Moody's stripped France of its prized triple-A badge yesterday (19 November), cutting the sovereign credit rating on Europe's No. 2 economy by one notch to Aa1 from Aaa, citing an uncertain fiscal outlook and deteriorating economy.
The downgrade, which follows a cut by Standard & Poor's in January, was widely expected but is still a blow to Socialist President François Hollande as he strives to convince the world he can fix France's public finances and stalled economy.
Moody's said it was keeping a negative outlook on France due to structural challenges and a "sustained loss of competitiveness" in the country, where business leaders blame high labour charges for flagging exports.
"The first driver underlying Moody's one-notch downgrade of France's sovereign rating is the risk to economic growth, and therefore to the government's finances, posed by the country's persistent structural economic challenges," Moody's said.
"These include the rigidities in labour and services markets, and low levels of innovation, which continue to drive France's gradual but sustained loss of competitiveness and the gradual erosion of its export-oriented industrial base."
Finance Minister Pierre Moscovici said in a statement that the downgrade was a motivation for the 6-month-old Socialist government to pursue reforms, but he noted that even after the S&P downgrade French debt has enjoyed record low yields.
He also said the government was committed to meeting its target of cutting the public debt to 3% of economic output next year from an estimated 4.5% this year.
The S&P downgrade had little impact on French yields, which have been trading at record lows of just over 2% in recent weeks despite the concern about France's sickly economy.
Moody's had been waiting to examine Hollande's 2013 budget and his response to a review of industrial competitiveness before adjusting its view on France as a sovereign lender.
Standard & Poor's has rated France AA-plus, with a negative outlook, since downgrading it by one notch in January. Fitch Ratings still has France at AAA, also with a negative outlook.
The loss of its Aaa rating from two agencies poses a problem for France, as investment funds often require their best assets to have at least two top notch ratings to remain in their portfolios.
Any rise in borrowing costs will be painful as the French government is already battling to rein in its deficit with potentially painful cuts to public spending.
With France's €2 trillion economy teetering on the brink of recession, Hollande surprised many this month by unveiling measures to spur industrial competitiveness, chief among them the granting of €20 billion in annual tax relief to companies, equivalent to a 6% cut in labour costs.
The government had already announced €30 billion in budget savings next year in an effort to meet its deficit goal and is working on reforms to labour laws to enable companies to hire and fire more easily with economic swings.