Recent developments, outlook and risks

Our authorities broadly share staff’s view on the short-term outlook: the economic recovery from the pandemic has been strong, though the consequences of Russia’s war in Ukraine are now weighing on the 2023 forecasts. Following the publication of the 3rd quarter national account figures (+0.2% q/q, after +0.5% q/q – non annualized), the carry over for 2022 is +2.6% (after +6.8% in 2021). Regarding 2023, according to the latest official forecasts, the government was slightly more optimistic on growth at 1.0% versus 0.7% in the report) and expected slightly lower inflation (4.7%, HICP, versus 5% in the report). These differences are marginal compared to the still very volatile global outlook. As noted by staff, the labor market has been particularly strong, with the unemployment rate declining from 8.2% in the fourth quarter of 2019 to 7.3% in the third quarter of 2022, reflecting in part labor market reforms and programs targeted on the youth. France’s dependence on Russian gas is more limited than its main EU partners; as mentioned in the report, the share of natural gas in French energy supply is lower than the EU average and imports by pipeline from Russia accounted for less than 15% of natural gas supply before 2022.

French authorities have a more balanced view on risks and are more optimistic on medium-term prospects. While we agree that the main downside risk to this outlook stems from a prolonged war and additional inflation pressure, risks seem more balanced than highlighted in the report. In particular, we consider that gas and electricity prices could go both ways going forward, a view supported by the marked decrease in prices observed over the last months and that, as documented by a recent Fund’s Working Paper, the likelihood of a wage-price spiral is low. The risks to gas and electricity supplies are now limited for the current winter, thanks to the measures taken to replenish gas stocks before the winter, the reduction in energy consumption made possible by the sobriety plan, as well as the restarting of nuclear reactors that were under maintenance. Although gas supply issues for the winter of 2023-2024 warrants close monitoring, the risks have decreased thanks to the exceptionally high level of gas stocks at the beginning of 2023. Regarding the medium-term, we expect faster growth than the Fund, as we estimate less scarring from the Covid and energy crisis and thus more catch-up potential. Private consumption should also be supported by a gradual decline in the savings rate, from its current historically high level. Finally, as we will develop below, our authorities also expect a boost in potential growth over the medium term from the effect of labor market and pension reforms.

Fiscal policies

The Government’s first priority is to respond to the urgency of the crisis by protecting households and businesses from exceptionally high short-term inflation, while maintaining public deficit under control and significantly reducing energy consumption. In 2022, France has put in place an extensive range of temporary protection measures to cushion swiftly the impact of the rise in energy prices for households and businesses, which has limited the adverse impact on confidence, investment, consumption and consequently growth. These measures were compatible with sound public financial management. Underpinned by the resilience of the French economy in the global uncertain context, the public deficit continued improving in 2022, reaching -5.0% GDP, and is expected to stabilize in 2023 as the Government continues to support most affected households and companies in the face of rising energy prices.

For households, income measures and transfers have been swiftly implemented and are gradually more targeted. As detailed in staff report, a tariff shield on electricity and gas prices benefiting also to some very small businesses has been deployed from October 2021 and extended until 2023. It is important to note that gas prices in October 2021 were already 50% higher than in January, which is already quite a sizeable price signal. As of January 2023, the gas price cap has been increased by 15%, whereas the electricity price cap will be increased by 15 % as well in February. For 2023, the existing untargeted “fuel discount” is removed and replaced by a “fuel allowance” targeted on the poorest households using their vehicles to go to work.

For businesses, a series of short-term measures has also been implemented to protect the most affected companies and the energy-intensive companies and attempt to limit the transmission of rising energy prices to sales prices. A new cushioning mechanism is currently being deployed to cover part of the electricity bill of very small businesses that do not benefit from the tariff shield and SMEs. France remains otherwise attentive to specific sectorial situations: targeted measures have been taken in favor of the sectors most exposed to rising input costs (agriculture, transport, construction and more recently, the bakery industry). The cost of all these measures would amount to 2 1/2% of GDP but their impact on the public balance would be largely offset by fiscal windfalls from renewable energy producers funding (1.3% of GDP), for a net cost around 1% of GDP.

Going forward, the French authorities are committed to find the right balance between supporting the most exposed households and firms and recreating fiscal buffers that would reinforce the government’s ability to handle future shocks. The policies implemented retain and fully integrate the objective of medium-term fiscal adjustment, based on a structural and sustainable adjustment which requires a broad buy-in in ambitious structural reforms and an effective mitigation of the risk of social unrest – hence the critical importance of the protection measures. Our authorities share the view that these protection measures are temporary and will gradually be better targeted. The pace of the adjustment will depend on energy market developments and will aim at gradually increasing the price signal passthrough, to keep incentives in line with our commitment to the green transition. The multiyear fiscal consolidation should strike the right balance between gradually rebuilding buffers, supporting the recovery and boosting potential growth. The fiscal trajectory considered by the authorities plansto bring the public deficit back to below 3% of GDP in 2027. It also aims to get the debt on a declining path by 2026. Given an already high tax-to-GDP ratio, this consolidation will be achieved by boosting potential growth factors, improving spending efficiency, and controlling public expenditure, while protecting investment needs for the green and digital transition. Reforms and some other areas for potential savings identified by staff in this regard appear broadly relevant and our authorities believe that the generated savings, growth and jobs will bring the deficit to target. Our authorities agree that the adoption of the medium-term programming bill is important for the credibility of fiscal targets and highlight that the new fiscal framework is already effective, with the spending review mechanism already been included in the annual financial bill. The medium-term programming bill is still in legislative procedure and the Government is working to get a positive vote in both houses of Parliament.

Unemployment benefits and pension reform are underway. Since the staff report was finalized, France has specified the key parameters of the pension reform, which are broadly in line with staff advice. It will aim to increase the active population and activity rate by increasing the effective retirement age, supporting the employment of seniors, and strengthening the sustainability of the system, while providing for careful adjustments to specific situations and increasing the minimum pension. The legal retirement age will be gradually raised to 64 by 2030, from 62 currently. The contribution period required to benefit from a full pension will also be gradually extended to forty-three years by 2027 – instead of by 2035. Finally, main special sectoral pension schemes will be extinguished.

Financial Sector

Our authorities broadly share staff’s view on the buildup of financial risks amid the tightening of financial conditions and consider that the French financial system is in a favorable position to face this new environment. Banks and insurers are in a solid financial and prudential position; the CET1 capital ratio of the six main banking groups is close to its all-time high and insurers’ solvency capital requirement coverage ratio increased in the first half of 2022. At the European level, the EBA with the SSM will carry out new stress tests in 2023 on the resilience of EU financial institutions. While staff recommends targeted liquidity support measures for critically integrated wholesale energy producers to cover margin requirements, the liquidity situation of French energy producers has been closely monitored by the authorities and such measures have not been deemed necessary so far. Despite extraordinary volatility in gas and electricity prices, these companies have been able to cover their margin requirement in 2022¹.

On other financial actors, our authorities consider that we collectively need to swiftly advance on reinforcing the regulatory framework for NBFI, with reforms currently under discussion at EU level. Advances are also made in Europe on cyber risks – as the DORA regulation will provide a framework for increased resilience and critical third-parties monitoring – and crypto-assets – with the adoption of the “Digital Finance” package including MiCA. To be effective, these efforts need to be pursued but also followed by the swift adoption of similar packages in other parts of the world.

As for the housing market, risks need to be monitored closely but are considered limited in France, thanks both to the implemented macroprudential measures, in particular borrower-based limits imposed by the High Council for Financial Stability on home loans, and the fact that over 97% of housing loans are at fixed rate, shielding current contracts from the effect of the increase in interest rate. In addition, the interest rate cap (usury rate) has proved successful in hedging borrowers from significant increases in interest rates. At this stage, with only limited constraints have been observed on first-time buyers.

Regarding macroprudential policy, in line with staff position, the High Council for Financial Stability decided in December 2022, following a previous announcement in September, to raise the credit protection reserve (i.e. the countercyclical buffer, CCyB) to 1%. In 2023, the economic slowdown calls for a balanced approach, avoiding to be procyclical or restrictive, in a context of monetary tightening. This could mean “pausing” the countercyclical buffer at 1%. We will also keep the “structural” measures in place regarding lending conditions for housing loans; and we will remain very vigilant regarding the detection of systemic risks, especially in commercial real-estate and the non-bank segment. The macroprudential measure regarding banks’ exposure to highly indebted non-financial corporations remains in place

Finally, the current environment should not slow down progress towards better accounting for environmental risks, and our authorities will continue supporting the disclosure of sustainability-related information – which will become compulsory for European banks in 2023 under ESG Pillar 3 – and the operationalization of transition plans and stress tests. France will remain at the forefront of sustainability-related disclosure both regarding financial stakeholders and non-financial corporates.

Structural policies

The reforms introduced by the French government during the last presidential term are paying off, driving an unprecedented momentum in the labor market and putting an end to two decades of dwindling competitiveness for French companies. Ongoing efforts will deepen their effects. Hence, the government’s actions revolve around four pillars.

First, the Government is investing massively to increase the pace for green transition and has implemented ambitious reforms and programs to deeply reduce the environmental impact of our consumption patterns. Recent GHG emission trends are encouraging, but the pace of emission cuts must increase. France will raise its greenhouse gas emissions reduction objective to around 50% versus 1990 levels by 2030 and achieve carbon neutrality by 2050. Two investment plans (France Relance and France 2030) are financing the decarbonization of industrial sites and the development of infrastructures, green mobility, low-carbon energies and technologies, and enhancing energy retrofitting of housing and public buildings. In addition, we share the view that carbon pricing should be enhanced, in particular at international level. We consider that increases in carbon pricing should be reflected in a medium-term manner, encompassed in a planned strategy of decarbonization and be part of a broader package of climate measures, for efficiency and acceptability reasons. France and the UE are implementing a clear medium-term strategy of strengthening the carbon price (Fit for 55 with strengthening of the existing EU ETS and the extension to housing and road transport sectors).

Second, France aims at achieving full employment and reducing recruitment pressures notably by modulating the duration of unemployment insurance benefits according to the labour market situation, improving skills development, and promoting senior employment. The unemployment benefits reform, the pension reform, the expansion of the Youth Employment Contract, and various training measures (including amplify apprenticeship dynamics) will strengthen incentives to return-to-work and integration initiatives for workers who are far removed from the labor market, harness senior employment to strengthen the workforce, and expand skills and occupational horizons. Other priorities will be implemented to achieve this goal of full employment, including renovate the public employment service (by creating France Travail), and reform the support for RSA beneficiaries and better integrate those who are furthest from employment.

Third, the COVID-19 crisis and the Russia’s war in Ukraine have shed the light on some strategic vulnerabilities, linked in particular to supply-chains disruptions. Our authorities aim at bolstering the resilience of our value chains and ensuring France’s energy, economic and digital sovereignty. The implementation of a “sobriety” plan to reduce energy consumption and secure short-term supply, while contributing to a sustainable change in behaviors, will be coupled with a medium-term strategy of diversifying sources of supply with low-carbon energies, notably the Renewable Energy Fast-Tracking Bill and strengthening our nuclear industry (including the construction of new EPRs).The latest figures already reflect significant efforts to save energy, the average electricity consumption has been for instance 7,6% lower during the month of December 2022 compared to December 2021. The authorities also aim at bolstering the competitiveness of French businesses by simplifying further the business environment, strengthening their capacity for innovation in strategic sectors (notably hydrogen, batteries semiconductors, digital data) with the continuation of the Program of Investments for the Future (PIA 4) and more recently the France 2030 investment plan, and closing the digital divide in regions by finalizing the country-wide rollout of mobile and high-speed broadband coverage. We plan to go even further by becoming the first green industrial nation in Europe. Moreover, the removal of the remaining share of the value-added contribution for businesses (CVAE) will deepen the cut in distortive production tax initiated over the last five years to the benefit of firms’ competitiveness.

Fourth, building equal opportunities remains a top government priority. The French authorities plan to increase investment in education by supporting pedagogical innovation and creating an environment conducive to the development of academic ambition for all. It also involves an increase in the attractiveness of the teaching profession, in particular by taking better account of salary and working conditions. We also aim to provide support in early childhood care with the massive creation of additional daycare spots, to promote access to healthcare and disease prevention for instance with free consultations at key moments in life, increase the assistance to elderly and the autonomy of people with disabilities to face the challenge of aging, and expand access to decent housing for all, in a context of increasing life costs