Staff Report for the 2002 Article IV Consultation Supplementary Information

This 2002 Article IV Consultation highlights that the economy of France is facing a fast-approaching demographic turnaround—with the active population beginning to decline in 2007 and reducing annual per-capita-GDP growth by about half a percentage point for a few decades. In 2002, the general government budget deficit is expected to widen to 2.6 percent of GDP from 1.5 percent of GDP in 2001. The deterioration is in good part owing to the cyclical downswing but also to structural factors, in particular to the trend increase in social security spending.


This 2002 Article IV Consultation highlights that the economy of France is facing a fast-approaching demographic turnaround—with the active population beginning to decline in 2007 and reducing annual per-capita-GDP growth by about half a percentage point for a few decades. In 2002, the general government budget deficit is expected to widen to 2.6 percent of GDP from 1.5 percent of GDP in 2001. The deterioration is in good part owing to the cyclical downswing but also to structural factors, in particular to the trend increase in social security spending.

1. This supplement to the staff report for the 2002 Article IV consultation with France provides an update on recent economic and policy developments, in particular the 2003 budget proposal and the authorities’ medium-term fiscal plans, and reflects discussions on these topics held during the Annual Meetings.1 This information qualifies the staff appraisal in the sense that the near-term outlook is now somewhat weaker than expected and that the authorities’ fiscal plans for 2003 and the medium term further delay fiscal consolidation with respect to earlier intentions and the staffs recommendations.

2. Economic indicators are somewhat weaker than envisaged in the staff report, increasing downside risks to the staffs baseline projection and casting doubt on the authorities’ 2003 growth assumption. Sentiment about the growth outlook has shifted down markedly in the recent period. For 2002, official (INSEE, Banque de France) and Consensus Forecasts seem to be converging toward a growth rate of some 1 percent (1.2 percent in the staff report). For 2003, the draft budget anticipates growth of 2½ percent. The authorities count on an improvement in the external environment and a supportive budget to reach this objective, but recognize that recent declines in equity valuations and the absence of signs of a revival of domestic demand in Germany and Italy constitute key downside risks. The staff is less upbeat, noting that uncertainty, including on energy prices, is weighing on business investment and that short-term indicators in France and elsewhere portend moderate growth rather than a strengthening recovery. Thus, despite a more supportive budget than assumed in the staff report, the staff continues to project GDP growth of 2¼ percent in 2003, with appreciable downside risks remaining, consistent with the near-term outlook for the euro area, Germany, and Italy as reflected in their respective supplements (Table 1). For its part, the October Consensus Forecasts place 2003 GDP growth at only 1.9 percent.

Table 1.

France: Main Economic Indicators

(Annual percentage change, unless otherwise indicated)

article image
Sources: Data provided by the authorities and Fund staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year’s GDP.

Harmonized CPI.

For 2002, year on year in July

In percent of labor force; harmonized index.

GDP over total employment.

Personal disposable income deflated by the implicit deflator for private consumption.

In percent of household disposable income.

In percent of potential GDP…

Index; Base 1995=100. For 2002, data as of July.

In percent of GDP; Data for 2001-02 exclude the proceeds from the sale of UMTS licenses, which amounts to about 0.1 percent of GDP.

3. The authorities view the 2003 budget—which postulates an unchanged deficit from 2002 (2.6 percent of GDP)—as designed to realize the government’s key priorities while supporting confidence and the economic recovery. These priorities involve: first, strengthening the state’s effectiveness in the areas of security, justice, and defense (on the latter, the authorities note that benefits would accrue also outside France), and second, implementing tax cuts to rekindle employment growth and investment. The authorities view the 2003 budget as realizing these objectives. It makes some room for the expenditure increases in the above areas (as well as in official development assistance) by savings in education, research, and some labor programs.2 The authorities also point to a reversal of the previous persistent rise in public employment. Though they acknowledge that the reversal is modest (reducing the narrowly defined civil service by 1,089 positions—against the background of more than 50,000 retiring civil servants), the authorities emphasize that this change of direction represents an important signal. All in all, real general government spending is set to rise by 1.5 percent in 2003, following an expected increase of 3.2 percent in 2002. On the tax side, the budget includes further targeted cuts in social security contributions to mitigate the cost pressures from prospective increases in the minimum wage (see ¶30 of the staff report) and support the hiring of young job-seekers (contrats jeunes en entreprise), the removal of the bias of the earned income tax credit against part-time work, a slight reduction in the top marginal income tax rate (to below 50 percent), and the elimination of the wage bill and expenditure on research and development from the base of the taxe professionelle. It also implements a further, modest across-the-board income tax cut to support household incomes.

4. The authorities consider the 2003 budget as braking the appreciable—and mostly inherited—deterioration of 2002, and as not inconsistent with fiscal consolidation, which they intend to undertake in earnest as from 2004 The authorities note that, with real expenditure growth kept at 1.5 percent, the expenditure-to-GDP ratio is set to fall by ½ of one percentage point of GDP. Tax cuts absorb only 0.2 of one percentage point of GDP of this amount, with the remainder taken up by prudent budgeting of tax revenues (with an underlying GDP elasticity of 0.8) and a return to more sustainable, lower levels of non-tax revenues. All in all, the authorities view the budget as placing public finances on a more transparent and sounder footing, and preparing for measurable fiscal consolidation from 2004 onwards, in a hopefully more auspicious growth environment. In the staffs calculations, the budget implies no improvement in the structural deficit in 2003, which would thus remain at some 2 percent of GDP.

5. In the update of their medium-term fiscal plans to 2006, the authorities intend to narrow the deficit from 2004 onwards and continue reducing the tax burden, so as to create the conditions for durable growth, achieve full employment, and deal with the impending demographic pressures.3 Tax cuts will continue to be implemented, for a total in 2004-06 of € 9 billion (0.6 percent of GDP, under the central assumption of annual average GDP growth of 2.5 percent), while expenditure growth will be held below output growth to create some room for fiscal consolidation.4 Staff estimates these intentions to imply a total underlying adjustment of 1¼ percentage points of GDP over the plan’s period (see text table). Even so, the general government balance is projected to remain in deficit through 2006 (-1.0 percent of GDP), reflecting the government’s priorities and a gradual approach to reform on the expenditure side. The authorities note that fiscal and other structural reforms could boost potential growth by ½ percentage point. Under such a scenario, with annual GDP growth at 3 percent during 2004—06, the authorities would allocate about half of the growth dividend to additional tax cuts while achieving a budget close to balance (i.e., a deficit of 0.5 percent of GDP) by 2006.

France: 2003 Budget and Medium-Term Fiscal Plans 1/

article image
Source: Data provided by the authorities and IMF staff calculations.

Projet de lot de finances 2003, including Rapport Economique, Social et Financier.

6. In the staff’s assessment, the 2003 budget, while containing a number of helpful features, falls short of requirements mainly due to the absence of determined structural efforts to rein in expenditure. The increased transparency, prudent budgeting of revenues, and the setting of realistic spending norms on health care are welcome. Some of the tax measures, in particular regarding the earned income tax credit, should improve the functioning of the labor market, but their magnitude is small, while some of the other tax reductions are not directed at strengthening the supply side of the economy. Moreover, the absence of appreciable efforts to restrain expenditure leaves the fiscal accounts ill-prepared to address cyclical and other risks: indeed with the staffs slightly weaker growth projection, the budget deficit is expected to rise to 2¾ percent of GDP in 2003, uncomfortably close to the 3 percent limit under the SGP, to which the authorities remain nonetheless firmly committed. Other factors—among which a possible call on the public purse to participate in the recapitalization of France Telecom and the return of non-tax revenues to historical, lower averages—could pose further fiscal risks. Finally, from a regional perspective, the budget’s explicit departure from the fiscal consolidation guidelines agreed by the Eurogroup’s majority places further strains on the fiscal framework in the euro area.5 Staff would thus urge that every opportunity be seized to strengthen expenditure restraint, in both the finalization and execution of the 2003 budget.

7. The staff considers the authorities’ fiscal plans for 2004-06 as insufficiently ambitious to boost potential growth and address France’s impending demographic shock; it encourages a stepped-up effort in the update of the Stability Program later this year. With expenditure restraint below that envisaged in the previous 2003-05 Stability Program and back-loaded, and no correction for past overruns, there is little room for meaningful tax cuts. The consequent decline in the tax-to-GDP ratio by ½ of one percentage point between 2002 and 2006—though helpful—is modest, and unlikely to raise potential growth appreciably. Accordingly, staff would recommend that the update of the Stability Program reflect greater expenditure restraint through well-specified measures. It would also note in this connection that, without additional fiscal consolidation, appreciable long-term budgetary savings will need to be obtained from the pension reform being prepared for mid-2003.

ANNEX I: Public Debt Sustainability6

This annex compares the staff’s baseline projection for France’s public debt with scenarios based on historical averages for key underlying variables. The sensitivity of the debt dynamics to a number of shocks is also considered. The shocks are applied as temporary deviations from the baseline, without consideration of feed-back effects, and with magnitudes based on historical developments over the past 10 years. With stress tests being standardized, the scenarios considered in this annex do not address other issues relevant for debt sustainability such as the impact of population aging on public finances or the process of divestiture of the state from commercial activities.

The baseline scenario envisages a stable debt ratio through 2003, followed by a steady decline, reflecting the authorities’ intentions regarding fiscal consolidation. It is based on the 2½ percent growth medium-term fiscal program presented with the 2003 budget (Projet de loi de finances 2003), but adjusted for the staffs macroeconomic assumptions. The latter do not differ much from the authorities, with growth being initially somewhat weaker but subsequently stronger as the recovery proceeds. In view of the need to establish the credibility of the authorities’ fiscal strategy and to address imminent demographic pressures, the staff has advised a more up-front and more ambitious path for fiscal consolidation.

The shocks to the baseline scenario reveal the sensitivity of debt dynamics to the macroeconomic environment and the importance of policy action to offset their adverse consequences on fiscal sustainability. Indeed, a prolonged episode of high real interest rates combined with low real GDP growth would give rise to adverse debt dynamics (stress test 1). In such a scenario, nominal deficits would be above 4 percent of GDP starting in 2003 and rise continuously thereafter. Given the commitment of euro-area countries to fiscal sustainability—and the 3 percent deficit ceiling under the Stability and Growth Pact—such a course of events is highly unlikely. In all other scenarios, the public debt-to-GDP ratio would be on a declining path by the end of the projection period, though in most of them the level of the ratio would be appreciably higher than in the baseline.

Table A1.

France: Public Sector Debt Sustainability Framework, 1997-2007

article image
Source: Staff Calculations

General government.

Defined as: r = interest rate; π = GDP deflator, growth rate; g − real GDP growth rate.

Real appreciation is approximated by nominal appreciation against US dollar plus increase in domestic GDP deflator.


The Supplement includes a draft Public Information Notice (PIN) and, in live with recent Executive Board guidelines, also presents a public dept sustainability analysis based on standardized tests (Annex).


In addition, the budget includes measures to contain health spending (notably, the non-reimbursement of drugs without proven effectiveness and limits on the reimbursement of other drugs to their generic equivalent). The authorities note that the budget adopts a more realistic approach to budgeting in health care, where spending is set to rise by 5.3 percent (in nominal terms). Furthermore, to keep social security spending within the norm, the possibility of implementing a corrective supplementary social security budget in mid-year—a new procedure—is provided for.


The authorities note that the medium-term fiscal plans presented at this time are in response to the requirements of the new Organic Budget Law, and that the ensuing parliamentary debate will inform the update of the Stability Program, to be presented to the EU Commission in late November.


Inclusive of measures already taken in 2002 and envisaged in the 2003 budget, total tax cuts would amount to € 15 billion in the period 2002-06 (1 percent of GDP).


At its meeting in early October, the Eurogroup agreed that countries that have yet to reach the SGP close-to-balance objective “need to pursue continuous adjustment of the underlying balance by at least 0.5 percent of GDP per year”, with “all Ministers but one accept[ing] this to start no later than in next year’s budget.” Eurogroup—Terms of Reference on budgetary developments in the euro area, dated October 7, 2002.


This Annex reports standardized stress tests for public dept sustainability (see SM/02/166, 5/28/02).

France: 2002 Article IV Consultation—Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund