Archive | December, 2011

2011: the year Asia really took off

31 Dec

2011 has been a pivotal year in the history of the world. The Arab Spring – which has changed the Middle East completely – has used traditional and new social media channels to inspire revolution. The importance of social media extends to the other global movement of the past year, the Occupy protests North America and Europe. Indeed, Eric Hobsbawn, the marxist historian, has equated 2011 to 1848, or the year of revolutions that set Europe on fire.

Asia has perhaps been a bit quieter in comparison. But the changes here have been just as important – and probably more so. For this was the year that the continent, in particular Asia-Pacific, has started to really take off. The flow of power and wealth that has been flowing from West to East since the financial world collapsed 5 years ago is now being entrenched, aided by the EU’s woes, America’s political deadlock, and the continued economic development of the Asian nations.

It is certain that we are one or two years away – at most – from the tipping point, when the fulcrum of the world moves from the Atlantic to the Pacific.

The Pacific century is about to begin.

Here are some of the more important events from Asia this year:

China flexes its might

China’s relations with its South East Asian neighbours have slightly deteriorated this year. Despite new initiatives to bolster Beijing’s influence, such as the deployment of Chinese police to the Mekong river, the region’s governments are seeking to

The neighbours are worried

broaden their relations with other countries, especially the US. The visit to Burma by Hilary Clinton and Vietnam’s welcome of a US aircraft carrier are just two such initiatives.

Chinese sabre rattling – such as Hu Jintao telling his navy to prepare for warfare, and intransigence over China’s claim to the South China Sea – has been a main source of these new tensions, but there are others too. Huge numbers of Chinese immigrants to Laos have led to concerns there, and South Korea and Japan have had clashes with their giant neighbour thanks to wayward fishing vessels.

China’s ‘peaceful rise’ might still be the official mantra, but it is looking less and less convincing to her fellow Asians – let alone the US.

US nails its colours to the Pacific mast

Washington has taken advantage of this regional anxiety by seeking to restrict China’s room for strategic manoeuvre in Asia-Pacific. It has done this with a mixture of bilateral and regional deals.

President Obama: more at home in the Pacific

The US free trade agreement with Seoul and its sale of fighter aircraft to Tokyo are two examples of America bolstering its influence with specific nations.

Washington is also looking to cement its position as the regional leader by joining the Trans-Pacific Partnership, and using that as a vehicle for APAC domination. If the TPP – which China is excluded from because of the liberal economic rules that dictate who can and can’t be a member – becomes the main APAC trading block then the US will have succeeded in maintaining its hegemony in the Pacific region.

All of which is looked upon with alarm by China, as numerous articles in its official newspapers bear witness. The chances of Beijing accepting America’s dominance are close to zero, so 2011 is only going to be the beginning.

The march of the Yuan to world currency status

China’s recent currency deal with Japan is a small but important step to making the Yuan a global reserve currency alongside the US dollar, the Euro (for now), and the Yen and Sterling. The deal – which allows Chinese and Japanese trading companies switch between yuan and yen without converting to dollars first – is not though just about regional trade.  China seeks a bigger role for its currency in global markets, and wants power in international forums that is commensurate with its economic might. The sooner its currency is fully convertible and its economy is open to global investment, the sooner this will happen.

Japan’s disaster

March 11 saw a huge earthquake and tsunami hit Japan, leaving at least 16,000 dead and causing $235 billion of damage – the world’s most expensive natural disaster. This came on top of two decades of economic stagnation which has led to Japan being overtaken by China as the planet’s second largest economy.

Prime Minister Noda

The net effect of the tsunami has been to shake Japan into realising its precariousness. For too long the country has been mired in deflationary decay and with a highly unhealthy political system that has seen 7 prime ministers since 2006.

The incumbant leader, Prime Minister Noda, seems to have recognised this and is looking for solutions. Reaching out to the Trans-Pacific Partnership earlier this year was a watershed in Japanese relations with its neighbours, and she has been busy making bilateral currency deals with China and South Korea.

Given the short-term nature of his position, it is hopeful that Noda can continue his apparent mission to further integrate Japan with the world economy well into next year.

India paralysed ahead of its 2012 elections

The world’s largest democracy has some way to go to catch up with its Asian rival China, as can be seen here. But it is not helping itself by sacrificing its economic development on the altar of party politics ahead of next year’s elections.

Not to India's liking - until 2012 anyway

The ruling Congress Party has been attempting to reassert its leadership and kick-start investment in the deteriorating economy, but has been blocked in several initiatives by opposition from other parties keen to position themselves ahead of 2012. The Government’s decision to halt foreign investment in the country’s huge retail sector is the main victim of this politicking, and has damaged India’s reputation as a place to invest.

The rupee’s 13% slide in 2011 – Asia’s worst performing currency – is a reflection on a lack of investment confidence.

If India is to start competing seriously with China then it needs to get its politics inline with what is best for its economy.

North Korea’s succession plans

The death of Kim Jong-il has been a major source of world anxiety. There has been widespread alarm at the youth of the apparent successor, Kim Jong-un, and the instability that his inexperience could bring.

Given the strong messages coming from Pyongyang over the last few weeks it seems likely that the young pretender is increasing his grip on the country. The worry therefore is less about a power vacuum, but perhaps too much power and with a need to use it.

As with all these events, time will tell. 2012 is going to be an interesting year indeed.

Why is southern China protesting?

22 Dec

Thousands of people have protested in southern China against plans to build a new coal-fired power plant, following disagreements over pollution fears from an existing plant. Protesters say two students died in the unrest in the town of Haimen in Guangdong province, although police deny this.

Guangdong has seen some high profile protests recently

This protest comes in the aftermath of another demonstration in the village of Wukan, also in Guangdong province. This is an anti-corruption movememnt that culminated last week in a local uprising, following the death in police custody of one of the protest leaders.

Residents in several villages near Wukan alleged that village officials had confiscated their farm land and sold it to for development to Country Garden, one of China’s largest developers. They alleged that the local communist party had pocketed RMB1 billion ($156m) from the sale, whilst the villagers had been left destitute.

When appeals to the authorities came to nothing, hundreds of people started a sit-in protest on 21 September.

The following days saw a brutal police crackdown on the protest.

Video footage shot by villagers in Wukan showed people of all ages being chased and beaten with truncheons by riot police. One Wukan villager described the police and other security staff as “like mad dogs, beating everyone they saw”.

The Financial Times reported that two children, aged nine and 13, were “badly injured”, and that one may have died. Villagers said elderly and children protesting peacefully were harassed and assaulted by “hired thugs”, provoking an angry reaction from villagers. The attacks on civilians by 400 police officers were described by the Financial Times as “indiscriminate”.

In a change of tactics, the authorities withdrew the police, perhaps at the insistence of the politically ambitious leader of the province, Wang Yang, who is tipped for a national political role in the future. This had the effect of diminishing the protests.

On December 9, one of the village leaders, Xue Jinbo, was arrested without a warrant. He later died in police custody, his body apparently covered in wounds.

Villagers were incensed, and promptly stormed the local police station, expelling both the police and local communist party officials.

A force of 1,000 police was quickly dispatched to surround the village, but the stand-off continued.

Eventually, on 21 December, villagers and officials came to an agreement. This included releasing other detainees, and handing over the corpse of Xue Jinbo to his family. Although officials are still claiming Mr Xue died of a heart attack (despite being caked in blood and with two broken thumbs), an independent autopsy has also been proposed.

Xue Jinbo's portrait is a rallying call to villagers

The China Daily reports that by Zhu Mingguo, deputy Party chief of Guangdong, promised that “We’ll undergo a thorough investigation of the dispute and do our utmost to protect the villagers’ rights,” he said at a work meeting in which some 400 local officials and villagers participated on Tuesday in Lufeng county, which governs Wukan village.

 Beijing is fully aware of the rising anger in the countryside. Rural tension is nothing new in the history of China, and numerous revolts have started there – not least the beginning of the Chinese Communist Party. Yet the issues of today are new.

First there is the huge gulf in wealth between city and countryside. Half the population lives in rural areas, but their (2010) annual average per capita disposable income of 5,900 yuan ($898) is less than a third of the average per capita disposable income of urban residents, which stands at 19,100 yuan ($2,900).

Second, welfare outside of the cities is a real problem. Until last month, the poverty threshold was set at around $0.50  a day and only captured 2.8% of the rural population; and it was only this group that was allowed to access most Government poverty-easing money. November though saw the Government raise the poverty line to $1 a day, which although lower than the World Bank limit of $1.25, still brings in a further 100 million people into poor group. Beijing is, in addition, adding $27 billion in poverty relief funds.

It is not only welfare which is missing. Access to services and the proceeds of the country’s increasing wealth are hard to find. As late as 2009 three of China’s poorest provinces – Tibet, Yunnan and Sichuan – were identified by China’s banking regulator as having more than 50 unbanked counties. This meant that they lacked even basic access to financial services.

Finally, the remoteness of many rural communities – and the provinces they sit in – means that Beijing has less of a grip on them. Corruption, although relatively bad in urban areas, is often endemic in the countryside. Land theft, police abuse, and illegal deals by local Government can all make life decidedly uncomfortable for local residents.

With over 90,000 mass demonstrations a year (characterised by more than 25 people attending) across China, according to the

Rural vs city wealth disparity is increasing

Chinese Government, there is plenty of internal strife. But many of the high-profile cases seem to come from Guangdong province.

What makes this part of China so vociferous in its demonstrations?

It may be that because it is next to Hong Kong protests here get more coverage than for example in Heibei or Shanxi.

On the same note, because Guangdong is next to the former colony – which is renowned in China as being a bastion of freedom and the rule of law – people living nearby may be more aware of their rights, and of the wrongs that are being committed.

Whatever foreign observers may say about China, one thing almost certain is that the leadership of the country have the best interests of the nation at heart. The President, Hu Jintao, is fondly known as Grandpa Hu for the caring manner he shows – he was for example quick to the scene of the major train crash in Wenzhou this summer.

The Government will also be acutely aware of how small demonstrations can quickly spread. Any large-scale protest would have to be put down hard, which would hardly go down well with the rest of the country – or China’s neighbours. And despite stringent controls on social media being brought in to reduce knowledge of the Wukan revolt – some Sina Weibo microbloggers told the BBC that internet searches related to Wukan and the area were blocked after the December uprising started, and villagers’ microblogs were deleted – it is highly likely that dissent could be cut off completely.

The recent rural welfare expansion is likely to be one of many measures coming over the next few years to ease the divide between city and countryside. But if these reforms are not carried out, for whatever reason, then expect Guangdong and many other provinces to loudly speak their mind.


China (unofficially) calls time on the Euro as we know it

20 Dec

The China Daily’s opinion piece this morning is of great note, and proposes that the Euro in its current form – as a European wide currency – will soon cease to exist.

The Eurozone is beyond saving; the euro will survive, but the zone will shrink. The only question is the scale, timing, and manner of its breakup. Greece, and probably other Mediterranean countries, will default and regain the freedom to print money and devalue their exchange rates.

 This will send shock waves throughout the world. But sometimes shock waves are needed to break the ice and start the water flowing again.

Bye bye (picture credit The Daily Telegraph)

The fact that this has appeared in the CD – as with all their opinion pieces – reveals what Beijing is thinking:

  1. It is now very unlikely that China will come to the aid of the Eurozone as it stands. There have been plenty of debates across the country as to whether China should help Europe – the EU is after all their biggest trading partner – but this appears to settle it. The Eurozone as it stands has just had one of its last hopes for salvation pulled away.
  2. China is pushing Europe to adopt Keynesian economics and to start investing. This fits nicely with China’s stated goal of investing in European assets, as posted here. With a divided Eurozone this may make deal-making with individual European countries easier.

 Meanwhile, it should be noted that the author is Lord Skidelsky, the Chinese-born arch Keynesian and enemy of austerity measures. Given the massive stimuli that China has given itself over the last few years it is no surprise that his piece was used.

Although he is highly critical of European measures to clear their deficits, it will be interesting to see his view if countries that followed his investment views – such as China – fail to come out of this economic gloom as well as he might have thought.

Lies and democracy

20 Dec

The China Daily today published an American writer’s list of the ‘US’ twelve biggest lies of 2012′. “I live in Washington where lying is an art form,” David J. Rothkopf wrote for Foreign Policy.

(Readers of the CD should reflect on the fact that, unlike their hawkish cousin Global Times, they very rarely criticise the US directly, but instead report critical assertions about America written by their own people. A subtle difference.)

Newt: Cold War hero

Some of the political lies of recent times are completely ludicrous, like Newt Gingrich ending the Cold War.

These ‘mis-speaking’ statements, as Hilary Clinton may have put it, are part and parcel of running a Government. Agendas need to have supporting struts, and when no actual ones are found then politicians the world over are happy to do a little invention. This applies to democracies and authoritarians alike.

Yet when American, British and European leaders don’t tell the truth they undermine a fundamental pillar of democracy: namely that our political masters should be upstanding members of the community in whom we can place our trust. If truth becomes expendable then they defile their office, and scorn the voters that put them there. There are of course times when leaders need to be careful what they say for reasons of national security – which we all understand – but when a policy has to be continually defended by mendacity then surely it is time to revisit whether the policy is the right one in the first place?

Despite the Arab Spring, democracy is not in a good place at the moment. Two democratically elected  European leaders have been usurped in favour of technocrats, and the US political system is paralysed by more bitterness and in-fighting than at any time since the Civil War.

With China and other countries showing off the economic advantages of authoritarian rule, it is time for Western democracy to stand up and be counted. A long list of lies is not going to help matters.

Here are the twelve, with CD commentary:

1. “The war in Iraq is finally over after nine years.” Rothkopf notes the US has been militarily engaged in Iraq since the early 1990 and this will likely be just the end of another installment in the long running series of US warmongering policies in the region.

2. “America’s mission in Iraq was a success.” He expresses astonishment at such a claim while Iraq is divided, undemocratic, corrupt, and the US invasion has cost USD1 trillion, thousands of US lives, hundreds of thousands of Iraqi lives, and its national reputation. US war in Iraq bears greater semblance to a full-scale “fiasco”, he says.

3. “We are winning in Afghanistan.” Rothkopf describes this one as a hot from the oven “howler” by the US Secretary of Defense Leon Panetta. Washington has strengthened the region’s extremists and the threat of instability in nuclear Pakistan is now actually higher than it was when US went in, he says.

4. Tie: “Pakistan is America’s ally” and “Afghanistan is America’s partner.” Neither Pakistan nor Afghanistan can by any “credible definition” be called a US ally. This is attested to by the animosity of Islamabad towards Washington and Kabul’s belittling of the US on the world stage, Rothkopf says.

5. “America is unthreatened by China’s growth.” A “prayer” by US Secretary of State Hillary Clinton, Rothkopf says. “It should be true. But it’s not,” he adds.

6. Tie: “Republicans are the problem” and “Democrats are the problem.” Rothkopf dubs this one as “the great lie of American politics.” He says the problem with US politics is not the parties, but the money. “The system is so resolutely corrupt that recent scandals have only resulted in more money flowing into the system and past reforms being undone,” he notes.

7. “Cutting the taxes of millionaires helps create US jobs.” There is not even one single solitary shred of evidence to support this “idiotic” suggestion, Rothkopf notes. [Personally I am not sure about this - there does seem to be some argument that lower taxes increases investment which creates jobs, but it is all a question of degrees I suppose.]

8. “This next summit of European leaders will be decisive …” Rothkopf says despite the fact that this claim has been made every few weeks for the past months, the “supposedly sophisticated financial markets” of the United States continue to fall for it.

9. “The Obama administration is committed to serious financial services reform.” The US financial system is still plagued by all the threats that instigated the 2008 recession. “Not an inch of progress,” Rothkopf says.

10. “Only nine percent of Americans approve of Congress.” “This can’t possibly be true. There can’t possibly be that many,” Rothkopf says in a stinging sarcastic tone.

11. “The operation in Libya will be over in a matter of days or weeks.” Rothkopf says the operation was wrong to begin with, “and then wrong and then wrong again for months.”

12. “I love Israel.”  Even though everyone in US politics makes such an assertion, nobody really means it, Rothkopf notes. What the politicians really mean, however, is that “I want American Jews to think I love Israel enough to vote for me and give me money,” he says



For those of you that looked at the source material, you will notice that there are actually 14 lies that Rothkopf lists. So the question is, did the CD alter the story – so in effect lie – or did they just make a mistake?

Out of interest, the lies that the CD missed were:

  1. “The US might default on its debt”. This would obviously have a huge impact on China, which is the biggest single holder of US debt.
  2. “We believe diplomatic pressure may stop Iran’s nuclear program”. Again, a touchy subject for China given its support for Tehran.

It seems we can never be sure of the truth.

Kim Jong-il dead: what next?

19 Dec

One thing springs to mind on hearing about the death of Kim Jong-Il: uh-oh.

The despot ridiculed by many as a heavy drinking, perverted odd-ball has finally died after years of ill-health. The world is becoming rather concerned about what happens next. Share in Seoul are already tumbling, and Japan and South Korea are preparing for the worst. America and Europe are keeping highly abreast of the situation.

A figure of fun with blood on his hands

The reason is that North Korea – the last Stalinist nation on earth – is highly unstable, with enormous internal problems. Famine has been widespread over the last few decades, leaving perhaps a million people dead. Millions of others have been left destitute by misjudged economic reforms that have established, abolished and then re-established limited private markets.

Tens if not hundreds of thousands have either escaped or been caught in the attempt. At least a similar number are assessed to be waiting for their time to flee the country.

Its internal issues are made worse by the fact that North Korea is now nuclear armed and with an army twice the size of China’s. The military has a long record of unprovoked assaults on its neighbours, from mass kidnappings of Japanese citizens to the shelling of a South Korean island and the murder of American servicemen.

The chance of something untoward coming out of the death of Kim Jong-il is thus rather high. The impact of wider instability would be quite immense.

Unfortunately, the opaque nature of North Korea means that no one really knows what is going to happen now. There are though some key issues which need to be considered to have even an inkling.

First is whether the heir apparent, Kim Jong-un, can secure the succession. The second is whether the new ruler will feel the need to mount a show of force to prove himself. Third is what China does.

A stable power handover?

One of the key problems that will be faced in the coming days, weeks, months and even years is how securely Kim Jong-il’s son, Kim Jong-un, can takeover the leadership of his father. Despite being named as the Great Successor, he is not guaranteed to inherit Kim Jong-il’s communist throne.

One of the weaknesses to his claim is the lack of time he has been groomed to take over the leadership.

Kim Jong-un. A wrong 'un?

As a comparison, when Syria’s Bashar al Assad took over from his own father, Hafez al-Assad, in 2000 he had had 6 years to be groomed for the role – not a long time in the scheme of things, but unavoidable given the untimely death of the heir apparent, Basil al-Assad. Al-Assad senior smoothed the succession in three ways.

First, support was built up for Bashar in the military and security apparatus. Second, Bashar’s image was established with the public. And lastly, Bashar was familiarized with the mechanisms of running the country.

Unfortunately, none of this has been possible for Kim Jong-un.

For a start, he is only in his twenties (no one knows his exact date of birth) and has apparently spent many years abroad. This means that he has probably not had enough time to build up strong political relationships or power-bases to guarantee his succession, despite a PR campaign that included making his holiday a national holiday. It is also unclear as to how well he understands the political system and how to manipulate it to his own benefit.

As Kim Jong-un has been named as head of the funeral committee and Great Successor, it is likely that he has at least some kind of hold on power currently. But given that the North Korean political hierarchy is almost completely unknown to outsiders, it is hard to say if there is anyone who is positioning themselves to make a challenge to the heir presumptive over the coming months.

The good news is that if there is a challenge to Kim Jong-un’s reign then it is more likely that it will be dealt with internal to the hierarchy, rather than spilling out to a wider war.

Show of strength

Even if succession goes well, the next risk is if Kim Jong-un is pushed to make a strong-man stand to prove himself. This could quite easily take the form of a military strike on South Korea, which the North has a long track record in doing.

Getting ready to march?

If this were to happen then it could not come at a worse time. Given the impotence of the SOuth Korean military’s response to a shelling incident earlier this year, and the sinking of a warship that left 46 dead, there is considerable pressure on the South to massively respond to any North Korean aggression.

This would obviously have serious consequences in the region, and most likely lead to a sharp war unless the sides were restrained by their allies.

What China thinks

Allies though is not what North Korea has in plenty. China is their last major supporter on the world stage. Despite Kim Jong-il’s horrendous treatment of his Chinese sponsors – the pinnacle being him not telling them he was about to test a nuclear bomb in 2006 – China have stuck with him. This is mainly for geopolitical reasons, namely that the last thing Beijing wants is a reunited Korea allied to America on its borders. They will therefore do anything they can to keep the country divided.

What China don’t want either is for North Korea to implode. This would undoubtedly lead to hundreds of thousands (if not millions) of refugees trying to get across the border, causing instability to China and raising regional tensions.

The best result for China therefore is for an orderly transition to Kim Jong-un – or any leader capable of keeping the country together – and the maintainance of the status quo.

It might be assumed that China would have opposition to this. However, although there will be hawks in Seoul, Tokyo and Washington that demand regime change, it is highly likely that orderly succession will be wanted all round. The main reason is the cost of not having it.

For a start, regime change would be highly likely to lead to a conflict that would drag in the US, South Korea, and probably China and Japan too. No one wants that. Second, the cost of reunification – a likely byproduct of such change – is absolutely staggering, with estimates ranging up to $5 trillion. This is five times the total annual GDP of the South, and is simply unaffordable without outside help – but with the world economy in tatters, who would be able to give such assistance?

No one wants this

In the absence of any desire by the West to see Kim Jong-un fail, China is likely to get its way. They will also in all probability try to act as a brake to any misguided attempt to attack the South.

That said, this does depend on China still having the ear of the new North Korean leader. If China felt that it was being ignored and that the North Koreans needed reigning in for whatever reason, then regional tensions would rise – with unknown results.

In other words

Given the rapidity of the regime in anointing Kim Jong-un as Great Successor, we are probably going to see Kim Jong-un take over from his father, supported by Beijing. It is also unlikely that they will lash out at anyone, at least in the foreseeable future – especially if China has its way. However, until there is more certainty emanating from Pyongyang, the markets – and neighbouring governments – will remain rather jittery.

The caveat though has to be that no one really knows what is going on inside the Hermit Kingdom. Time is the only way we will know the future.




China tells Europe to get its act together – again

18 Dec

One of the advantages in China having a state-controlled press is that it makes it easier for the observer to understand what Beijing is thinking. When the China Daily prints an editorial highly critical of the EU and its attempts to get control of its rapidly worsening economic situation, it is highly probably that this is a direct message from the Chinese Government.

The article – actually written by an economic advisor to the EU – has a strong message for Europe, and in particular the ECB (European Central Bank) to act now. The proposal is for eurobonds to be created in an orderly fashion in order to shore up the national economies.

Eurozone leaders could also set out a road map toward eurobonds, subject to strict conditionality, and tied to a credible mechanism for ensuring fiscal prudence. This would provide an additional incentive for governments that wish to qualify to introduce the necessary reforms, while reassuring the ECB and markets that governments remain committed to making the euro work.

It is also interesting that the CD currently has a debate on its pages discussing the future of the EU – and the answer of both contributors is pretty negative. So whilst China wants the EU to get its act together, it seems also to be writing off the Euro project as feasible.

What though would be the advantage to China of an EU break-up? On the face of it, nothing, given that the EU is the country’s biggest trading partner. But a weakened EU would remove a strategic block from the international scene, and perhaps Beijing thinks it easier to get its way in the world dealing with smaller nation states than a continental monolith. It is hard to say.

The only thing certain is that, whatever the political outcome, given the importance to China of the EU economies we can expect more rattling in the media until the EU is back on the straight and narrow. This could take some time.

France’s economic outlook downgraded

17 Dec

“We would prefer to be French right now than British” said Francois Baroin, France’s Finance Minister yesterday.

M Baroin perhaps regretted those words when Fitch, the ratings agency, made the first move on the forthcoming assault on France’s AAA rating by revising their outlook to negative from stable.

Really, Minister?

This negative outlook means that although a downgrade in credit rating is not imminent, there is, according to Fitch, a “slightly greater than 50% chance of a downgrade over a two-year horizon.”

Fitch don’t stop the kicking there though: “Relative to other ‘AAA’ Euro Area Member States, France is in Fitch’s judgement the most exposed to a further intensification of the crisis.”

To reiterate, the reason this is important is that should France have its credit score downgraded then it will have to pay more to borrow. Given the parlous state of France’s banks, the Paris Government needs to have its economy as fit as possible to absorb the huge losses that could come their way should the banks need to be bailed out. Add to this the fact that 2012 is going to be an important year in terms of re-financing, both sovereign and private, and any increase in borrowing cost would be have a serious impact on the wider French economy.

The truly hurtful thing about the downgrade, from a French point of view, was that the Fitch team that made the call was based in…London.

Fitch Ratings-London/Paris-16 December 2011: Fitch Ratings has today affirmed France’s Long-term foreign and local currency Issuer Default Ratings (IDRs) as well as its senior debt at ‘AAA’. Fitch has also simultaneously affirmed France’s Country Ceiling at ‘AAA’ and the Short-term foreign currency rating at ‘F1+’. The rating Outlook on the Long-term rating is revised to Negative from Stable.

The affirmation of France’s ‘AAA’ status is underpinned by its wealthy and diversified economy, effective political, civil and social institutions and its financing flexibility reflecting its status as a large benchmark euro area sovereign issuer. In addition, the French government has adopted several measures to strengthen the creditability of its fiscal consolidation effort. Nonetheless, government debt to GDP is currently projected by Fitch under its baseline scenario to peak in 2014 at around 92%, higher than any other ‘AAA’-rated sovereign with the exception of the UK and US and significantly higher than other ‘AAA’-rated Euro Area peers.

France’s sovereign credit profile benefits from a broad and stable tax base – the volatility of the revenue to GDP ratio is half the ‘AAA’ median – and the interest service burden is moderate and broadly comparable with other ‘AAA’s. Under Fitch’s baseline scenario that does not incorporate the realisation of substantial fiscal liabilities arising from the Eurozone crisis or other adverse shocks, even such an elevated level of government indebtedness is consistent with France retaining its ‘AAA’ status assuming that government debt is firmly placed on a downward path from 2013-14. The Negative Outlook on the French rating reflects Fitch’s view that the likelihood of the realisation of contingent liabilities, although still not our base-case assumption, has materially increased, as has the risk of a much worse than expected economic and consequently fiscal outturn.

Similar to other highly rated peers, France faces medium and long-term challenges to improve the functioning of the labour market and enhance international competitiveness. Fitch recognises that the authorities have adopted measures to address these weaknesses, though a more radical structural reform agenda would underpin greater confidence in the underlying potential growth rate of the French economy. However, corporate and especially household indebtedness is moderate compared to some ‘AAA’ peers, notably the UK and US, while foreign indebtedness remains modest, albeit rising.

The Negative Outlook is prompted by the heightened risk of contingent liabilities to the French state arising from the worsening economic and financial situation across the Eurozone, as reflected in the Rating Watch Negative placed on the sovereign ratings of several Euro Area Member States (EAMS) on 16 December 2011. As Fitch commented in its report on 23 November, ‘French Public Finances’, the fiscal space to absorb further adverse shocks without undermining its ‘AAA’ status has largely been exhausted.

The intensification of the Eurozone crisis since July constitutes a significant negative shock to the region and to France’s economy and the stability of its financial sector. Since May, when Fitch last affirmed France’s ‘AAA’ status, its forecast for economic growth in 2012 has been cut from 2.1% to 0.7% with around one-in-four chance of outright contraction. Despite the additional fiscal measures announced in August and November equivalent to around 1% of GDP, further measures are likely to be required in order to cut the deficit to 3% of GDP by 2013 and stabilise government debt below 90% of GDP in light of the worsening economic and financial outlook.

In Fitch’s opinion, the commitments made by leaders at the EU Summit on 9-10 December and by the ECB were not sufficient to put in place a fully credible financial firewall to prevent a self-fulfilling liquidity and even solvency crisis for some non-AAA euro area sovereigns. In the absence of a ‘comprehensive solution’, the Eurozone crisis will persist and likely be punctuated by episodes of severe financial market volatility.

Relative to other ‘AAA’ Euro Area Member States, France is in Fitch’s judgement the most exposed to a further intensification of the crisis. It has a larger structural budget deficit and higher government debt burden relative to Euro Area ‘AAA’ peers. Moreover, relative to non-Euro Area ‘AAA’ peers, notably the US (‘AAA’/Negative Outlook) and the UK (‘AAA’/Stable Outlook), the risk from contingent liabilities from an intensification of the Eurozone crisis is greater in light of its commitments to the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), as well as indirectly from French banks that are less strong than previously assessed as reflected in recent negative rating actions by Fitch.

The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. The triggers that would likely prompt a rating downgrade are as follows:

- Increased likelihood that contingent liabilities from an intensification of the Eurozone crisis will be crystallised onto the French state balance sheet.

- Material slippage from the fiscal targets that the government has set itself, notably the aim of stabilising the government debt to GDP ratio from 2013 and placing it on a firm downward path towards levels that would increase the ‘fiscal space’ necessary to absorb adverse shocks.

- Weaker than expected economic performance that prompts a re-assessment of France’s medium to long-term growth potential.

Conversely, economic and fiscal performance in line with Fitch’s baseline expectations, as set out in the Special Report, French Public Finances (23 November 2011), along with the resolution of the Eurozone crisis would likely result in the stabilisation of the rating Outlook.

In the absence of a material adverse shock, most likely associated with dramatic worsening of the Eurozone crisis, Fitch would not expect to resolve the Negative Outlook until 2013.


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