We thank staff for the rich discussions during the 2015 Article IV Consultations with France as well as for the well-written report.
French economic recovery is well underway. The authorities have been pursuing a comprehensive reform agenda over the past three years, to reduce the fiscal deficit, address excessive unemployment and improve competitiveness. This strategy is starting to bear fruits.
While we broadly concur with the staff appraisal, which validates the agenda that is being implemented since 2012, we think that the report could have put a stronger emphasis on the impact of recent or on-going reforms. Since the beginning of the crisis, the French economy demonstrated its resilience. In the long term, a strong birth rate, rising innovation efforts by French corporates, a highly qualified and productive workforce, excellent infrastructure and a stable investment rate during the crisis are factors bound to support France’s growth prospects.
1. Economic outlook
In the short run, an improvement of the economic situation is on-going, structural reforms are starting to pay off and external factors, such as the decrease in oil prices and a moderate depreciation of the effective exchange rate, are supporting aggregate demand. GDP rose by a robust 0.6 percent (quarter-on-quarter) in Q1 2015.
Staff growth projections of 1.2 percent in 2015 and 1.5 percent in 2016 appear slightly above the government’s own and voluntarily cautious scenario (1.0 percent in 2015 and 1.5 percent in 2016). Staff projections are also in the lower range of the available forecasts: the latest Consensus Forecasts stands at 1.2 percent in 2015 and 1.6 percent in 2016, and the OECD and the European Commission both expect 1.1 percent in 2015 and 1.7 percent in 2016.
In the medium term, growth should gradually improve on the back of internal drivers that are expected to gather strength and gradually replace the role of external factors. Investment is expected to strengthen in line with more robust activity levels. In the Stability Programme, growth is forecast to reach 1.5 percent in 2017 and 1.8 percent in 2018, broadly in line with staff projections.
2. Public finances
French public deficit stands at 4.0 percent of GDP in 2014 which is significantly lower than the objective set in the last multiyear budget law for 2014-2019 passed in December 2014 (4.4 percent of GDP). This performance resulted from the strict containment of public spending. Indeed, nominal public spending excluding tax credits has increased by only 0.9 percent in 2014, significantly below the target set in the 2014 Stability Programme (1.4 percent) and the lowest in decades.
Fiscal medium-term consolidation path
France targets a 0.5 point of GDP structural adjustment of public balance in 2015, 2016 and 2017, which will allow under a prudent growth scenario to bring back the headline deficit below 3 percent in 2017 with a safety margin, a trajectory which is compliant with our European commitments. This pace of consolidation, fully based on expenditure containment, strikes the right balance between the need to secure public finances sustainability in the medium term and avoid a drag on growth in the short term. We do not find that the alternative fiscal adjustment path presented by staff makes a compelling argument for a faster consolidation.
To reach these targets, the government has committed itself to implement a EUR 50 billion savings plan over 2015-2017. This commitment has been enacted in the multiyear budget law of December 2014. To offset the negative impact of low inflation, the French authorities committed to undertake additional expenditure-based savings measures, representing EUR 4 billion in 2015 and EUR 5 billion in 2016.
Long term sustainability
Strong demographics, the improvement in its older workers participation rate and the phasing-in of recent pension reforms, have placed France in a better position to deal with its ageing population than most of its OECD partners. The latest pension reform adopted in 2014 will raise the number of years of service required to obtain a full pension, up to 43 years in 2035. Negotiations between social partners for a new agreement to be signed in 2015 on the financing of the supplementary retirement scheme are currently underway. According to the latest long term projections of the European Ageing Report 2015, public pension spending is expected to decrease by 2.8 percent of GDP between 2013 and 2060. The financial equilibrium of France’s pension system is no longer a major issue for the long-term sustainability of public finances.
3. Structural reforms
France is fully committed to reforming its economy in order to reduce unemployment, continue to improve competitiveness and enhance its potential growth.
Improving cost competitiveness
Labor cost and tax reductions (Crédit d’Impôt Compétitivité Emploi and the Responsibility and Solidarity Pact) represent a positive supply shock of almost EUR 40 billion (close to 2 percent of GDP) which has already led to concrete results: the average unit labor cost in the manufacturing sector is inferior to German unit labor costs and profit margins have been recovering since the beginning of 2015 (and reached their highest level since early 2011). Empirical studies, including previous staff working papers, concur to find a very positive impact of labor tax cuts on employment and growth.
Little is said in the report on the on-going external rebalancing. Over the pre-crisis decade, real wages have been in line with productivity in France. It is only in the aftermath of the crisis that real wages have slowed down less markedly than productivity, due in particular to negative inflation surprises. However, it is worth noting that unit labor costs in France have been less dynamic than in Germany since mid 2012, which is a positive development not only from a domestic perspective but also for demand rebalancing within the euro area.
Cutting red tape and improving public administration efficiency
The intensification of the “simplification shock” will help improving the non-cost competitiveness of our economy. The measures already implemented enabled EUR 3.3 billion savings since 2013, and a permanent council of companies’ executives and public administration representatives will propose and assess new measures every six months.
In parallel, the government has also launched several institutional reforms that will significantly improve the functioning of the public administration and will improve the long term efficiency of local governments. The number of regions will be halved by merging administrative structures, a major reform since the administrative map will be completely revamped. The repartition of competencies among the different levels of local government will be further simplified and clarified.
Improving the functioning of product markets
The Macron Law on growth, economic activity, and equal economic opportunities aims to enhance competition across the economy.
The law which will be definitively adopted by summer 2015 will improve the functioning of transportation services, of retail distribution (with more power given to the French competition authority), will open up regulated professions and link their tariffs to costs, as well as release the conditions governing Sunday and evening working. The law will also provide a reform of commercial courts to enable a comprehensive, more efficient processing of the most important cases.
Improving the functioning of the labor market
The Rebsamen Law on social dialogue modernization will increase the effectiveness of social dialogue at firm level by rationalizing the rules, adapting them to the size of the companies, and giving companies greater leeway with regard to collective agreements. Social dialogue will become simpler and of higher quality, with a reduction of the effect of thresholds related to the number of employees.
After the staff visit, the Government also announced in early June a Small Businesses Act in order to boost employment and activity, with measures to improve flexibility and security (job retention agreements), to enhance job creation (strong financial incentives for first job creation), to allow renewal of fixed-term contracts two times instead of one and to cut legal uncertainty on individual dismissals costs (prud’hommes).
Overall impact of structural reforms
Reforms are starting to yield positive results, and have an impact on growth potential. The Government estimates that the reforms implemented since 2012 and to be adopted by the end of the year will have a positive impact of about 4 points of GDP by 2020, with significant impact starting in 2015 and 2016. Consistently, the OECD estimated the impact of several reforms decided between 2012 and 2014 to have a positive impact of 3 points of GDP at a 10-year horizon.
4. Financial sector
Staff’s report rightly highlights the potential build-up of risks in the financial sector due to the low interest rate environment. However, while these risks exist and should be closely monitored, they are not specific to the French financial sector. Regarding insurers, French average guaranteed rates are relatively low, in most cases based on an annual revisable commitment, and the total duration gap is not of significant size compared to peers.
French banks have achieved strong progress towards meeting Basel III requirements, as underlined in the report. Regarding risk weights, it should be noted that the in depth assessment of the AQR has not lead to significant revision, suggesting that current RWA calculation is well grounded and prudent. French banks have reduced their dependence to short term wholesale funding: their loan-to-deposit ratio has decreased, in particular thanks to an increase in deposits, since 2008, following an adjustment of their funding model.
Regulated savings deposits and accounts play a key role in encouraging a stable pool of savings. Regarding their returns, the French authorities acknowledge the importance of having regulated interest rates consistent with an efficient transmission of ECB monetary policy. In this respect, the guaranteed interest rate on the housing savings plan (Plan Epargne Logement) was recently cut.