Outlook

Despite the Euro Area slowdown and rising trade tensions, growth remains robust and broad based while the employment outlook continues to improve. GDP growth in 2019 is projected at the same level than in the Euro Area (at +1.3 percent). Business climate and consumer confidence have significantly increased since the beginning of the year and are both above their long-term average levels. Tax measures targeted to the middle class and aimed at “making work pay” are increasing household’s purchasing power which in turn supports private consumption. Driven by favorable financing conditions and structural reforms such as the capital taxation reform or the conversion of the CICE into a social security contribution reduction, corporate investment is still dynamic and remains one of the prime engines of growth. While exports are suffering from the weakening of external demand, competitivity gains underpinned by recent fiscal measures help to cushion the impact of this shock and export growth remains well-oriented overall. France’s international attractiveness is improving significantly with inward FDI at historically high levels (France ranked second among European economies in the EY Europe attractiveness survey of June 2019). It is particularly attractive for R&D activities of multinationals and an ecosystem of innovation is building up around tech-oriented entrepreneurs. Reflecting this robust growth performance, job creations have been once again particularly dynamic during the first quarter 2019 and they are expected to remain elevated during the rest of the year. Hence unemployment is decreasing for the 4^th consecutive year. The significant increase in the share of new hiring made under open-ended contracts and the long-term unemployment rate decreased are additional signs of the good health of the labor market.

The current account remains closed to balance (-0,6 percent) and the external position is broadly in line with fundamentals as highlighted by staff. Net exports contributed positively to growth in 2018. Export performance in key sectors such as aeronautics, pharmacy and luxury goods notably helped the non-energy good balance to improve while the service balance remains in positive territory. The primary income balance is largely positive reflecting the capacity of French multinationals to generate revenue abroad. Price competitiveness of French exports has been strengthened by measures taken over the last years to lower the cost of labor. Thanks to a significant rebound in their profit margins, French firms are now better able to compete internationally. Moreover, French competitiveness is also underpinned by a wage growth which is aligned with productivity dynamics over the medium term. Recent labor market reforms aiming at decentralizing further wage bargaining will reinforce the wage setting process to ensure faster wage adjustments in case of shocks. Better wage coordination at the European level, notably thanks to the European Semester and the establishment of National Councils of Productivity, should also help to balance price competitiveness within the Euro Area. In terms of non-price competitiveness, the numerous structural reforms aiming at improving the investment climate and strengthening human capital will translate into further innovation capacity and should contribute to give an edge to French firms on international markets. Higher profit margins will also help firms to invest and innovate.

We broadly agree with staff forecast that next year growth will remain resilient and that the unemployment rate will continue to decline. Supported by the various structural reforms undertaken over the last years, France growth will continue to benefit from its strong domestic demand (+1,3 percent). Increased households’ purchasing power coming from tax reduction will continue to support domestic consumption. Firms will benefit from improvement in the business climate and workers from better income prospects. Nonetheless, we also agree with staff that there are several downside risks to the outlook notably stemming from a potential weakening of the external environment. An upside scenario, where activity picks-up more than expected as reforms recently implemented produce their full impact earlier than planned, cannot be ruled out.

Reform Strategy

My authorities remain strongly committed to a comprehensive reforms plan aiming at modernizing the French economy while ensuring the conditions for equal opportunity.

One can acknowledge that the pace of structural reforms, not seen for decades in France, has not abated over the past year. Indeed, since the last Article IV review, the labor market reform, additional growth-friendly tax measures, an overhaul of the apprenticeship and vocational training system and several reforms of the education system have been implemented. In the context of the yellow vests movement, a package of additional measures have been decided to reinforce the orientation of the already-implemented reforms, namely strengthening the purchasing power of the low to middle-income workers and reducing the overall level of taxation. Staff should therefore feel reassured regarding the determination of our authorities to pursue the implementation of their reform agenda. In such a context, our authorities don’t consider that there is a risk of a slowdown of the reform momentum.

Moving forward, a package of additional transformative structural reforms is already well advanced in its preparatory process:

• - Unemployment insurance reform: while on a continued decline, the unemployment rate remains elevated. The reform, that has been made public in June 2019, will both strengthen the access of unemployed people to training and incentivize work by increasing the requirements to access to the unemployment benefits. Importantly, rules that define the possibility to cumulate unemployment benefits with wages from part-time activity will be reviewed to remove disincentives to return to full-time jobs. Additionally, the ceiling of unemployment benefits for high wage earners, that was elevated compared to other European economies, will be lowered and a bonus-malus mechanism aiming at disincentivizing abusive recourse to short term contracts in certain sectors will be introduced.

• - Pension reform: the existing pension system relies on a pay-as-you-go mechanism, that is effective in preventing poverty within the elderly but is complex (with 42 different pension regimes) and does not entail an automatic mechanism to ensure the financial sustainability of the system depending on demographic variations. While past parametric reforms have created the conditions for the financial sustainability of the pension system¹, some uncertainty remains due to the difficulty to predict demographic trajectories and to forecast growth over the long term. Moreover, the age of effective retirement is lower in France than in many peers. The reform under preparation would create a universal pension system with the same level of contribution giving access to the same right to pension, thus creating a major simplification of the system. The new mechanism will be calibrated so as to ensure intergenerational equity and the quasi-automatic financial stability of the system.

• - Civil service reform: the reform aims at modernizing the civil service to make it more agile, more open and more attractive. It will create the conditions for public administrations to adapt more flexibly and swiftly to their changing missions and new environment, notably to reap the benefits of new technologies. One of the main features of this comprehensive reform will be to facilitate the recourse to temporary contracts (rather than relying quasi exclusively on employed-for-life civil servants) depending of the need of the different administrations. The reform will also simplify greatly the decision-making procedure for posting of civil servants with the aim to increase mobility between administrations.

• - Healthcare: the reform presented by staff in Box 2 will be adopted by the end of the Summer.

• - Competition: some precise measures have been announced to enhance competition, facilitate entry into several markets and increase the level the playing field. In the coming months, our authorities will engage reforms to combat rent-seeking behaviors in the car spare parts market, the driving license schools and the condominium associations (“syndic”). While we note staff’s assessment regarding possible progress on retail distribution, sales of medicines and professional services, we feel that the PMR index should be used with caution to derive potential growth gains, as it is done in the dedicated selected issues paper. Some features of the PMR calculation have no direct relation with the intensity of competition, such as the state ownership in some companies (for example, despite a publicly-owned operator, France telecommunication sector is very competitive with a comparatively high number of competing firms resulting in low prices).

While all those reforms will contribute to ensuring the financial sustainability of the social protection system, they also pursue wider objectives such as ensuring adaptation and modernization in a context of rapid socioeconomic transformation and creating the conditions for an inclusive growth model. On the latter, as highlighted in Annex V, France has one of the lowest poverty rates in the OECD and disposable income inequality has been broadly stable over time, which contrasts with the trajectory of many other advanced economies. Those positive results are the direct outcomes of a redistributive tax and benefit system and the constant attention to social cohesion. Those results could have received more emphasis in the core of the report since they are closely related to other dimensions, including the chosen fiscal consolidation path. We have doubt on the robustness of the indicator on intergenerational mobility put forward in the core of the report, since cross-border comparison of intergenerational mobility is technically difficult and some literature points to different results. France also has one of the lower genders pay gap in the world and relatively high female participation. Nonetheless, some dimensions of inequality and the differentiated impacts of reforms remain insufficiently apprehended, such as the differentiated impact of carbon taxation on households’ disposable income depending of their location.

Our authorities are committed to the transition to a low-carbon economy. France’s ambitions in term of climate change mitigation is defined by its Nationally Determined Contributions set in the 2015 Paris agreement augmented by the objective of reaching carbon neutrality in 2050 set in the 2017 Climate Plan. To operationalize these commitments, France has designed and adopted a multiyear strategy to reduce carbon emissions (Stratégie Nationale Bas Carbon) which defines sectoral ceiling emissions and lays out concrete measures to reach these sectoral objectives. A wide range of tools have already been deployed to reduce the carbon footprint of the economy including an already high carbon tax, participation to the European emissions trading scheme and ambitious sectoral regulation notably in the housing and transportation sectors. Following the yellow vests protest, the government has decided to maintain the carbon tax at its current level. The Grand Débat National clearly highlighted that French citizens were deeply concerned by climate change and wanted the government to act decisively to accompany the transition toward a low carbon economy while taking compensation measures to ensure a fair burden sharing among the population. With these insights in mind, our authorities are thus committed to continue to implement a strong climate mitigation agenda.

Public finance

Maintaining a strategy to contain spending growth and durably put public debt on a downward path.

A consistent strategy has been implemented since the beginning of the presidential term aiming at reducing the level of public spending growth compared to GDP growth. The choice has been made to privilege a durable containment of the rise in public spending, despite inflationary trends related to ageing and health costs. This strategy seems adequate given the findings of the updated benchmarking exercise presented in Annex VI that France has a relatively high level of spending in most expenditure areas compared to peers with potential efficiency gains in several categories. At the same time, the comparatively high level of public spending in France should be read while bearing in mind the choice made, in contrast with some of its peers, to socialize large parts of the social protection system (health, education and pensions notably). This feature of the French social model makes international comparisons somewhat difficult to interpret and does not automatically entail lower value-for-money in terms of services (health and education being good examples of sectors where public provision can prove particularly cost-effective).

The fiscal strategy is bearing fruits. The fiscal deficit has been reduced further to reach 2.5 percent and the fiscal debt stabilized at 98.4 percent of GDP at end 2018. Those results have been obtained thanks to a slow-down of the public spending increase (+0.3 percent in volume without the tax credits, compared to + 1.4 percent in 2017). Those efforts will be maintained in 2019. While the transformation of CICE into a permanent cut of social contributions will provoke a one-off increase of the public deficit to 3.1 percent of GDP, the deficit will be reduced toward 2.3 percent of GDP without this exceptional factor. The public deficit will then decline further to reach 2.1 percent in 2020, 1.7 percent in 2021 and 1.3 percent in 2022. Our authorities’ projections diverge from staff’s projections over the medium term given the new methodology used by staff that takes into account only the impact of legislated measures. We would insist in this regard that an increase of the public deficit after 2020 in a context of continued growth appears highly unlikely and contradicts our authorities’ plan and intentions. According to our authorities’ projections, the public spending ratio would decline by 2,9 points of GDP over the presidential 5-year term and the tax to GDP ratio would decline by 1,3 point over the same period. Moreover, the public debt structure, with long average maturities, is a factor of resilience to a rise in interest rates.

Clear objectives have been set for all the segments of public spending:

• - Central government: the contribution of the central government to fiscal consolidation efforts has been significant. In real terms, the central government spending increased by +0,5 percent in 2018 and they decreased by 1,1 percent in volume.

• - Local authorities: as highlighted in the selected issues paper on subnational fiscal policy, the innovative contractual relationship set up with local authorities has performed well. It created the conditions for a significant decrease of the current spending level of the local authorities (+0,3 percent in 2018 when the objective was set at +1,2 percent and when it increased by +2 percent in 2017).

• - Social spending: for the second year, the financing need of social security administrations were in a positive territory. This is notably due to the target for health insurance (ONDAM) being met for the ninth year in a row.

A resilient and well capitalized financial sector, serving well the economy

Our authorities share the positive assessment of the French financial system and the recognition of its robustness and resilience. Significant progress has indeed been made since the last 2012 FSAP in many key areas as reflected in the report. The French banking and insurance industries have been experiencing an increasing amount of prudential regulation emanating mainly from European ruling (CRR/CRD IV, BRRD, Solvency II). As a consequence, capital, asset quality and liquidity coverage in the banking sector as well as solvency ratios in the insurance sector have markedly improved and are at adequate levels to absorb adverse shocks, including in tail scenarios. Regulatory Tier 1 capital to risk-weighted assets reaching 15,4 % in 2018 from 13,2% in 2013, Liquidity Coverage Ratio and Net Stable Funding Ratio are above 100 percent for both G-SIBs and other banks. The insurance sector reached a general Solvency Capital Requirement coverage ratio of 240 percent at the end of 2018, following an increase by 6 percentage points from end-2017.

The Financial Conglomerate (FC) business model has been effective in allowing optimization of products generation and distribution, income flows, resources allocation albeit having led to internal reorganizations when necessary. The oversight of the latest key component of the French financial system including investment service providers and asset managers has been heightened in line with the 2012 FSAP recommendations. As duly underscored by staff, the supervision by the Autorité des Marchés Financiers (AMF) over investment service providers has been stepped up across all categories through onsite inspections and macroprudential tools are available, albeit not active, for the asset management industry.

In this regard, France has strengthened its institutional arrangements for macroprudential policymaking in a context of rising nonbank financial intermediation. Reforms set out in the Loi PACTE approved in April 2019 intended to facilitate SMEs’ access to diversified financing included IPO, private equity, crowdfunding and ICO under the supervision of the AMF for the latter through the creation of a “visa”. France is also advanced in terms of resolution preparedness, less significant banking institutions, which fall within the scope of the Autorité de Contrôle Prudentiel et de Résolution (ACPR), are at an advanced stage for recovery and resolution planning cycles. Moreover, a comprehensive resolution framework has been set up for insurance institutions.

The micro and macroprudential oversight have been strongly reinforced and financial stability risks have been mitigated through preemptive measures. Reacting to the main FSAP recommendations, we would like to add the following considerations:

• Preemptive Management of Systemic vulnerabilities: the recommendations referring to the use of Pillar II measures to address residual risks related to corporate exposures do not fall directly and solely within the scope of French authorities. The development of an analytical framework for borrower-based measures for corporates seems difficult to endorse in an open economy like France where companies can raise funds from foreign investors. The French authorities assess this recommendation as smacking more of factual impossibility than a challenge as presented in the report. They also recall that the use of a sectoral systemic risk buffer, which will be included in the next banking legislation under the CRR II and CRD V, is not currently allowed by CRR/CRD IV which only allows to apply the SRB on all institutions or some of them, without distinguishing between exposures. The reduction of the debt-enhancing tax bias will come in the coming years through a decrease in the corporate income tax which the authorities consider adequate while preserving the balance between public finance considerations and fair tax competition. Moreover, and as indicated above, the Loi PACTE already enlarges the long-term financing options for very small, small and medium-size companies.

• - Ensuring adequate liquidity management and buffers: disruptions in wholesale funding markets could cause additional costs and translate into higher risks to profitability and solvency. Still, the issues raised on USD funding only concern a couple of banks and should not be made a general issue for the French banking system as a whole. At the same time, liquidity is not a major risk for life-insurance activities and liquidity and leverage related tools already exist in France in the 2016 Loi Sapin II which namely encompasses “gates” mechanisms to cap fund repurchases.

• - Further integration of financial conglomerate oversight: the FC business model has acted as for now as a strong safeguard for banking and insurance groups’ profitability and risk profile through diversification effects that enable more regular revenue and economies of scale with respect to the distribution network. This model has proved to be relevant given the context of low interest rates environment and the digitalization process. However, we agree that operations of the conglomerates cannot be only contemplated from the point of view of their component bodies. Moreover, we see a link between applying a risk-based approach at the group level and removing the impediments to free circulation of capital and liquidity within the Banking Union. The integration of a conglomerate dimension in the resolution framework could be further examined in this respect and addressed from a European perspective as it would require a revision of BRRD.

• Enhancing governance, financial policies and financial integrity: the institutional setup has been actively reinforced after the financial crisis and has proven to be effective in producing thorough and shared diagnostics on vulnerabilities and taking adequate actions to remedy them. The HCSF benefits from the contribution of its various members-institution and the principle of collegiality enables candid and open discussions. As regards the funding of those institutions, we do not share staff’s view that they should be exempted from the constitutional and legal framework that applies to budget appropriation. As for regulated savings products, their large popularity within the French population and their important role in the saving structure for low and middle-income earners could make radical shift difficult. Transitioning to more market-based products would be politically difficult. Nonetheless, steps have already been taken to upgrade the method of calculation of the interest rates of these products such as Livret A whose new rate calculation will come into force next year. Lastly, the authorities fully agree with the need to enhance AML-CFT supervision of smaller banks rated as high-risk.

• Reinforcing crisis management safety, safety nets, resolution arrangement: the authorities feel that an enhanced resolution framework for insurers should be the task of European Union supervisory and enforcement authorities and would again insist on the need to focus on France’s fields of jurisdiction. Such a framework does not exist at the EU level and as said, France is clearly far more advanced in this regard.

The strengthening of the regulatory framework allows for a more effective fight against corruption.

France was pleased to volunteer to have its anti-corruption supply-side provisions reviewed by staff in partnership with the OECD’s Working Group on Bribery. The Law on Transparency, the Fight Against Corruption, and the Modernization of the Economy (adopted in December 2016) has very effectively complemented the tools to better prevent, detect and sanction corruption and related offences with proportionate, effective and dissuasive sanctions. This is already being demonstrated by the resolutions of cases since the adoption of this law, whether they are resolved through trials or through settlement agreements, while enhancing cooperation with foreign authorities. Going forward, we encourage other IMF members to submit themselves to this voluntary review process.