Abstract
The French economy weathered global crisis better than most of its peers. The authorities have taken important policy actions to stabilize the financial system and have implemented suitable fiscal stimulus to cushion the downturn. Executive Directors welcomed the policy, which aims to strengthen the economy through fiscal consolidation, recovery of financial system, improving financial regulation, and also implementing structural reforms to raise potential growth, create jobs, and strengthen competitiveness. They stressed the importance of a multiyear budget framework to enhance the credibility of the consolidation effort.
We wish to thank staff for a comprehensive set of papers, which depict well the policy challenges faced by France. The discussions with the mission were frank and very much appreciated by my authorities, and provided useful input to policy formulation. The mission was also an opportunity to follow-up on several recommendations made last year by the Executive Board, such as the reduction in tax expenditures, the freeze in expenditures at the level of the central government, and the launch of an ambitious pension reform which are all being implemented.
At this critical juncture, the French authorities have clearly indicated their strong commitment to fiscal consolidation so as to ensure long-term sustainability, as well as their resolution to maintain the momentum of structural reforms with a view to increasing competitiveness and potential growth. They consider these two pillars of the economic strategy as mutually reinforcing.
Outlook: the recovery is gaining strength.
The French economy has weathered the crisis relatively well compared to its peers. The fiscal stimulus, complemented by the full effect of the sizeable automatic stabilizers, helped maintain private consumption in positive territory throughout the crisis, and the economy exited recession during the second quarter of 2009. The financial sector proved fairly resilient and benefited from an appropriately targeted support, which has now been almost entirely phased out. Structural features of the economy also contributed to soften the impact of the shock, as mentioned by staff.
The recovery is now underway and my authorities agree with staff’s growth forecast for 2010 at 1.4 percent. Activity is rebounding faster than the euro area average and is driven by private consumption, net exports, and a turn in the inventory cycle. The depreciation of the euro, by 7.7 percent in nominal effective terms between November 2009 and June 2010, is also expected to bolster the recovery during the second half of the year.
Staff’s forecasts seem, however, rather pessimistic on the growth outlook for 2011. Indeed, while consumption is expected to remain solid, my authorities foresee that private investment, which has not yet recovered, will bring a significant contribution to growth in 2011. Short-term indicators from business surveys already suggest a recovery in investment, and the conventional accelerator effect should gather steam. This forecast for private investment is also underpinned by the level of interest rates, which is expected to remain low, and the positive effects of the removal of the local business tax. Besides, my authorities believe that downside risks should be nuanced, as recent data suggest, e.g., that credit growth has ceased to slowdown.
My authorities are more sanguine than staff about the impact of the crisis on potential growth. They estimate French potential growth at 1.7 percent per year over the medium term (2009-13). While staff rightly indicates that this divergence of views is mainly related to the foreseen impact of the crisis on total factor productivity growth–which is indeed ambiguous–we would also stress that the crisis had slightly different features in France, and in particular a less disruptive effect on the financial sector and on households’ balance sheets. Besides, we expect that the pension reform will gradually translate into a higher rate of activity, as it was the case following previous waves of reforms (the employment rate in the 55-64 years bracket has already been raised by 3.6 percentage points since 2002).
A strong commitment to fiscal sustainability
The global crisis and the large fiscal impulse led to a sharp deterioration of the French public finances, calling for an ambitious fiscal consolidation. The cost of financing for the Treasury remains at historically low levels (2.9 percent for 10-year bonds) due to flight to quality effects. However, recent events in Europe triggered a heightened awareness of risks to debt sustainability.
In this context, the government is firmly committed to undertaking a large and durable fiscal consolidation starting in 2011. The French stability program will bring the deficit down from 8 percent of GDP in 2010 to 6 percent in 2011, and aims at returning to 3 percent of GDP by 2013. Half of the adjustment in 2011 will come from structural savings, the rest being provided by the phasing out of the stimulus and the recovery of tax revenues. The complete package of measures to secure the announced deficit path will be finalized by September.
In line with IMF recommendations, and consistently with the comprehensive diagnostic of France’s public finances which has been realized beforehand, my authorities intend to achieve most of the consolidation over the 2011-13 period through expenditures cuts, as explained in paragraph 16 of the report. All levels of government (central, local, and the social security system) will contribute to this effort to ensure fiscal sustainability.
The recently announced pension reform is a key element of the fiscal consolidation strategy. Relying mainly on the gradual increase in the legal retirement age from 60 to 62 and the legal minimum age of full pension entitlement from 65 to 67, this major reform will eliminate the deficit associated with the pension system by 2018 and bring France in line with the main comparator countries. The reform will considerably improve medium-term fiscal sustainability without affecting labor cost and will also have an immediate impact on tax revenue, since it is partly financed with a moderate increase in taxation of investment income. As for the residual deficits during the transition period, they will be financed by the Reserve Fund of the pension system (Fonds de reserve des retraites), which has accumulated over â33 billion of assets. All other things being equal, the reform will reduce the general government deficit by 0.5 point of GDP in 2013 and 1.2 point by 2020, and will save close to 10 points in the gross public debt-to-GDP ratio through the period.
This consolidation effort is also underpinned by several structural reforms aiming at strengthening fiscal discipline. The multiyear budgetary framework has been maintained and should be strengthened to become more binding. The dynamics of healthcare spending will also be better controlled with the strengthening of the early warning procedure on spending overruns, while fiscal governance has been improved with the decision of my authorities to ban the introduction of any new tax measure outside the budget law (Loi de Finances) or the social security budget law (Loi de Financement de la Sécurité Sociale). And finally, as mentioned by staff, the authorities are considering the introduction of a fiscal rule at the constitutional level. Specific proposals made by the working group chaired by Michel Camdessus will be discussed with major political parties in the coming weeks, with a view to introducing the rule in 2011.
Pursuing structural reforms aimed at improving growth
My authorities are determined to maintain the pace of structural reforms, in accordance with the commitments taken in the E.U. and under the G20 MAP. This effort is being pursued in several directions to improve competitiveness, increase flexibility of the labor and product markets, and raise potential growth.
Raising competitiveness is clearly a key priority, and action has been taken in three main directions. First, the removal of the local business tax (Taxe Professionnelle) is a major improvement to the French tax system and will improve competitiveness and attractiveness to foreign investment. Second, as the rise in unit labor costs is one of the main causes of the deterioration in export performance over the recent period, the elimination of the discretionary increase in the minimum wage, as recommended by the IMF, should contribute to addressing this issue. Third, the launch of a € 35 billion investment program (Grand Emprunt or Dépensesd’Avenir) designed to only have a marginal effect on public finances and to leverage private resources, is meant to boost capacities in education, research, and innovation, and promote a vibrant knowledge economy over the medium term. The success of the tax credit on research and development expenditures (credit d’impôt recherche) will further contribute to stimulating potential growth.
Efforts are under way to improve the flexibility of the labor market and reduce structural unemployment. The impact of the crisis has been softened by the temporary unemployment schemes - as illustrated by the fact that France transitioned from above to below the Euro area average rate of unemployment during the crisis - and net job creations are expected to resume by end-year.My authorities are also pursuing their efforts to raise the employment rates, especially among vulnerable groups. The ongoing pension reform will complement the efforts made over the last few years (as mentioned above) to address the situation of senior workers and will have a fairly rapid impact since the increase in the legal retirement age will be phased in at a faster pace than under similar reforms in other countries. Fostering low-skilled workers’participation is also necessary and a consistent effort has been made over the last years to eliminate inactivity traps with the creation of the PIT tax credit (Prime pour l’emploi) and the recent introduction of the Working Solidarity Benefit (RSA).
Finally, my authorities are in full agreement with staff that further enhancing domestic competition would strengthen economic efficiency. They recognize that there is scope to build on recent measures such as those contained in the Economic Modernization Law and that the transposition of the E.U. Services Directive is improving competition intensity in France. Ongoing reforms to boost competition in the utilities sectors will also be beneficial.
Financial sector: maintaining stability
The French financial sector has proved resilient to the crisis and remains solid. Banks have restored their profitability and strengthened their capital base, and are in a sound position to support the recovery. The results of the E.U. stress testing exercise have confirmed this assessment: all the four French banks that have been tested (accounting for 80 percent of the total assets of the French banking system) have easily passed the most adverse scenario, with a Tier 1 ratio above 9 percent on average. This shows the resilience of the universal banking model that my authorities intend to preserve going forward.
My authorities are aware that the highly uncertain environment calls for maintained vigilance, but they consider that potential risks associated with banks’ exposure to the so-called “EA5” (Box 7) should be nuanced. The geographical breakdown of exposures must be taken into account in that regard, as well as the nature of claims and the strength of French banks’ capital base. French banks are indeed mainly exposed through loans to corporates rather than securities and government bonds, which suggests that potential losses, if any, would be gradual and slow. Strong revenue flows (the four biggest French banks posted a 28 percent increase in net income in the first quarter of 2010) would also help absorb such losses. Full transparency has been made on French banks’ exposures to sovereign risk in Europe and it clearly shows that such exposures are manageable and that even the most adverse simulations would leave the banking system with a strong capital base.
My authorities are also actively engaged in the international financial regulatory reform. The introduction of a financial levy based on financial institutions’ riskiest assets and the establishment of a framework for sound compensation practices in the financial industry demonstrate their commitment to avoiding excessive risk taking and promoting stability. This commitment also underpins the recent reform of the supervisory architecture, with the creation of a unique supervisor for banking and insurance and the establishment of a systemic risk board.
International cooperation
Finally, my authorities remain committed to international cooperation and provide significant financial support to the IMF to mitigate the impact of the crisis. The French commitment to the New Arrangements to Borrow (NAB) for SDR 18.6 billion has been ratified by the Parliament on June 7, 2010. In addition, France pledged a SDR 1.3 billion loan to the PRGT which will soon be effective.