Abstract
This 1999 Article IV Consultation highlights that the economic recovery in France—which began hesitantly in the mid-1990s—strengthened in the first half of 1998 when internal demand became the driving force in a setting of price stability, strong competitiveness, and falling interest rates. By summer 1998, though, a weaker external environment in the wake of the emerging market crises had started to dampen the upswing. Activity softened as business confidence deteriorated and excessive inventories were worked out. Nonetheless, GDP growth for the year was still the fastest in the decade.
This statement provides information on economic and financial developments and on the year 2000 draft budget, which has become available since the issuance of the staff report for the Article IV consultation (SM/99/250, 10/1/99). This information does not alter the thrust of the staff appraisal.
1. After the slowdown of late 1998 and early 1999, real GDP grew at an annual rate of 2.4 percent in the second quarter of 1999, in line with the staffs projections. Domestic demand continues to support activity: private consumption and investment grew at annual real rates of 2.4 percent and 5.2 percent, respectively. The external sector has recovered as well, with exports growing at an annual real rate of 10.4 percent.
2. The latest cyclical indicators show that, in September, consumer sentiment reached a record high and business confidence continued to improve. Consumption of manufactured goods was 3.6 percent higher in August than a year earlier. These developments are in line with the growth outlook presented in the staff report (GDP growth of 2.5 percent in 1999 and 3 percent in 2000, as in the latest Consensus Forecast).
3. In the labor market, employment expanded strongly in the second quarter of 1999, at a rate of 1.8 percent year-on-year, while unemployment was stable at a seasonally adjusted rate of 11.3 percent in August 1999. Wage inflation remains contained, as hourly wages increased at an annual rate of 1.9 percent in the second quarter of 1999. Price inflation continues to be low, with the September harmonized price index 0.6 percent higher than a year earlier.
4. Recent interest rate developments have paralleled those in other euro-area countries: the 10-year government bond yield rose in mid-October to about 5.5 percent, a 21-month high, while the short-term interest rate increased to about 3.3 percent. To put these changes in perspective, the spread with respect to comparable (10-year) U.S. Treasury bonds has fallen to 60 basis points from 150 basis points in mid-June. The yield on the 10-year inflation-indexed bond reached 3.5 percent, up from 2.8 percent in June 999.
5. The authorities’ most recent projection for the 1999 general government deficit is 2.2 percent of GDP, 0.1 percentage points less than anticipated in the budget, reflecting better-than-expected revenue collection that was only partly offset by slippages in health care spending.
6. The recently announced draft 2000 budget for the general government projects a deficit of 1.8 percent of GDP, which implies a reduction in the structural deficit of about 0.3 percent of GDP under the assumption of 2.8 percent real GDP growth (compared to 3 percent in the Staff Report’s projection). The draft budget envisages real growth of total expenditure of about 1.3 percent, and a reduction in the tax burden of 0.5 percentage points of GDP. If these targets are attained, the fiscal deficit would be reduced by about 0.9 percent of GDP in 1998-2000 (with half of the reduction owing to cyclical factors), the ratio of public spending to GDP would decline by about 1 percentage point, and the revenue ratio would be cut by about 0.2 percent of GDP over the same period. With a primary surplus of about 1.4 percent of GDP, the debt ratio is projected to decline for the first time since 1980.
7. At the level of the central government, total state expenditures are projected to be stable in real terms, while primary spending will increase in volume by 0.3 percent, with priority given to the areas of employment, education, justice, and environment protection. The two main tax measures in the budget are the reduction of the value-added tax rate on home improvements and the elimination of the 1997 surcharge on corporate taxes (already legislated in 1998). A reduction of the income tax has been postponed to 2001.
8. As regards the social security system, real expenditure is expected to increase by about 2.2 percent (after an estimated 2.7 percent growth in 1999), and the general fund is projected to achieve balance for the first time since 1989. The major features of the draft 2000 social security budget are: the establishment of new taxes to partially finance the 35-hour workweek initiative (namely a tax on profits of large enterprises and an ecotax), an allocation to the pension reserve fund; and a 2.5 percent ceiling on the growth of health care spending.
9. The 2000 draft budget is broadly in line with the authorities’ 2000-02 Stability Program: it implements the strategy of cutting the deficit by about 0.4 percent of GDP each year over the medium term, and gradually reducing the tax burden. However, in the staffs view, the draft budget does not go as far as had been hoped in addressing structural issues in the public finances, in order to allow for a sizable decline of the government’s weight in the economy. In particular, it does not appear to make meaningful inroads into streamlining the civil service (where staffing is expected to remain constant) or curbing healthcare spending (which is projected to be 4.1 percent greater than the initial 1999 objective).