THE RATINGS GAME / THE ECONOMIST ( HIGHLY RECOMMENDED READING )

France and the euro crisis

The ratings game

The perils for Nicolas Sarkozy in trying to preserve a credit rating

Dec 3rd 2011
PARIS
.      .

THE choreography has become wearisomely familiar. For the fourth time this year, European leaders are holding a summit, this one in Brussels on December 8th and 9th, at which they are promising a “comprehensive package” of measures to solve the euro crisis. The French president, Nicolas Sarkozy, and the German chancellor, Angela Merkel, are trying once again to produce a joint plan. They badly need to persuade wary investors and their own unsettled voters that, this time, it is for real.


Yet the two leaders are, as ever, at odds over exactly what to do. And Mrs Merkel, set on fiscal discipline, the avoidance of moral hazard and preserving European Central Bank independence at any cost, seems in no mood to give ground.

With the euro zone hurtling into uncertainty and maybe towards a nasty end, irritation over German inflexibility has prompted a new sense of urgency. Radek Sikorski, Poland’s foreign minister, this week called it “the scariest moment of my ministerial life”, and said “we are standing on the edge of a precipice.” Jacques Attali, head of an economic commission that advises Mr Sarkozy, said “chaos is staring us in the face”, adding that he could not be sure the euro would survive until Christmas. In a speech on December 1st, Mr Sarkozy was expected to try to calm the panic, and to persuade voters that surrendering budgetary powers would be beneficial.


Mr Sarkozy is doing his utmost to appear as a joint commander of the “Merkozy” rescue mission. He invited Mrs Merkel, along with Italy’s new prime minister, Mario Monti, to a pre-summit summit in Strasbourg on November 24th. The unspoken message was: we, the leaders of Europe, welcome you, the Italians, back to the virtuous core. Facing a tough re-election bid next spring, the French president has to show that he is in charge.

And in some ways, it suits outsiders to have him play the role of cajoler-in-chief. When it comes to urging the Germans to support the ECB’s purchases of government bonds, for instance, Mr Sarkozy, unlike hectoring voices in Washington and London, has a better claim to Germany’s ear. “We need the French, or else this will be seen as Germany bossing everybody else,” notes a German official.


Yet as the crisis deepens, an alarming prospect looms: that France’s own status could lapse, and thus its clout at the heart of the euro zone. France is by far the most vulnerable of the zone’s six AAA-rated countries. It has the highest level of debt as a share of GDP. Its banks are particularly exposed to the troubled periphery, especially Italy. The spread of French over German bonds recently hit its highest level since the launch of the euro (though it has fallen back a bit), suggesting that traders are already anticipating a downgrading. Moody’s, a ratings agency, has put France’s AAA rating under surveillance, with a reassessment due in January. Guillaume Menuet, an economist at Citigroup, expects a negative outlook on French sovereign debt within weeks, followed by a formal downgrade in 2012.


Yet despite such alarming signs, senior French officials seem almost disconcertingly calm. There is a palpable sense of frustration with German intransigence, but senior officials dismiss all talk of a downgrade as scaremongering. They point out that Britain, which is also rated AAA, has a bigger budget deficit and higher ratios of debt to revenues and of interest payments to revenues than France.


The French government may not have balanced its budget since 1974, and it has big debts, but it manages them well and has not defaulted in modern times. Even Moody’s acknowledges that the French treasury has exploited strong markets in 2009, 2010 and the first nine months of this year to lock in historically low rates. Twice since the summer, as the economic outlook has worsened, the government has responded with emergency budget-austerity measures.


If there is a lack of confidence in the markets, say French officials, it touches all top-rated euro-zone sovereigns, even Germany, and not just France. “We think there is no objective reason for a downgrade or negative outlook on France’s credit rating,” comments one. “We have absolutely no worries about raising our debt.”


Yet in today’s miserable euro zone such a tone of confidence could turn out to be chillingly complacent. The OECD this week cut its 2012 GDP growth forecast for France from 2.1% to just 0.3%, well below the 1% on which the government based its latest austerity plan. French firms are facing a credit squeeze, as banks cut lending in order to meet new capital requirements. Some economists are forecasting outright recession.


The chances are that France will need even more budget savings early next year—which means just a couple of months before the presidential election. Mr Menuet reckons that the government will need to find another €6 billion. France could be further stretched by commitments to the euro’s bail-out fund, the European Financial Stability Facility (EFSF) and to any potential bank rescue. “Under a stress scenario”, concluded Fitch, a (French-owned) ratings agency, last week, “France’s AAA-rating would be at risk.”


Were it to be lost, the consequences would be felt not just in the markets, but politically too. Within the euro zone, the knock would be considerable. The credit rating of the EFSF, which rests on the six AAA countries, would be at risk. The relegation of France from top table to scullery would be an historic post-war shift. Already, despite the façade of parity, Germany dominates the relationship that has traditionally set the agenda in Europe. A loss of market credibility, which is difficult to reverse, would tilt the balance even more firmly towards Germany.


For Mr Sarkozy, it would also be a huge personal setback. Despite periodically railing against all ratings agencies, he has made much of his determination to hold on to France’s AAA status. In a recent television interview, he explained clearly how a top-tier rating protects the French from higher borrowing costs and therefore further austerity. His main hope for 2012 has been to seem like a steady hand of experience in a crisis, next to an opponent, the Socialists’ François Hollande, who has never been in government and has offered few thoughts on how to solve the euro crisis. Recent polls suggest that this was starting to lift Mr Sarkozy’s numbers. But by raising the stakes over the AAA rating, Mr Sarkozy has set himself up for a potentially devastating blow that could strike at any time before voting begins in April.