 billion euros next year would give it breathing room even if growth underperformed.

"We must above all avoid taking measures that plunge the country into recession," Pecresse said.

But Moody's said that slowing growth combined with rising interest rates would make it hard for France to hit its target of cutting the fiscal deficit from an estimated 5.7 percent at the end of this year to an EU ceiling of 3 percent by 2013.

"The French social model cannot be financed if the French economy's potential is not preserved. With further weakening GDP growth the political scope for the government to generate further savings in this case would be tested," Monday's note from Moody's said.

In a research report on Monday, JP Morgan's David Mackie said the stress in core euro zone bond markets increased the need for a dramatic response from policymakers.

"Not surprisingly all eyes are on the ECB, as the only institution able to step in quickly and decisively," he said, adding the ECB would start to intervene in the bond markets of even core countries.