A rise in interest rates on French government debt and weaker growth prospects could be negative for the outlook on France's credit rating, Moody's warned in a report on Monday, adding to pressure on European debt markets.
Worries that France has the weakest economic fundamentals among the euro's six AAA-rated countries have drawn the Eurozone's second largest economy into the firing line in the debt crisis this month.
The rating agency said the deteriorating market climate was a threat to the country's 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.
As we noted in recent publications, the deterioration in debt metrics and the potential for further liabilities to emerge are exerting pressure on France's creditworthiness and the stable outlook (though not at this stage the level) of the government's Aaa debt rating, the Moody's note read.
The yield differential between French and German 10-year government bonds rose above 200 basis points last week, a new euro-era high.
Moody's said that at that spread 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.
In early Monday trade, the French 10-year spread was up about 20 basis points at 167 bps following publication of Moody's report but remained well short of the 202 bps hit last week. The CAC 40 index, which was down 1.7 percent in opening trade, was down 2.2 percent after an hour of trade.
With the government's forecast for real GDP growth of a mere one percent in 2012, a higher interest burden will make achieving targeted fiscal deficit reduction more difficult, Moody's said.
On Oct. 17, Moody's said it could place France on negative outlook in the next three months if the costs for helping to bail out banks and other Eurozone members overstretched its budget.
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.
The agency said the management of the euro area debt crisis complicated the government's fiscal consolidation efforts. The stress on banks' balance sheets can lead to further increases of liabilities on the government's balance sheet when further state support to banks is needed, it added.
(Reporting by Geert De Clercq; editing by Patrick Graham)