A French downgrade could derail eurozone rescue

NEW YORK (CNNMoney) -- In what would be another blow to Europe's beleaguered rescue fund, there is growing speculation that France will eventually lose its top-tier credit rating.

Standard & Poor's could change its outlook for France's AAA credit rating within 10 days, according to a widely circulated report Tuesday in La Tribune, a French financial daily newspaper. If true, analysts say the move could lead to an official downgrade of the nation's rating within months.

S&P declined to comment on the report.

"It wouldn't surprise me if France got downgraded," said Kathy Jones, fixed-income strategist at Charles Schwab, noting that several other European governments have recently faced their own downgrades.

But a downgrade of France's credit rating would have serious repercussions for the European Financial Stability Facility, which European Union leaders have billed as a "firewall" against the debt crisis spreading across the eurozone.

France is the second-largest backer of the EFSF, after Germany. Paris stands behind over €158 billion worth of loan guarantees under the latest iteration of the rescue fund.

"If France gets downgraded, the stability fund gets downgraded too," said Jones. "That's the real concern."

All told, the fund boasts some €780 billion worth of "capital." But analysts say the actual amount is much smaller, given all of the fund's existing commitments.

In the event of a downgrade, investors would likely favor bonds issued by other AAA rated nations at the expense of the stability fund.

"People would go into German Bunds and shun EFSF bonds," said Tobias Blattner, economist at Daiwa Capital Markets in London.

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That would make it harder for the stability fund to raise the money it needs to continue supporting troubled euro area nations, such as Ireland and Portugal, which already depend on the fund for bailout money. Not to mention a planned second €110 billion bailout for Greece.

In addition, a downgrade would raise questions about a plan to leverage the fund by using it to insure new issuance of government bonds.

EU finance ministers are expected to unveil details of the insurance scheme later Tuesday after meeting in Brussels.

The loss of AAA status would also hinder an already faltering effort to use EFSF funds to back a special investment vehicle designed to attract capital from non-European governments and private sector investors.

On the bright side, if there is one, a downgrade would not necessarily drive up borrowing costs for the French government, according to Blattner.

"Investors are already pricing in the downgrade," he said.

The yield on French 10-year notes rose above 3.7% last week amid a broad flight from European bond markets. On Tuesday, yields were hovering near 3.5%, sharply higher than the 2.5% seen in early September.

As part of a series of auctions this week, France will offer up to €7 billion worth of 6-, 10-, 15- and 30-year debt on Thursday.

Blattner expects France to be downgraded sometime early next year. He said a combination of the nation's EFSF liabilities, the exposure of French banks to troubled sovereign debt and the government's massive budget deficits make a downgrade all but certain.

S&P downgrades Belgium

In an interview with France Info radio, French Finance Minister Francois Baroin stressed that France is not the only country implicated in the intensifying debt crisis.

"Everyone is concerned, it's not just France," he said, adding that French policy makers are "lucid" and recognize the seriousness of the crisis.

But he ruled out additional austerity measures, saying the French government has a "margin" of €6 billion in reserve.

Tuesday's La Tribune report, based on unnamed government sources, comes weeks after S&P mistakenly sent a message to subscribers indicating that France had been downgraded.

Moody's and Fitch, the other main credit rating agencies, both warned recently that France's credit rating would be at risk if the debt crisis in the eurozone continues to deteriorate.