France: Staff Report for the 2006 Article IV Consultation Supplementary Information
Author: International Monetary Fund
Publication Date:
01 Nov 2006
eISBN:
9781451813685
Language:
English
Keywords:
ISCR; CR; headline inflation; deficit; director; government; firm; expenditure measure; revenue windfall; budget provision; spending control; expenditure growth; Budget planning and preparation; Central government spending; Fiscal stance; medium-term plan
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France’s economic short-term outlook is positive, and long-term prospects have improved. Fiscal adjustment remains high on the government’s agenda. Tax reforms have improved the economy’s growth potential. Reforms in financial, labor, and product markets are necessary to boost job creation, prepare the economy for aging, and allow it to benefit from global activity. The financial sector’s profitability and capitalization put it in a good position to manage increasing risks. Structural reforms in labor and product markets remain essential to boost long-term growth and secure fiscal sustainability.

Abstract

France’s economic short-term outlook is positive, and long-term prospects have improved. Fiscal adjustment remains high on the government’s agenda. Tax reforms have improved the economy’s growth potential. Reforms in financial, labor, and product markets are necessary to boost job creation, prepare the economy for aging, and allow it to benefit from global activity. The financial sector’s profitability and capitalization put it in a good position to manage increasing risks. Structural reforms in labor and product markets remain essential to boost long-term growth and secure fiscal sustainability.

This supplement to the staff report for the 2006 Article IV Consultation with France provides an update on recent developments, in particular the authorities’ 2007 budget proposal and their medium-term fiscal plans presented with the budget. The new information does not alter the thrust of the staff appraisal.

Summary

Growth is likely to reach 2.5 percent in 2006, slightly higher than anticipated in the staff report because of historical data revisions, but growth rates going forward remain unchanged, consistent with newly released short-term economic indicators. Headline inflation fell to 1.5 percent in September, helped by declining oil prices. The staff’s growth projections are somewhat higher than those of the authorities, leading it to project general government deficits of 2.6 percent of GDP and 2.4 percent of GDP in 2006 and 2007, respectively, compared to official targets of 2.7 percent and 2.5 percent of GDP. Tight spending control and slightly above-trend nontax revenues are expected to accommodate previously announced tax cuts of about 0.3 percent of GDP. In the staff’s estimates, the structural deficit is set to remain broadly constant in 2007, while the authorities see a continuing structural improvement. The 2007 budget raises spending on ODA to 0.5 percent of GNI. On structural issues, privatization is continuing, but the removal of administered schemes in the financial sector is being resisted.

Output and inflation

1. The authorities project growth in a range of 2–2½ percent in 2006 and 2007, on the basis of robust consumer spending. The staff projections are at the top end of this range in 2006 and at 2.3 percent for 2007, above the Consensus forecast (Table 1). Recent data releases are consistent with growth settling at about 2½ percent in the second half of 2006. Consumer confidence is up, and spending on manufactured goods was exceptionally strong in August. Industrial production weakened during the summer, but business sentiment held up well, and the outlook for production has been improving. Labor shortages have emerged in a briskly expanding construction sector. Higher oil prices and buoyant imports led to a further widening of the current account deficit in July, despite strong export growth. Employment has been edging up, but the unemployment rate rose marginally to 9 percent in August, following a 1 percentage point decline over the past 12 months. Headline inflation has moderated while the slight upward trend in underlying inflation was reversed in August– September 2006, with a decline to 1.0 percent.

Table 1.

France: Main Economic Indicators, 2002–11

(Annual percentage change; unless otherwise indicated)

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Sources: Banque de France; data provided by the authorities; and IMF staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year’s GDP.

Harmonized CPI.

For 2006, year-on-year September.

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 2000=100. For 2006, data available up to August.

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

Maastricht definition.

Data for 2005 exclude the EDF pension fund transfer (0.5 percent of GDP); in percent of potential GDP.

2006 Budget

2. Owing to stronger growth, the reduction in the 2006 general government deficit is larger than expected, and underlying adjustment is still expected to amount to 0.5 percent of GDP. The authorities project the deficit to fall from 2.9 percent of GDP in 2005 to 2.7 percent of GDP in 2006, below the initial target of 2.9 percent of GDP. The structural adjustment results from the replacement of one-off revenues (transfer of the energy utilities’ pension funds) with durable expenditure restraint. In social security, tight control of health care spending appears to be more than offsetting higher-than-budgeted pension payments. Fiscal incentives favoring energy conservation have been strengthened, with marginal budgetary implications. As noted in the staff report, tax expenditure approved outside the budget law appears to be weighing on the budget and is estimated to have reduced revenues by 0.1 percent of GDP in 2006.

2007 Budget

3. The draft 2007 budget aims to reduce the deficit from 2.7 percent to 2.5 percent of GDP while lowering the tax burden. With growth assumed to be 2¼ percent, this is to be accomplished as follows:

  • On the expenditure side, general government spending is set to grow by 1.4 percent in real terms, for a 0.4 percent decline in the expenditure-to-GDP ratio. Central government expenditure is planned to fall by 1 percent in volume terms after three consecutive years of zero real growth. The number of civil servants will decline by 15,000 (in full-time equivalents), a step-up from the record to date, but still implying a replacement rate of four out of five retiring employees. Nominal social security spending growth is projected to stabilize at about 3¼ percent, anchored by a health care spending norm of 2.5 percent. To achieve this, new measures will be introduced to foster the use of generic drugs and reduce fraud. However, pension payments will rise as an increasing number of baby boomers are retiring. Local government expenditures are expected to continue growing above nominal GDP, reflecting strong investment and a rising wage bill.

  • Revenues from taxes and social security contributions are projected to fall by 0.3 percentage point to 43.7 percent of GDP. Two thirds of this decline stem from a preannounced income tax reform, which reduces the number of brackets and the highest marginal rates. In addition, the earned income tax credit (prime pour l’emploi) is being raised further, and firms will benefit from the capping of the taxe professionnelle at 3.5 percent of value added, the exemption of new investment from this tax, and the elimination of social security contributions for minimum wage workers in small firms. The budget again stipulates that all revenue windfalls be applied to deficit reduction. Nontax revenues are maintained at slightly above-trend levels.

4. In the authorities’ estimates, the 2007 budget implies a structural adjustment of 0.4 percent of GDP. However, this adjustment reflects the assumption that potential growth is significantly higher than actual projected growth of 2¼ percent of GDP in 2007 and particular assumptions about the behavior of structural revenues. On the basis of the staff’s already upward-revised estimates of potential growth (see staff report ¶14) and unit elasticity of revenues with respect to GDP, there would be virtually no underlying adjustment in 2007.

Medium-term fiscal outlook

5. Over the medium term (2008–10), the authorities intend to pursue underlying adjustment through expenditure restraint, while leaving the tax system unchanged. In their “low-case” medium-term scenario, growth is set to continue at 2¼ percent per year, and real general government spending growth would decline further to average 0.6 percent during 2008–10 (Text Table). Central government spending would decelerate to become constant in value by 2010, and social security, health care, and local spending growth would be limited, respectively, to 1.1 percent, 2.2 percent, and 2 percent per year in real terms. This scenario would result in a cumulative structural adjustment of 2.2 percentage points of GDP by 2010. As measures to achieve these objectives have not been specified, the staff projects that on current policies, real general government spending would average 1.8 percent per year beyond 2007, limiting the improvement of the structural balance to 0.3 percent of GDP by 2010. The authorities also present a high-case medium-term scenario with higher actual and potential annual economic growth of 3 percent due to structural reforms. Excluding tax cuts and taking into account lower spending on unemployment benefits, this scenario would improve the fiscal situation by almost 1 percent of GDP.

Text Table.

France: 2007 Budget and Medium-Term Fiscal Plans

(In percent of GDP)

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Sources: Authorities; and IMF staff calculations.

The medium-term plans correspond to the “lower scenario” in the authorities’ draft budget.

Excluding the EDF pension transfer in 2005.

Structural issues

6. Parliament approved an energy law paving the way for divestiture of Gaz de France(GDF), while the authorities sharply criticized EU attempts to challenge the distribution monopoly of an administered savings scheme (Livret A).

Staff Assessment

7. While the 2007 budget envisages continued spending restraint, it is partly used to fund tax cuts, with an inopportune pause in underlying adjustment. Economic projections underlying the 2007 budget are cautious, and the planned reduction in central government expenditure by 1 percent in real terms represents a welcome breakthrough, building on the successful real containment of recent years. However, on the basis of the staff’s more conservative estimates of potential growth and structural revenue behavior, there is virtually no structural adjustment in 2007. The tax reform improves incentives and economic efficiency. To be effective, the budget provision to allocate revenue windfalls to deficit reduction will need to be complemented by a rule prohibiting tax expenditure from being implemented outside the budget law.

8. For the medium term, the considerable reduction in spending as a share of GDP envisaged by the authorities will require the adoption of durable expenditure measures. On current policies, the staff projects the structural balance to remain in a deficit of about 1½ percent of GDP over the medium term. Implementing the authorities’ planned spending path for the central government, balancing social security budgets and curbing local spending growth would eliminate this deficit. Even so, as illustrated in the staff report, fiscal sustainability will only be achieved with further growth-enhancing structural reforms.

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Cover IMF Staff Country Reports
France: 2006 Article IV Consultation—Staff Report, Staff Supplement; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund
Volume/Issue:
Volume 2006: Issue 389
Publisher:
International Monetary Fund
ISBN:
9781451813685
ISSN:
1934-7685
Pages:
63
DOI:
https://doi.org/10.5089/9781451813685.002