Defensive play

French President Nicolas Sarkozy broke off his summer holiday on Wednesday and summoned key government figures to the Elysée palace for a "working meeting about the economic and financial situation," his office confirmed.

The meeting was attended by Prime Minister Francois Fillon, other cabinet members and central bank governor Christian Noyer. It came one day after Budget Minister Valerie Pecresse and Finance Minister Francois Baroin made lengthy media appearances aimed at heading off speculation that France might be downgraded by one of the major credit ratings agencies.

Sarkozy ordered the ministers to come up with new suggestions to speed up efforts to slash the deficit by August 17, adding that he would decide on the most appropriate steps at a meeting with the prime minister one week later.

He also praised the European Central Bank's decision to buy up Italian and Spanish bonds on Monday, saying the steps taken were "efficient measures to significantly reduce the interest rate payments on the debt of these countries."

High debt, high deficit

Along with Germany, the Netherlands, Finland and Luxemburg, France is one of the few European Union member states with a AAA rating, which tells investors it is very likely to meet its financial obligations.

Of those AAA members, France has the highest budget deficit and the highest public debt measured in terms of gross domestic product (GDP): about 5.7 percent and 85 percent respectively.

Europe's second biggest economy is expected to grow just 0.2 percent in the third quarter of 2011, the French central bank said on Tuesday. Second-quarter data is due to be released on Friday.

After the meeting, President Sarkozy stressed in a statement France's commitment to reduce its public deficit was "inviolable" and would "be adhered to no matter how the economic situation evolves."

S&P support

Earlier this week, the Standard & Poor's ratings agency said it saw no reason to downgrade France. It said Paris, unlike Washington, had a clear policy aimed at reducing its budget deficit.

But market pressure on French bonds has been increasing since S&P downgraded the United States' credit rating on Friday, unleashing a wave of sell-off on world markets.

The cost of insurance policies against a French default, so-called credit default swaps, has increased by 10 percent. Rising costs of credit default swaps can serve as an indicator of financial difficulties.

Grave consequences?

If France were to be downgraded by one of the 'big three' rating agencies, it would have to pay higher interest rates on money borrowed from the bond market.

That would make it more costly for France to take up new loans - which it would need to do if it continued to contribute to the eurozone's bailout fund, the European Financial Stability Fund (EFSF).

The alternative would be for France to get out of the EFSF, which would decrease the overall value of the fund and increase the burden on other European nations.

"Both (scenarios) would lead the markets to increasingly doubt the eurozone's financial sustainability," Ansgar Belke of the Berlin-based German Institute for Economic Research told the Handelsblatt newspaper.

Author: Andrea Rönsberg (Reuters, AFP)
Editor: Sam Edmonds