Macroeconomic outlook

After two quarters of weaker than expected activity in late 2012 and early 2013, early signs of returning growth are beginning to show for the second quarter of 2013. In this regard, my authorities concur with staff analysis that growth should progressively pick up during the second part of the calendar year, due to a gradual rebound of internal and external private demand‥ The size of the rebound in 2014 compared to 2013, as estimated by staff, is quite in line with what my authorities expect.

Nevertheless, we forecast a higher level of growth than staff in 2013 as well as in 2014, even if these forecasts will be reassessed for the 2014 budget law draft. This difference notably comes from the fact that my authorities include the macroeconomic impact of the National Pact for growth, competitiveness and employment that was adopted in November, and notably the corporate tax credit that was introduced as part of this package, which will amount to 20bn€ (1% of GDP) as of next year, based on payrolls (with an estimated reduction in the cost of targeted labor force of more than 4%, yielding a total reduction of 3% of overall labor costs). Its effects on competitiveness should help boost exports performance and contribute to the rebound.

We also have a different view than staff regarding the potential negative impact of policy uncertainty on growth. The determination of our authorities to keep on a fiscal adjustment mostly driven by reducing expenditures and to implement structural reforms in order to boost competitiveness is strong and clearly stated. Consulting stakeholders, notably social partners, might entail a longer process, but it ensures full ownership. Indeed the experience with the labor market agreement in January 2013 has shown how productive social dialogue can be. In this regard, we do not think it is appropriate to say that policy uncertainty has increased, especially based on a somewhat uncertain indicator.

Fiscal policy

My authorities’ stance on fiscal policy has been unchanged since the last Article IV consultation, in line with our European commitments and also with recommendations of the IMF: the main focus of our medium-term consolidation plan is still on structural adjustment, so that debt will be put on a firm downward path, while at the same time letting the automatic stabilizers fully play in case the outlook deteriorates, which happened in end 2012-early 2013. Consistent with that approach, the Council of the European Union has decided to postpone the target of reaching a 3 percent of GDP nominal deficit of the general Government by two years, to 2015. The consolidation path still entails a substantial structural effort, continuing what has been achieved already in 2012 and 2013.

In terms of composition of the fiscal adjustment, France has also chosen a mix that is consistent with the fiscal stance recommended by the IMF and aims at minimizing the induced drag on growth (notably by targeting the efforts on better-off households and on big enterprises), The bulk of the effort is progressively shifting from revenue raising to rationalization of expenditures (the balance should thus shift from 70% of the effort in new revenue and 30% in expenditures containment to 30% and 70% respectively). On this question, we would like to stress two points:

• – First, as a methodological point, it should be noted that social entitlement schemes, and more generally public policies, often take the form of tax rebates and exemptions alongside direct cash transfers. Closing tax loopholes and rationalizing exemptions should thus be considered as much an expenditures side reform as a revenue side measure. This was typically the case in the recently announced reform of family benefits, where the reform consists in a mix of reducing direct cash transfers and implementing a lower ceiling for the reduction on income tax that benefit parents;

• – Second, a lot is underway to ensure more efficient public spending. Mechanisms do already exist, that help with containing expenditures growth at levels even below their natural trend. This is not only true for the central Government, where spending freeze in real terms represents a notable effort, but also for social security administrations, where for instance the progression of healthcare insurance spending has been firmly kept in check, as noted by staff in the selected issues paper on expenditure savings. Local governments’ deficit is constrained by a golden rule that prevents them from financing current expenditures or debt rollover through new debt. All major public policies are currently under review with the objective of improving their efficiency. In particular, we agree with staff that the pension reform will be a key element of this strategy. Following a first move by social partners on mandatory supplementary pensions (3-year under-indexation as of next year), the Government should be in a position to present a draft law to Parliament by the end of summer.

Last but not least as regards fiscal policy, we would like to underline that much attention has been given to public finances governance these last years, putting France at the highest standard in this matter with mechanisms that allow for flexibility while ensuring credible enforcement of medium-term fiscal targets, in line with our European commitments. As part of this new framework, the new independent fiscal council, the Haut conseil des finances publiques (High Council for Public Finances), has begun its work and already issued a first assessment of macroeconomic assumptions underlying the Government projections. More public advices will follow in the fall as a contribution to the discussions on the 2014 budget.

Structural agenda

The main issue at the moment remains employment. As explained in the framework of the previous Article IV discussion, the roll-out of the emplois d’avenir (subsidized jobs targeted at low-skilled young people), and the contrat de génération (contracts that grant firms with a subsidy when they hire young workers while keeping older ones, geared to boost employment at the bottom and top of the age range) should help curb the increase in unemployment. The staff report also rightly emphasizes the importance of the agreement reached between social partners in January (Accord national interprofessionnel sur l’emploi – ANI – interprofessional agreement on employment) and its transcription into the law without changes. My authorities are confident that its implementation will give more flexibility to enterprises to adapt to economic conditions and provide workers with a higher degree of security. The fact that many decisions will now be taken at firm level, notably temporary reductions of wages and working hours in case of a downturn, will provide flexibility to adapt to short term economic developments while enhancing social dialogue at enterprise level.

Two reforms are also planned, that should contribute to increase further the flexibility of the job market and the labor force participation rate: social partner are discussing a reform of the unemployment insurance scheme, which should enhance active unemployment measures, and also the reform of the pension system, which should continue increasing the incentives to work longer and thus senior workforce participation.

We do not entirely concur with staff’s appraisal on the minimum wage. Indeed reductions in the tax wedge are sizable. They have proven effective to offset the negative effect on labor demand of the minimum wage and to stabilize the share of unskilled labor in total employment. It has to be noted that the automatic minimum wage increase should be relatively low due to subdued inflation. My authorities are not convinced by the proposed freeze of the minimum wage, at a time when indexation rules just changed in 2013.

Building on the social dialog method that has successfully been experimented for the ANI, the Government has tasked social partners on the 8th of July to reach an agreement on an overhaul of the system of professional training, where room for improvement is considerable, as underlined by staff. Their proposals should be made in the fall, in time for the Government to be able to propose a draft law on this basis before the end of 2013.

My authorities also intend to implement the comprehensive agenda that was launched last fall with the National Pact for growth, competitiveness and employment. The French trade balance has started to regain ground both in terms of price and non-price competitiveness (the commercial deficit outside energy stands at 5bn€ at end-May (0.25% of GDP), compared to 15bn€ at the same period in 2011 (0.75% of GDP)). The competitiveness agenda is also epitomized by the long term investment plan of 12bn€ presented on July 9 (which will be funded mostly through the selling of public stakes in listed enterprises), but it is larger than these specific action plans and permeate a number of other structural policies.

My authorities are also launching a series of measures aimed at simplifying the business environment and enhancing the quality of public service, as noted by staff. The last Comité interministériel pour la modernisation de l’Etat (Cabinet meeting on State administration modernization) on July 17 has seen the Government approving a number of concrete measures to give substance to the “simplification shock” announced by the President of the Republic. Inter alia, it has been decided to reverse one of the overarching principles of French administrative law, which required an explicit approval of the administration for individual decisions in most fields. In the future, tacit approval will be the norm - in most fields, absence of reaction in a two-month delay will be considered approval.

A law is currently debated in the Parliament on rationalizing competences between the various levels of local administration by transferring some powers to the level deemed the most efficient for each policy and by designating a clear leader in a number of policy fields. It will notably give reinforced powers to the metropolitan level, with a view to create strong institutions covering each of the major urban areas so as to overcome the institutional weaknesses and the lack of coordination between fragmented city councils, without adding to the layers of local government (see for instance specific measures for the future métropoles of Paris, Lyon and Marseille).

As regards housing market developments, which in the past years have weighed not only on household’s consumption but also on the overall competitiveness evolution, my authorities concur with staff’s appraisal that prices are modestly overvalued, although we would estimate the probability of a price correction in the short-term as “low-medium” rather than “medium”. In a medium-term perspective, my authorities are committed to address shortcomings on the supply side, both by making a portion of public landing property available for construction and by preparing measures intended at simplifying the way new construction is decided at local level.

As regards markets for goods and services, we concur with staff that a number of bottlenecks should be lifted in the medium-run to boost productivity and employment. It should be noted that France will participate during the next two years in a review exercise of the Services directive, aimed notably at assessing transparency of regulated professions. In the transportation sector, the reform currently underway aims at reuniting infrastructure and maintenance activities into one entity so that management of the network infrastructure will be more efficient. This prepares the railway sector to competition, which should be opened around 2019, depending on new European directives currently under discussion. It should also be noted that the draft law on decentralization mentioned above also contains measures to liberalize interregional bus transportation services.

Financial sector

We concur with staff’s analysis on the good health of the French financial system, as demonstrated also in last year’s FSAP. French banking groups have pursued the rebalancing of their funding model, in line with the French supervisory authority (ACP, Autorité de contrôle prudentiel) and the IMF recommendations, and have reinforced their capital base with the objective of complying with Basel III’s new rules already in 2013.

We welcome the follow-up of the FSAP, which is useful to keep a fruitful ongoing dialog with the authorities. Indeed, measures relating to powers of the ACP and to governance of financial institutions (banking and insurance sectors) have been included in the banking law that the Parliament definitely adopted a few days ago. This law represents a substantial enhancement of the legislative framework in three main elements:

• – It introduces the cantonment of speculative business lines, with the financing of the real economy as a key criterion;

• – It reinforces the crisis management framework by setting up a resolution authority with the ACP at its core, now relabeled ACPR (Autorité de contrôle prudentiel et de resolution). It receives new powers to prevent and manage banking crisis (notably regarding the internal organization of banking groups, in line with mandatory individual recovery and resolution plans), under the direction of a resolution board that comprises all stakeholders. This whole set up is in line with the framework of the future European resolution directive, on which the ECOFIN Council reached an agreement two weeks ago;

• – Regarding macroprudential supervision, it transforms the COREFRIS (Comité de regulation financière et du risque systémique – Committee on Financial Regulation and Systemic Risk) into a new body endowed with legally binding powers, the Haut Conseil de Stabilité Financière (High Council for Financial Stability), which draws heavily on the expertise of the Banque de France under the presidency of the Minister for Finance.

We also welcome the assessment by staff that supervision by the ACP is of high quality, based on a culture of intrusive and on-site supervision. We are notably pleased that the staff takes note of the seriousness of ACP’s controls over the adequacy of risk weights and internal risk-based models used by banks.

On the financing of the economy, we concur with staff that the overall robustness of the banking sector has resulted in a more resilient credit flow to the real economy. We also concur with the thrust of staff’s appraisal regarding the reforms needed to accompany the structural transformation underway, towards a more disintermediated system, and to better mobilize long-term savings for long-term financing projects. Recourse by corporates to capital markets has substantially risen in the past years, and initiatives have been launched to help securitize SME loans. Long-term savings mobilization is underway through a multipronged approach:

• – The creation of the Banque Publique d’Investissement brings together a number of public tools for investment both in equity and in debt, that were scattered and will be better coordinated;

• – Rebalancing of tax incentives regarding different products of long-term savings is underway and the recommendations of the Berger-Lefebvre report offer a good basis in this regard. Changes in the life-insurance framework should also be noted, which will enable insurance group to invest more in SMEs debt;

• – Lastly, the Government announced last week that 30bn€ of regulated savings product (notably livret A) should be given back to commercial banks (“decentralized”) to enhance their capacity to lend to SMEs, thus making it easier for them to beef up their liquidity ratios and lessening the impact of this specific system.