Germany Frets as France Declines

A Moody’s downgrade of French debt highlights France’s weakness | “This downgrade will increase pressure on France big-time”

Carol Matlack, James Hertling, and Leon Mangasarian

The euro zone has slipped into recession as France’s economy barely grows and Germany’s slows

It was bad news for France — and possibly worse news for France’s neighbors. Late on Nov. 19, Moody’s Investors Service stripped Paris of its AAA bond rating. The move, though widely anticipated, raises the likelihood that other European economies could be hit with downgrades.

Moody’s move followed a downgrade by Standard & Poor’s last January. Market response on Nov. 20 was relatively muted: Yields on French 10-year debt widened to 2.134 percent, which was the biggest increase in a month but still close to a record low 2.002 percent reached on Aug. 3. More ominously for Europe, Moody’s reiterated its “negative outlooks” on Germany, the Netherlands, and Austria. Those countries are at risk of downgrades, Moody’s said, because they bear “the main financial burden of support” for the plans put in place to aid the euro region’s weaker economies.

The downgrade underscores “the wider problems of the euro zone. They’re going from bad to worse,” says John Wraith, a fixed-income strategist at Bank of America Merrill Lynch. The European Financial Stability Facility, which raises money to fund the bailouts of euro-area countries, could also be at risk of a downgrade, Wraith says. The EFSF on Nov. 20 had to delay a planned bond sale after Moody’s action on France. The transaction was pulled because so-called deeds of guarantee require new bond issues to be covered by member states with ratings similar or better than the EFSF’s own AAA rating.

Officials in France and Germany sought to downplay the ratings cut. “Our most important partner has received a little bit of an admonishing assessment ... but France’s rating is still very stable,” German Finance Minister Wolfgang Schäuble told the German parliament. French Finance Minister Pierre Moscovici told reporters in Paris that France remained “one of the top-rated countries.”

Still, the downgrade is a blow to President François Hollande’s six-month-old government, which is struggling with rising unemployment and weak growth. Adding to the gloom, on Nov. 20 the national statistics office said French industrial orders declined in most sectors during September, and manufacturing output was down 2.5 percent year-on-year. Moody’s warned that France could face further downgrades “in the event of additional material deterioration in the country’s economic prospects or difficulties in implementing reform.” Hollande recently announced plans to offer €20 billion ($25.6 billion) in tax credits to business to help ease labor costs, but French corporate executives say the measure doesn’t do enough to restore competitiveness.

The Moody’s action could weaken Hollande’s hand in upcoming European budget talks. “This downgrade will certainly increase pressure on France big-time,” says Jan Techau, director of the Carnegie Endowment for International Peace office in Brussels. “It gives Germany more of an edge over France.” In the talks, France aims to keep European farm subsidies fully funded, while Germany wants to contain spending.

German anxiety over France’s economy is rising. On Nov. 13, Schäuble spoke out against fellow Germans who call France the “sick man” of Europe. Germany wants France, its closest partner in Europe, to bear its weight in the rescue of the euro area. It “would be good if the Socialists there would courageously initiate real structural reforms now,” said Volker Kauder, head of the parliamentary group of Angela Merkel’s Christian Democratic Union bloc, according to a report in Der Spiegel. Germany would like Hollande to “move a little more” toward Merkel’s position on austerity, Kauder was quoted as saying.

Hollande has mainly moved in the opposite direction, lowering the retirement age for some workers, imposing a tax of 75 percent on earnings over €1 million, and lifting the minimum wage. He’s also pressed Merkel to dial back her push for austerity to fight the debt crisis.

France will roughly match last year’s record trade deficit, according to the Finance Ministry. Unemployment has jumped to a 13-year high of 10.2 percent. By contrast, Germany has sustained economic growth all year, despite Moody’s warning that its indicators are weakening. The Federal Employment Agency’s key unemployment rate was at a two-decade low in August but rose by 0.1 percentage points to 6.9 percent in September. A robust France would be a boon for Germany and all of Europe. Instead, says Fredrik Erixon, head of the European Centre for International Political Economy in Brussels, “Germany is helplessly watching the deterioration of the French economy, knowing that it will have an impact on Germany and the euro area — but without Berlin being able to do much about it.”

The bottom line France’s economic decline puts increased pressure on other euro-zone countries as the costs of the euro crisis continue to rise.


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