Moody's credit rating agency has stripped France of its coveted AAA rating and declared that the country's economic outlook remains "negative".

In what will be a severe blow to Socialist president François Hollande, the agency said it was reducing the country's rating from AAA to AA1, claiming France's ability for economic growth was being hampered by "structural challenges" including its lack of competitiveness, high unemployment, public debt and market rigidity.

It said it was not confident Hollande's government could – or would – introduce the necessary structural reforms and spending cuts to improved its rating in the medium term and expressed concern over France's exposure to risks from other ailing eurozone countries.

Moody's decision follows Standard & Poor's downgrading of France's rating a notch in January.

It came as France was reeling from a damning Economist article entitled "The time-bomb at the heart of Europe". The special report warned that the parlous state of the French economy, its rising unemployment, lack of competitiveness, dwindling industry and high public spending, could overshadow the problems of Greece or Spain, and sparked angry reactions from French ministers.

Defending the downgrade, Moody's stated: "France's long-term economic growth outlook is negatively affected by multiple structural challenges, including its gradual, sustained loss of competitiveness and the long-standing rigidities of its labour, goods and the service markets.

"France's fiscal outlook is uncertain as a result of its deteriorating economic prospects, both in the short term, due to subdued domestic and external demand, and in the longer term due to the structural rigidities noted above."

The agency expressed concern over France's exposure to other beleaguered eurozone economies through its trade and banking links.

Moody's said it was unlikely to upgrade France's rating in the medium term, but would consider changing the outlook from negative to stable if the government implemented economic reforms and tax measures that "effectively strengthen the growth prospects of the French economy and the government's balance sheet" and reverse the "upward trajectory in public debt".

It recognised that Hollande has pledged structural reforms including reducing France's public deficit to 3% by 2013, but stated the proposed measures were "unlikely to be sufficiently far-reaching to restore competitiveness".

"Moody's notes that the track record of successive French governments in effecting such measures over the past two decades has been poor," it said.

The Socialist government's economic strategy rests on forecasts that growth will reach 0.8% next year and in bringing unemployment, currently at a 13-year high, down.

France's finance minister Pierre Moscovici said the downgrade was a "sanction for past management" of the country, intended to incite the government, elected in May, to carry out reforms rapidly.

He said reducing the public debt was a priority. "The debt is an enemy."

© 2012 Guardian News