France looms large as next market's downgrade target

SOVEREIGN DEBT:FRANCE HAS come under the spotlight as markets hunt for the next downgrade candidate in the wake of the US ratings cut by Standard Poor's last Friday.

Its bond yields, credit default swaps and deficit levels are relatively elevated compared with other AAA countries and some of the major rating agencies regard it as one of the weakest of its peers.

On Friday, sovereign debt markets will be watching closely as France publishes its official second-quarter growth figures. These are expected to show a sharp drop from the 0.9 per cent of the first three months to 0.2 per cent. Failure to meet that forecast will intensify fears that France will also miss its target to bring its deficit from last year’s 7.1 per cent of gross domestic product to less than 3 per cent by 2013.

France has already faced criticism for factoring overoptimistic growth forecasts into its debt reduction plans, while the International Monetary Fund last month warned more spending cuts were needed to meet the 2013 target.

And the pressure is intensifying after this week’s turmoil. Prices for credit default swaps (CDS) hit a new record yesterday for France of 161 basis points, compared with just 55 basis points for the US.

Peru, Indonesia, South Africa and the Slovak Republic all have a lower default risk than France, according to CDS markets.

French officials insist there is no immediate danger of a downgrade, and SP reiterated on Monday that France had a “well thought out budget strategy”.

Some experts say there is uncertainty about what is driving the CDS markets. “Is it the US that is wrong at a CDS of 55 or France that is wrong at a CDS of 160?” asked Jim Leaviss, head of retail fixed income at MG, one of Europe’s biggest investors.

But the French government, which has launched the most severe fiscal consolidation programme in 50 years knows more must be done to reassure markets.

France would do whatever it takes as this is about credibility, said one budget ministry official.

France’s European partners are equally concerned by the market’s latest focus as its rating is seen by many as crucial for the stability of Europe’s bailout vehicle, the European Financial Stability Facility.

“The French triple A underpins the triple A rating of the EFSF and any downgrade would put the entire rescue mechanism in question,” said Steven Englander, a currency analyst at Citi.

Analysts at Brown Brothers Harriman actually think the weakest triple A country is the UK which they rate as double A. – Copyright The Financial Times Limited 2011. (Additional reporting by Jennifer Thompson in Paris)