This 2016 Article IV Consultation highlights that economic recovery in France is solidifying. The economy is projected to expand by 1.5 percent in 2016, primarily driven by strong consumer spending. There are also signs of a cyclical recovery in investment, and the slump in residential construction appears to be bottoming out. By contrast, net exports are declining as demand from trading partners has slowed. Private sector job creation has remained lackluster, and the unemployment rate has hovered at about 10 percent. The government has continued to advance important reforms to help create the conditions for improved economic performance. As for budget policies, there are ongoing efforts to contain spending growth at all levels of government while easing taxes.
We thank staff for a thorough and detailed set of papers on the main challenges that the French economy is currently facing. Candid and open discussions during the Article IV mission led to a comprehensive and fruitful engagement with my authorities. We are pleased to note that staff is broadly in agreement with the authorities’ overall strategy implemented since 2012.
Since the financial crisis, the French economy has shown its resilience. In 2015, the economic recovery accelerated, supported not only by external factors such as the decline in oil prices and a moderate depreciation of the real effective exchange rate but also domestic factors resulting from the implementation of reforms (in particular the reduction of the labor tax wedge, pro-competition measures, incentives for private investment) which are already bearing fruits. Going forward, my authorities remain committed to their economic strategy relying, in particular on ensuring the sustainability of public finances and structural reforms, particularly on the labor market.
1. Macroeconomic outlook
In 2015, the economic recovery accelerated with a pickup in growth to 1.3 percent (higher than the forecast of 1 percent in the 2015 Budgetary Plan) and after 0.6 percent in 2014. Economic growth was driven by households’ spending, and corporate investment (+2 percent in 2015). Ongoing efforts to restore businesses’ competitiveness have allowed France’s share of export markets to stabilize (real exports grew by 6 percent in 2015) and contributed to lowering the country’s trade deficit and almost balancing the current account.
Concerning the outlook for 2016 and 2017, the French economy is expected to gradually recover. Staff has revised its growth projections upward to 1.5 percent for both years, compared respectively with 1.1 percent and 1.3 percent in the last WEO. Staff growth forecasts are similar to the French authorities’ projections as indicated in the Stability Program released last April, as well as to the latest Consensus Forecasts. Additionally, they are also in line with the forecasts of the OECD (1.4 percent in 2016 and 1.5 percent in 2017) and the European Commission (1.3 percent in 2016 and 1.7 percent in 2017).
The result of the United Kingdom’s referendum on the EU Membership is expected to have a limited economic impact in France through trade channels whereas it is still difficult to assess how this outcome will affect the economic activity through the financial channels and the confidence effect on the United Kingdom and the Euro area.
In a medium and long term perspective, France’s growth prospects should be supported by key factors, including its institutional framework, world-class infrastructure, sound financial system, well-educated workforce, positive demographic trends, and a high productivity rate in the world. Furthermore, the ambitious agenda of structural reforms currently implemented by the authorities will boost potential growth.
2. Fiscal policy
French public deficit stands at 3.6 percent of GDP in 2015 which has over-performed the objective set in the Budget bill passed in December 2015 (3.8 percent of GDP). This performance resulted from the containment of public spending following the first year of the saving plan’s implementation. Additional saving measures were also taken during the year for EUR 4 billion in order to offset the negative impact of a lower-than-expected inflation. Indeed, nominal public spending excluding tax credits increased by only 0.9 percent in 2015, the lowest in decades. With the implementation of tax reduction measures targeting businesses (Crédit d’Impôt Compétivitié Emploi, Pacte de responsabilité et de solidarité) and private households, the tax-to-GDP ratio was reduced by 0.1 point to 44.7 percent of GDP.
We therefore do not share the findings of the staff report that the authorities’ consolidation strategy “has not delivered the hoped-for fiscal savings in the context of low growth and inflation.”
Fiscal medium-term consolidation path
As set out in the Stability Program published in April, France targets a 0.4 point of GDP structural adjustment of public balance in 2016 and 0.5 point of GDP in 2017 and 2018, which will allow under a prudent growth scenario (real GDP growth of 1.5 percent per year in 2016 and 2017) to bring back the headline deficit below 3 percent in 2017 with a safety margin (2.7 percent of GDP), a trajectory which is compliant with our European commitments. This target was restated by President Hollande at the end of June.
Recently announced measures will be financed to ensure that our headline deficit target of 2.7 percent of GDP will be met in 2017. This target has been confirmed and the compensations have been disclosed in the report published July 5th in order to prepare the draft budget bill discussions this autumn.
In this regard, we would like to underline that the report finding of a structural “fiscal adjustment slowing to around zero” is based on a scenario that does not fully take into account the measures set out in the Stability Program. Moreover, this difference of appreciation of our structural efforts is partly due to a lower estimate of potential growth by staff, compared to the Stability Program (1.1 percent for 2016 and 2017 compared to 1.5 percent).
From 2017 to 2019, we forecast that the growth of public expenditure will be close to inflation. The pace of consolidation strikes the right balance between the need to secure public finances’ sustainability in the medium term, while reducing the tax burden, and avoiding a drag on growth in the short term.
Overall, given the strong commitment of the authorities to the consolidation path of the Stability Program, we consider that staff overestimates the implementation risks of a deviation.
Long term sustainability
Strong demographics, the improvement in its older workers’ participation rate and the phasing-in of recent pension reforms, have placed France in a better position to deal with its aging population than most of its OECD partners. This long-term sustainable position has been reinforced by the latest pension reform adopted in 2014 as well as the new agreement signed in 2015 on the financing of the supplementary retirement scheme. According to the latest long term projections of the European Aging Report 2015, public pension spending is expected to decrease by 2.8 percent of GDP between 2013 and 2060. The financial position of France’s pension system is no longer a major issue for the long-term sustainability of public finances.
3. Structural reforms
In order to reduce unemployment and foster potential growth, the French authorities are pursuing the implementation of a bold agenda of structural reforms aiming at improving cost competitiveness, enhancing the business environment, improving the functioning of product and services markets, improving the functioning of the labor market as well as promoting social inclusion and equal opportunities.
Improving cost competitiveness by cutting the labor tax wedge
The authorities remain fully committed to the implementation of the measures decided to foster job creation and improve business cost competitiveness by reducing the labor tax wedge.
The Crédit d’Impôt Compétivitié Emploi (CICE), which is a tax credit equivalent to 6 percent of gross wage targeted on lower wages than 2.5 times the minimum wage, has been fully implemented and will amount to EUR 19 billion labor cost reduction in 2017. The Pacte de Responsabilité et de solidarité (Responsibility and Solidarity Pact) amounts to EUR 20 billion and includes a reduction in social security contributions which has been implemented since April 2016.
These measures, which represent a positive supply shock of almost EUR 40 billion (close to 2 percent of GDP), are already bearing some concrete positive results: the growth of the unit labor cost in France has decelerated (+0.8 percent annually on average between 2013 and 2015 after +2 percent between 2000 and 2013 according to Eurostat) and has been lower than in Germany (+1.9 percent) and in the euro area on average (+1 percent).
To complement this labor cost reduction, a hiring bonus (so-called “Embauche PME”), targeted on lower wages less than 1.3 times the minimum wage, was created in January for new hires made in 2016 in SMEs, and was recently extended to next year hires. Furthermore, the President’s recent announcements regarding the last phase of implementation of the Responsibility and Solidarity Pact in 2017 included the increase of the CICE to 7 percent of gross wage, corporate income tax cuts for SMEs, and EUR 150 million tax cuts for self-employed workers.
Enhancing the business environment and improving the functioning of goods and services markets
The government continues its efforts to reduce the red tape faced by businesses, through the so-called “choc de simplification,” and thus improves the business environment. On February 3, 2016, the authorities announced new measures focused on jobs and innovation, notably the simplification of applications for the Research Tax Credit (Crédit d’Impôt Recherche - CIR).
The Growth, Economic Activity, Equal Economic Opportunity Act (so-called Macron law) adopted last summer has enhanced competition across the economy by opening-up various regulated professions, better aligning their fees with costs as well as extending the possibilities for Sunday and evening work hours. Since the adoption of this significant reform, its implementation has made tremendous progress since almost all the implementing decrees are published.
In the same vein, the transparency, anti-corruption and the Economic modernization Bill, which is currently before the Parliament, will ease the creation and growth trajectories of VSEs and SMEs, and the access to certain self-employed professions through a streamlining of qualification requirements.
Improving the functioning of the labor market
As indicated by staff in its report, several structural reforms (the 2013 Job Security Act, the 2015 Act on Labor-Management Dialogue and Employment – so-called Rebsamen law - and the Macron law) have been implemented over the last years to improve the functioning of the labor market. The overall objective is to give businesses more leeway to adapt to their environment while providing employees with greater protection during times of career change, particularly periods of unemployment.
Building on these achievements, the draft Labor Bill (so-called El Khomri law), which is currently before the Parliament, aims at modernizing the functioning of the labor market by promoting social dialogue, providing greater predictability to companies as well as making career paths more secure.
First, the El Khomri law will increase the decentralization of the labor market’s functioning and expand the scope for negotiation between social partners at the firm level, notably by shifting the responsibility from the branch to the firm level on determining how work is organized and working hours. Collective bargaining rules will be reformed to make agreements more effective. The occupational sectors’ contribution to regulating competition between businesses will be reasserted and the number of branches will be reduced from 700 to 200 over four years.
Second, the objective of the Bill is also to give greater visibility to companies in order to encourage hiring people on permanent contracts. Indeed, it identifies and spells out the economic difficulties faced by a company that can justify economic layoffs. In addition, a decree will set an indicative scale for compensations that labor tribunals can hand down for redundancies found to be without real and credible grounds, giving heightened visibility to both employers and employees.
Third, the Bill introduces new safeguards, particularly for employees with little job security and young people. The Personal activity account (CPA), that will enter into force on January 1, 2017, will allow all workers to accumulate entitlements throughout their career, regardless of their status (salaried employee, self-employed worker, civil servant, jobseeker), particularly for training or support in setting up a business.
The final adoption of this draft law by the Parliament is expected in the coming days.
4. Financial sector
Since the financial crisis, French banks have made significant progress in strengthening their balance sheets, in application of the new regulatory requirements. As indicated in the report, they have significantly increased their capital level and improved their liquidity position, as illustrated by the reduction of their dependence on short term wholesale funding and the decrease in their loan-to-deposit ratios. Compared to the European average, French banks appear relatively more profitable. The quality of their assets was confirmed by the AQR led by the ECB in 2014 and which has led to one of the smallest adjustments within the euro area. French banks have lower non-performing loans (NPL) ratios than the European average and their cost of risk remains under control.
Concerning the challenges facing the French banking system, we acknowledge that the current environment of low interest rates puts some pressures on banks’ profitability, in particular in a context of regulatory uncertainties since there are still some ongoing discussions at the Basel committee on further reforms which could increase the capital requirements. However, it is important to underline that this challenge is not specific to the French banking sector and concerns all financial sectors in advanced economies. In fact, the model of universal banking of French banks contributes to their resilience thanks to a diversification of activities and could also ease the evolution of their business model.
In this context, the authorities remain vigilant that French banks strengthen their balance sheets as required by the regulation in order to preserve the financial stability and also that their adaption to this new environment does not negatively affect the economy’s financing.
Last but not least, while we generally appreciate a more important focus on macrofinancial linkages in the Fund’s surveillance activity, we note that the Selected Issues Paper on macrofinancial issues conducted for the Article IV consultation on France is quite detailed on the resilience of France’s biggest banking institutions to market volatility. We consider that it could have been more interesting to focus on the interlinkages between financial developments and the real economy. We also believe that comparing France’s biggest banking institutions with other G-SIBs is not the most relevant approach from a macrofinancial perspective, given the differences among G-SIBs (in particular but not only between European and US banks) in business models and their relative shares in the financing of their domestic economy, as well as regulatory environments (notably on housing loans). Going forward, we agree with staff that it should focus its follow-up work on having a better understanding regarding the transmission channels of financial conditions to economic activity.