Moody's on Monday downgraded France's credit rating from Aaa to Aa1. The loss of its triple A status follows a downgrade by Standard & Poor’s last January.

“France’s fiscal outlook is uncertain as a result of its deteriorating economic prospects, both in the short term due to subdued domestic and external demand” and “structural rigidities” in the longer term, Moody’s said in a statement last night.

France last reported an annual budget surplus in 1974; it has had a trade deficit every year since 2002.

Moody's decision to downgrade France's rating and maintain the negative outlook reflects the following key interrelated factors:

"1) France's long-term economic growth outlook is negatively affected by multiple structural challenges, including its gradual, sustained loss of competitiveness and the long-standing rigidities of its labour, goods and service markets.

2) France's fiscal outlook is uncertain as a result of its deteriorating economic prospects, both in the short term due to subdued domestic and external demand, and in the longer term due to the structural rigidities noted above.

3) The predictability of France's resilience to future euro area shocks is diminishing in view of the rising risks to economic growth, fiscal performance and cost of funding. France's exposure to peripheral Europe through its trade linkages and its banking system is disproportionately large, and its contingent obligations to support other euro area members have been increasing. Moreover, unlike other non-euro area sovereigns that carry similarly high ratings, France does not have access to a national central bank for the financing of its debt in the event of a market disruption.

At the same time, Moody's explains that France remains extremely highly rated, at Aa1, because of the country's significant credit strengths, which include (i) a large and diversified economy which underpins France's economic resiliency, and (ii) a strong commitment to structural reforms and fiscal consolidation, as reflected in recent governmental announcements, which may, over the medium term, mitigate some of the structural rigidities and improve France's debt dynamics.

The current issue of  The Economist says France is the "time-bomb at the heart of Europe."

It highlights:

• Public spending is 57% of GDP (gross domestic product). For years it has been losing competitiveness to Germany and the trend has accelerated as the Germans have cut costs and pushed through big reforms. Without the option of currency devaluation, France has resorted to public spending and debt.;
• Debt-to-GDP is 90%;
• French firms are burdened by overly rigid labour- and product-market regulation, exceptionally high taxes and the Eurozone’s heaviest social charges on payrolls. Not surprisingly, new companies are rare. France has fewer small and medium-sized enterprises, today’s engines of job growth, than Germany, Italy or Britain;
• No new company has entered the CAC-40 stock market index since 1987;
• Trade unions resist any reforms;
• France continues to have a high standard of living, and has some of the best companies in the world, but growth has stalled;
• The external current-account deficit has swung from a small surplus in 1999 into one of the Eurozone’s biggest deficits;
• Unemployment is 10%. Youth unemployment much higher;
• France's borrowing rates remain low but that may not last;
• "Yet set against the gravity of France’s economic problems, François Hollande, France's president, still seems half-hearted. Why should business believe him when he has already pushed through a string of leftish measures, including a 75% top income-tax rate, increased taxes on companies, wealth, capital gains and dividends, a higher minimum wage and a partial rollback of a previously accepted rise in the pension age? No wonder so many would-be entrepreneurs are talking of leaving the country."

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