On behalf of our authorities, we thank staff for their report and constructive policy discussions during the Article IV mission. Since the last review, the macroeconomic situation of France improved markedly. Growth reached 2.3 percent in 2017 – its highest level since 2007 – and the rebound has been broad-based, notably driven by strong investments and a positive contribution of exports. The current account deficit decreased slightly and the public deficit decreased significantly further both in nominal and structural terms. Such positive developments result from both the impact of structural reforms, leading notably to the restoration of firms’ profit margins, as well as from a more benign external environment.

Against this backdrop, our authorities are dedicated to implementing a comprehensive and far-reaching structural reforms agenda to be rolled-out over the five-year presidential mandate with the overarching goal of transforming the French economy and modernizing its social protection system.

In the current context of rising international tensions, France remains a strong proponent of multilateralism and international cooperation, notably in the domains of trade, tax, financial regulation and sustainable financing of development. My authorities also strongly support a further deepening of the European Union integration as well as of the European Monetary Union in order to enhance both their resilience and the convergence of their members. The joint statement of Meseberg by the French and German heads of state puts forward major proposals to progress further in this direction. Importantly, France remains committed to achieve its carbon emission reduction objective, consistent with the Paris agreement on climate change.

The pace and reach of the structural reforms currently implemented in France is without precedent over past decades.

A comprehensive and far-reaching set of reforms aiming at strengthening growth, enhancing job creation and restoring competitiveness has been adopted and is already implemented. The impact of structural reforms and will materialize progressively, but the first effects have already been felt, notably in terms of business confidence and international investors’ perception.

• - Labour market reforms. Unemployment decreased further in 2017 and during the first two quarters of 2018. The reform, adopted in the very first months of the mandate, aims at enhancing job creations by addressing long-standing issues. It will notably increase the flexibility of the labour market functioning and its predictability for firms. One important aspect of the reform, among many others, is the decentralization at the firm level of significant aspects of collective bargaining that were discussed at the branch-level so far (notably on some parts of the compensation packages and on working hours). This will increase the ability of firms to react to changing economic conditions. Moreover, dismissal procedures have been simplified and their cost reduced which will provide greater security to firms in their hiring decisions and decrease the duality of the labor market.

• - Tax reforms. A major set of tax measures have been adopted to support firms’ investments and enhance the attractiveness of the French economy, as well as channeling savings towards productive investments and reducing the debt bias. The Budget for 2018 provides for a gradual reduction of the corporate income tax rate from 33 percent to 25 percent by 2022. A comprehensive flat tax of 30% applies to all capital income earned by individuals as from January 1^st, 2018 (to be compared with a total rate of taxation on capital income that could reach 60% under the previous regime). The personal wealth tax is from now on limited to real estate assets incentivizing productive investments and risk-taking. Moreover, employees’ social contributions to health insurance is eliminated to reduce the labor wedge and compensated by an increase in the broad-base part of the personal income tax (CSG), rewarding labor income for workers and reducing labour cost for firms.

• - Education reform. Improving human capital is a key pillar of our authorities’ strategy to adapt the French workforce to a fast-changing environment, enhance productivity and increase equality of opportunities for all. The University reform tackles the longstanding issue of the transition from secondary to tertiary education. It does so by strengthening the guidance of students towards the curricula with higher subsequent chances of hiring and it improves the matching between students’ choices and universities’ curriculum through a set of explicit qualification criteria. In primary education, 1^st years classroom size has been halved in the most vulnerable neighborhoods, a measure with already-assessed strong impact on students’ performances.

Our authorities reaffirm their willingness to keep up the pace of reform aiming at modernizing the French economy, enhancing the growth potential and strengthening the training system.

France reform momentum continues in 2018:

• Draft law PACTE, approved by the Cabinet in June, will be adopted by the end of the year 2018. It addresses a wide range of issues aiming at spurring investments, promoting innovation and improving the business environment. It notably entails a simplification of the different regulatory thresholds applying to SMEs and a streamlining of the rules related to firms’ creation. Savings will be increasingly channeled towards productive investing through a modification of the regulatory framework of both supplementary pensions savings and life insurance savings. It will also facilitate employees’ incentive compensation scheme in firms smaller than 250 employees. Firms’ insolvency regime will also be streamlined (through the introduction of cross class cram down in the regulatory framework).

• CICE (so far, a tax credit reducing the labor cost at the lower end of the wage distribution) will be transformed in a permanent cut in social contributions in order to enhance transparency as regards the effective tax wedge. Over the past decades, the tax wedge has continuously declined at the minimum wage level. Therefore, rather than comparing minimum wage (SMIC) to median wages ratios, we reiterate our call for staff to compare the total labor cost at the minimum wage level with the total labor cost at the median wage level. Otherwise, the impact of the continuous decrease of the tax wedge at the SMIC level is not taken into consideration and the assessment of the impact of the SMIC indexation formula can be misguided. The ratio of the total labor cost at the minimum wage level to the total labor cost at the median wage level dropped below 50% in 2014 and remained below that level since then. The conversion of the CICE into a social contribution cut will exacerbate the decrease of labor cost at the minimum wage. More generally, apart from the crisis period in 2008-2010, France’s real wages have evolved in line with productivity both pre- and post-crisis (real unit labor cost being flat both between 2000-2008 and between 2010-2017). Moreover, most of the gap between labor cost and productivity growth that appeared during the crisis has been reduced by the CICE and other measures that have reduced social contributions. As clearly stated in last year’s Article IV selected issues paper on French competitivity, France’s nominal unit labor cost has been in line with the average of the euro area since early 2000. The ULC gap with Germany which increased between 2000-2008 due to wage moderation in Germany is now, even if gradually, closing thanks to a more vibrant wages dynamic in Germany and price competitivity measures implemented in France.

• The draft law on professional and vocational training is currently examined by the Parliament. It is a major milestone in the revamping of France’s social model aiming at equipping all individuals with the necessary skills to find a job and reaping the full benefit of the current technological revolution. It will simplify and increase the rights to training of professional, while rationalizing the governance structure of the system and simplifying its financing. To address the fragmented nature of training supply and enhance its quality, a new agency will certify that the training programs impart genuine and appropriate skills, otherwise financing will be discontinued.

• A profound reform of the rail transportation system has been adopted in June 2018. It modernizes French National Railways (SNCF) and aims at ensuring its profitability over the medium-term by modifying its status (transformation into a public limited company). By doing so, it will also level the playing field to new competitors, consistently with the European regulatory framework.

Increasing social mobility, portability of social rights and inclusiveness. Compared to European peers, France has a relatively low level of inequality of disposable income and a low poverty rate (13.6 percent in 2016 against 17.3 percent in EU). The tax-and-transfer system strongly reduces market income inequality as well as the risk of poverty (the poverty rate would be 10 percent higher without social transfers). Against this background, our authorities are of the view that the priority is to enhance equality of opportunity for all in France.

• A reform of the educational system has been launched. Improving the acquisition of basic knowledge is one of its main objectives. The reduction of class sizes for children in the first year of primary school in most vulnerable neighborhoods (corresponding to 12 or 13 students per class in the 2,500 classes concerned) will be extended in the coming years to the second year of school and more geographical areas. Many other will be implemented such as lowering the compulsory school attendance age to three years in 2019 and the reform of the baccalauréat in 2021.

• As in many other economies, France has to deal with the hysteresis effect of the crises on the unemployment rate. This is why, beyond the draft law on professional and vocational training, 15 billion euros will be dedicated to the training of the low-skilled workers and long-term unemployed over 5 years. Additionally, while the average replacement rate for unemployed people is not out of line with the European average replacement rates, some features of the unemployment insurance system encourage regular rotations between short-term contracts and unemployment, contributing to the segmentation of the labour market. Social partners are therefore currently discussing on a potential reform of the unemployment insurance system.

• A wide consultation has been initiated on a reform of the French pay as you go pension system. The main aim of the reform, as presented during the presidential campaign, is to increase the transparency of the system for future pensioners, as well as its equity by ensuring that one euro of contribution opens the right to the same level of pension for all. Regarding the financial sustainability of existing pension regimes, the last report of the independent authority in charge of financial projections of the pension regime (Conseil d’Orientation des Retraites) concludes that the sustainability of the system is assured over the long term. This is notably due to the impact of past reforms, in particular, the automatic increase of the minimum number of quarters necessary to retire with a full-rate pension (to reach 43 years for individuals born from 1973 onwards).

Putting public finances on a stronger footing through the modernization of public administration and by curtailing public spending trends relative to growth.

Due to the measures taken immediately after the presidential election, notably on housing subsidies and subsidized jobs, and in a context of accelerating growth, the public deficit fell to 2.6 percent of GDP, well below the 3 percent European threshold. Consequently, France has exited the excessive deficit procedure under the European rules. Even with the one-off fiscal impact of the transformation of CICE into permanent social contributions cuts in 2019, France will remain below the 3 percent threshold. For the first time since the global financial crisis, the debt to GDP ratio is on a downward trend and it will continuously decrease until 2022 according to our authorities’ last projections. Looking forward, our authorities remain committed to their medium term targets whose broad objective is to put public finances on a stronger footing by 2022: (i) public spending will be reduced by 3 points of GDP over five years; (ii) overall, tax revenues will be reduced by one point of GDP over five years; (iii) the debt to GDP ratio will decrease by 5 points by 2022.

For these objectives to be met, the choice has been made to curtail public spending growth so as to create the conditions for a lasting decline of the ratio of public spending to GDP. The expenditure reduction strategy relies on structural choices and transformative reforms of the administration (at all its levels) and of our social protection model. Our authorities are firmly convinced that such an approach is both more sustainable and politically acceptable than pursuing across the board cuts. Furthermore, in a context of rising external risks, a gradual fiscal consolidation appears well suited not to endanger the ongoing recovery. Concretely, this strategy is translated at all administrative levels:

1. As regards to the central government spending, in real terms, total spending will increase by 1.7 percent in 2018, a significant slow-down compared to the growth level in 2017 (+ 3.7 percent).

2. An innovative mechanism has been created to contain the increase of local authorities spending. The main local authorities subscribed, through a contractual pact cosigned with the government, to an engagement to limit the growth of their operating expenses.

3. Efforts to contain the increase of social protection spending will be pursued. The objective for the health sector (ONDAM) has been set at 2.3 percent for 2018, significantly below the natural growth rate of health expenditures, and will be contained thereafter.

Moreover, our authorities are determined to pursue the modernization of the administration so as to improve the quality of the public services as well as their efficiency. The work of “Action Publique 2022” Committee included avenues for reforms, which were submitted to the government and discussed among its members. The government is designing its strategy in order to curtail public spending on the basis of this report. Two measures have already been put forward. On the one side, public services broadcasters will be modernized and streamlined. One the other side, the digitalization of the tax administration, will allow to reduce the number of public agents dedicated to those tasks. A large consultation has also been initiated regarding the evolution of the civil service with the view to enhance internal and external mobility and to better link compensation levels with merit. Further reforms will be announced in the coming months.

The financial sector resilience has been significantly reinforced since the global financial crisis.

The international standards adopted since the Global Financial Crisis haven been diligently implemented in France, partly through the European regulatory framework. Since the creation of the Single Supervision Mechanism, the ECB and Banque de France jointly exert a close supervision on the banking sector. The capitalization of the banking sector increased significantly since the global financial crisis (from around 10 percent of RWAs before the crisis to almost 19 percent in 2017). Moreover, the French banking system is well advanced in the issuance of bail-inable instruments (MREL requirements) that would allow for the implementation of resolution plans if need be. The non-performing loans ratio is low and on a downward trend (at 3.1 percent in 2017).

Against this sound background, our authorities remain nonetheless vigilant to potential risks. They activated the counter-cyclical buffer in July 2018 in a context of dynamic lending to non-financial corporates. In this regard, my authorities thank staff for the selected issues paper dedicated to the corporate debt in France. To replace this issue in a broader context, it is worth noting that while corporate debt has been overall dynamic, the increase is much more moderate when debt is consolidated among non-financial corporations due to the magnitude of intercompany loans. Additionally, it is worth recalling that household debt level is significantly lower in France than in many European peers (at 58.5 percent of GDP in 2018). Finally, there is no concern regarding the short-term liquidity in US dollar of the French banks. The LCR in USD for the top 5 French banks (which represent 99 percent of USD liabilities) was on average close to 80 percent in 2017 and reached 109 percent at the end of May 2018.