In a setback for President Francois Hollande's Socialist administration, Moody's Investors Service stripped Europe's No. 2 economy of it of its prized AAA credit rating late Monday on concerns that its rigid labour market and exposure to Europe's financial crisis were threatening its prospects for economic growth.
This is the second ratings downgrade to have hit France this year: Standard & Poor's agency lowered its score in January. The third leading agency, Fitch, still ranks France at AAA-rating but warned it could still be downgraded.
Finance Minister Pierre Moscovici insisted that France's credibility remains strong and that the government's plan to reduce unemployment and restore growth would bear fruit.
France has come under scrutiny as its €2 trillion ($2.5 trillion) economy has stagnated, with many leading French companies laying off workers. Meanwhile, Hollande has struggled to reassure economists that his attempts to revive the French economy will be successful.
Hollande's administration has laid out a series of deficit-reduction targets, vowing to bring it in line with European rules next year. It has also unveiled a plan to improve the competitiveness of its economy, by giving companies €20 billion ($25 billion) in tax rebates, reducing red tape for businesses, and providing small companies with extra support to compete abroad.
However, many economists say that the greatest threat to France's economy is its stringent labour rules, which make firing difficult and expensive and thus deter hiring. The country has been losing global business for years to more dynamic economies like China's, while fighting unemployment of 10.8 per cent and concerns about the future of the eurozone.
The French government is currently leading negotiations between businesses and unions in the hopes of reforming labour rules by the end of the year.
Moscovici pleaded for time Tuesday, arguing that the government had inherited a difficult economic and budgetary situation from former President Nicolas Sarkozy. He said the government is convinced it is now on the right path but that its reforms just need to take effect.
"It takes time to reverse the flow of things. It takes courageous decisions, and that's what we're promising to do," he told reporters.
To the ratings agencies, critics and investors, he said: "Judge us on our results."
Trouble for France would mean wider trouble for Europe. France and Germany, which underpin the group of 17 European Union countries that use the euro, have taken the lead in finding solutions to the continent's debt crisis. Any slip in France's clout could endanger its ability to lead negotiations.
In an early sign of how the rating could affect the eurozone ability to solve its financial crisis, its bailout fund was forced to cancel a bond auction Tuesday. Officials with the European Financial Stability Facility said the downgrade caused a technical problem since the EFSF's rating is now higher than that of France, which is a major backer of the fund.
EFSF CFO Christophe Frankel did not say how the glitch would be resolved but said he thought it could be. The EFSF has been replaced by the European Stability Mechanism, but is still handling the bailouts of Greece, Ireland and Portugal.
Moscovici also insisted that relations with Germany remained strong. There have been reports recently that Germany is concerned about the health of the French economy.
But German Finance Minister Wolfgang Schaeuble seemed unconcerned about the downgrade.
"We have received the news that, overnight, our most important partner got a little admonition from a rating agency," Schaeuble said in the German Parliament. "The rating for France is still very stable, so that we avoid any dramatization."
Moody's itself said that the rating remains so high — now Aa1, just a notch below triple-A —because of the size of the French economy and the government's commitment to make structural reforms. It kept the rating's outlook at negative, meaning it could face future downgrades.
The downgrade, like S&P's before it, appeared to be having a limited effect on France's borrowing costs. The yield, or interest rate, on the benchmark 10-year bond was up 0.05 percentage points to 2.01 per cent on Tuesday afternoon. Germany's was up the same rate to 1.39 per cent.
Moscovici said he expected the country to continue to be able to borrow at those historically low rates because of the seriousness of its reform package.
Analysts warned, however, that French banks could next face downgrades, since they are significant holders of French government debt and ultimately backed by the government.
Geir Moulson in Berlin and Carlo Piovano in Brussels contributed to this report.Suggest a correction