France: The things that investors just can't overlook

After the US lost its prized AAA rating early this month, investors lost little time in starting the hunt for the next downgrade target. Last week, France came in the crosshairs of the financial markets. So, what is it about the eurozone’s second-largest economy that makes global investors so nervous?

1. France’s lumbering pace of economic growth and a high level of public debt have left investors wondering whether the country will be able to repay its borrowings.According to data released on Friday, France’s economic growth skidded to a halt in the three months to June - zero percent - after a drop in household consumption, which only added to the concerns over France’s ability to repay its debts.

[caption id=“attachment_60414” align=“alignleft” width=“380” caption=“France’s lumbering pace of economic growth and a high level of public debt have left investors wondering whether the country will be able to repay its borrowings. Reuters”]  [/caption]

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The economy expanded by 0.9 percent - robust by European standards- in the previous quarter. France’s official target for GDP growth in 2011 is 2 percent, but that seems unlikely now. When growth declines, revenues dry up, and this increases speculation that the country will be unable to repay its debt.

2. According to the International Monetary Fund, France’s debt as a proportion of GDP will reach 85 percent this year. That’s the highest for any European country with an AAA rating. Even by 2015, France’s debt is estimated to remain at 83 percent of GDP, according to Standard &Poor’s. That’s higher than the 79 percent that the ratings agency predicts for the US that year. Nevertheless, S&P did note that France would have better control over its debt than the US by that time, although that point seems have been ignored by investors for now.

3. France has the second-highest public deficit - the gap between government spending and revenues - after the United Kingdom, among the AAA-rated countries in Europe.The French government aims to lower the deficit from 7.1 percent of gross domestic product last year to 5.7 percent this year. Germany, the eurozone’s biggest economy, is projected to have a deficit of 2.3 percent this year.

A stagnating economy will make it much harder for the French government to cut down the deficit. Implementing tough spending cuts as the country heads into a presidential election year will also be extremely difficult. So, despite French President Nicholas Sarkozy’s promise to meet its deficit targets, the markets are betting against that happening.

[caption id=“attachment_60516” align=“alignright” width=“285” caption=“Eurozone credit ratings. Graphic Reuters.”]  [/caption]

4. French banks are among the lot most exposed to Greek, Spanish and Italian debt. They also hold huge amount of French sovereign debt.

5. France’s borrowing costs are climbing as Europe’s debt crisis makes investors wary of lending to any nation other than Germany. Investors currently demand about 90 basis points of extra yield to buy 10-year French debt rather than German bonds, even though both carry AAA grades from the rating companies. In addition, the annual cost of insuring $10 million in French government debt against default climbed to $175,000 last week, up from $100,000 a few weeks ago.

No doubt, France is under attack from the markets. As the debt contagion spreads rapidly across Europe, there is speculation swirling that the next target is Italy.