Downgrade raises stakes for France to reform economy

Pressure increased Tuesday on France to reform its economy following a debt downgrade from the ratings agency Moody's, but financial market reaction was muted and the government stood by promises that change is underway. Moody's became the second of the three major ratings agency to cut France's top-notch triple A rating, noting it down to "Aa1" with a warning that a further downgrade could be on the cards. Moody's warned of several big challenges, and pinpointed the contentious issue of labour reforms. "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," a statement said. President Francois Hollande sought to reassure financial markets while reaffirming his determination to control public finances and pursue reforms. "We must take account (of the decision), pursue our policy, stay the course and understand that it is in our interest to correct our public accounts," Hollande told a gathering of French mayors. France has benefitted from low borrowing rates, and Hollande is keen to maintain that advantage as he tries to reduce the public deficit and debt. To do so he must convince financial markets that he is serious about reforming the economy. Hollande pointed out that even after the downgrade, which left France's rating at a very high level, "interest rates did not move and the spread with German rates remained exactly the same". The difference between the rate a country must pay to borrow money on sovereign debt markets and that paid by Germany, the eurozone benchmark, is a common indicator of market confidence. Finance Minister Pierre Moscovici also highlighted the fact that at "Aa1", France was still "well rated" and blamed budget conditions that preceded the downgrade on the previous conservative government. France has not run a balanced budget since the 1970s however, despite having elected governments from both sides of the political spectrum. The economy has been stumbling along at almost zero growth for about a year but in the last quarter rallied to show a gain of 0.2 percent, the same level as in Germany which has been hit by a slowdown in business activity. "Poor" track record on reform ----------------------------- The Moody's downgrade is also problematic for the eurozone which faces big problems with its debt crisis and especially how to absorb a debt mountain in Greece, a point underscored by Moody's. The ratings agency said Tuesday that it would now study the impact of its downgrade of France on the triple A ratings of eurozone rescue funds that are underpinned in part by France. Moody's ratings of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) were under negative watch, implying that they could be downgraded, the agency said in a statement. The EFSF subsequently said that it would postpone an auction of three-year bonds. "The rating action by Moody's, reducing France's long-term debt rating from "Aaa" to "Aa1", means that EFSF's new long term issuance (currently rated Aaa by Moody's)" no longer satisfies the necessary criteria for selling debt, the EFSF said in a statement. "EFSF is currently unable to proceed until this technical aspect is resolved," added Christophe Frankel, the fund's chief financial officer. Moody's said it would consider in particular whether the support of other countries with "Aaa" ratings was strong enough to justify a continued top rating for the funds as well. Eurozone countries that still benefit from the "Aaa" rating include Finland, Germany, Luxembourg and the Netherlands. Moody's said that despite a change of policy stance in France two weeks ago with a switch in emphasis to competitiveness, a long slide of flagging efficiency hangs over the country's future. However, it also noted that the country had many points of strength, including a broadly based economy. But Moody's, referring to the reforms it considered necessary, stressed: "The track record of successive French governments in effecting such measures over the past two decades has been poor." Stock markets initially fell on the news but by the end of the day they had bounced back and the French stock market closed with an additional gain of 0.65 percent a day after leaping by almost 3.0 percent. France has been able to borrow at record low interest rates in recent months since tensions in the eurozone eased. The yield or interest rates indicated on the market for benchmark French debt edged up on Tuesday however to 2.151 percent from 2.073 percent. At French bank BNP Paribas, one bond strategist said: "France is now considered to be a country between AAA and AA. Consequently there could be a slight upward adjustment (of borrowing rates) on the market in the short term." The warning from Moody's followed several other sources of external pressures on France to move quickly on reforms. The International Monetary Fund has warned that France risks falling behind Spain and Italy in terms of its ability to compete in the global economy. And Germany, the main powerhouse in the eurozone but also the twin pillar with France at the centre of the zone and of the European Union, has sent strong signals that it is concerned about the state of the French economy and outlook for reforms.