France -- 2009 Article IV Consultation Mission, Concluding Statement
June 29, 2009
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
France has taken decisive actions to address the domestic impact of the financial crisis and the unprecedented global contraction. Crisis management needs to remain a cornerstone of near term policies, but a renewed focus on medium-term fiscal sustainability and a deepening of the country’s ambitious structural reform agenda will help to minimize the longer-term costs of the current downturn.
1. Key policy challenges are addressing the ongoing crisis, while laying the foundation for renewed growth. Given underlying economic structures and early policy action, France has weathered the current crisis better than most other large economies. Nevertheless, the country remains in deep recession, and short-term policies to support recovery are essential. Equally important will be to build a bridge from crisis management to the longer-term structural reforms that are needed to avoid a lasting impact of the crisis on potential output, which is already expected to slow due to demographic changes. The mission sees four key challenges for the French economy:
• The global financial crisis is not over, and additional efforts are needed to uncover the full extent of underlying vulnerabilities. Relatively high leverage ratios and the economic downturn might exert further stress on the financial system throughout the recession. Policy actions based on forward looking recognition of losses will help ensure adequate buffers and restore banks’ lending capacity.
• In the longer term, financial sectors will only work efficiently if they benefit from broad-based confidence. France can support confidence in its financial system through continued adequate supervisory action and full transparency about the financial standing of key institutions. In the context of the ongoing European response to the financial crisis, France can champion a bolder response to necessary reforms.
• Fiscal stimulus and strong automatic stabilizers have been helpful to cushion the downturn in France, but a return to medium-term sustainability will now be needed. The rapidly increasing level of public debt and further aging-related spending in coming years require a credible strategy of fiscal consolidation. To avoid that part of the stimulus expenditure becomes permanent, the authorities should initiate an early review of these measures. Additional fiscal stimulus should only be considered in the event downside risks were to materialize.
• The structural reform agenda holds the key to higher growth and should not be derailed by the crisis. Under the Government’s 2007 program important measures have been implemented, despite the difficult economic situation, but competitiveness remains a concern. The focus should be on lifting labor market participation to the European average, including through a change in the very early retirement age. Renewed emphasis on competition in retail and other services would have benefits, most importantly for consumers’ purchasing power.
2. The global downturn is exacting a heavy toll on the French economy. Output has shrunk at an unprecedented rate and unemployment is rising steeply. The economic contraction is expected to slow in the remainder of 2009, followed by a sluggish return to growth beginning in early 2010. The expected gradual recovery of the global economy and France’s long-standing supply rigidities are likely to weigh on the upturn. Annual consumer price inflation will dip below zero during the summer months but, given entrenched wage and price rigidities, inflation is expected to rebound somewhat in 2010.
3. Although there are some signs that the economic situation is stabilizing, risks remain tilted to the downside. As two-thirds of French exports are destined to the European Union, the economy would be seriously affected by a further contraction in the region. A worsening of the financial crisis could hurt banks’ balance sheets and further depress credit growth. The jump in unemployment this year and next could further shake confidence and weaken private consumption, which has been the bedrock of aggregate demand thus far. Finally, an acceleration of the ongoing house price correction, prompted by the falling house sales and waning consumer demand, could depress construction activity and possibly consumption. The fall-out is likely to be mitigated by the relatively low household indebtedness and the weaker relation between housing wealth and private consumption in France than in other countries.
4. French banks have proven comparatively resilient to the financial crisis thus far. Total losses and write-downs of French banks since the onset of the crisis are below those in France’s peers and considerably less than in the hardest-hit countries. While net earnings have dropped sharply, the decline in valuations of French financial stocks and the rise in perceived default risks have been less than for other European banks. The less negative impact of the crisis on French banks thus far appears due in part to their relatively conservative lending practices and to the consistent supervisory coverage of all lending institutions by the Commission bancaire.
5. The authorities have taken important policy actions to support the financial sector. Capital injections through the Société de Prises de Participations de l’État (SPPE) have enhanced the banks’ capital adequacy. The bank refinancing scheme’s (Société de Financement de l’Économie Française, SFEF) ability to attract a wide range of investors from various market segments and to place debt at very tight spreads has helped banks to expand their lending capacity at low funding costs. Also, the government’s support of the merger between Groupe Caisse d’Épargne and Groupe Banque Populaire with capital injections and the setting of conditions for further government intervention were positive steps in moving towards resolving problems in a subsidiary of these two banks (Natixis). While the authorities are rightly concerned about maintaining credit growth in the economy, the credit targets associated with the use of government funds should be implemented flexibly, in order to minimize distortions. The creation of an independent médiateur de crédit is helpful to ensure fair lending practices. The implementation of some measures under the Paris-Place Financière initiative and the generalized distribution of the Livret A are welcome steps to increase competition and efficiency in the financial sector.
6. Nonetheless, pressures on bank earnings and profitability are mounting and the financial turmoil will likely continue to exert an adverse impact for some time. Earnings risks come not only from decelerating lending and narrowing interest margins, but also from the trading book due to high market volatility and valuation uncertainty. With the turn of the economic and credit cycle, as well as the ensuing rise in defaults, asset quality has deteriorated. Potential losses in corporate and investment banking activities are posing a substantial risk to banks’ financial strength going forward. The mature market bias of French banks suggests that possible spillovers from these markets would have a material impact on their performance. Although a worsening of the economic situation in emerging markets, in particular in Central and Eastern Europe, would increase pressures on French banks’ performance, their comparatively lower engagement in this region will help contain spillovers.
7. In light of the remaining risks in the financial sector, additional measures may be necessary to strengthen financial stability. Although capital adequacy ratios have improved and banks have strengthened their shock-absorption capacity, some amount of deleveraging remains needed. Also, the risky assets still held on banks’ balance sheets as well as the unfolding feedback loops between the financial sector and the real economy suggest the possibility of additional losses and write-downs. The authorities have conducted stress tests and conveyed to the mission their confidence in the banks’ capacity to withstand negative shocks. At the same time, they agree with the mission on the importance of carrying out rigorous, preferably EU-wide coordinated stress tests, focusing on the quantity and quality of capital needed, as well as on the coordinated publication of the stress test results. On the basis of such stress tests, if needed, follow-up action should be taken to further recapitalize banks and ensure sound balance sheets.
8. With integrated financial markets in Europe and close links to the rest of the world, regulatory and supervisory reforms need to be coordinated at the European and international level. France has been very active in promoting and supporting European regulatory reform, including with respect to harmonizing regulatory frameworks; undertaking joint supervision of cross-border banks and insurance companies; and enhancing the transparency and surveillance of non-regulated markets, tax havens, credit rating agencies, and compensation. The mission is confident that France will continue to play a leading role in bringing European regulatory reform to a successful next stage. In this connection, it would also be important to strengthen international cooperation on financial sector exit strategies, particularly on the maximum coverage of deposit insurance and bank-asset guarantees across the European Union, to avoid destabilizing financial flows.
9. The fiscal response to support aggregate demand in 2009-10 has been appropriate. In addition to letting the automatic stabilizers operate fully, the suitably sized package of stimulus measures has been front-loaded and well-diversified. The good public financial management in terms of closely coordinating and monitoring the execution of the stimulus measures is helping to keep its implementation timetable on track. It may be prudent to prepare for further stimulus, in case the economic downturn turns out to be deeper and more protracted than currently envisaged. Since fiscal space is limited, such stimulus could also only be modest in size. It should focus on measures with the largest impact on the economy, such as investment spending and targeted transfers, and promote growth by enhancing productive capacity and alleviating financial constraints on SMEs.
10. In view of the strong need for medium-term fiscal consolidation, it is important to ensure that the current fiscal stimulus is indeed temporary. All measures should include sunset clauses or be automatically reversible. This should also apply to the recently announced VAT reduction for restaurants that introduces an additional distortion in the tax system without generating broader economic benefits. The elimination of the part of the Taxe professionnelle that hurts business investment is an important step. Its implementation should be guided by the principle of revenue neutrality without adding to the already high tax burden on enterprises.
11. France’s main fiscal challenge remains to consolidate its public finances as current policies would lead to an unsustainable debt dynamics. With an already high public debt, the cost of the recession and the fiscal stimulus are set to significantly worsen the fiscal outlook over the medium term. The drop in tax revenues in 2009-10, resulting from the sharp output contraction, will lead to uncomfortably high fiscal deficits. Looking ahead, rising debt service obligations will aggravate the fiscal costs related to population aging. Decisive implementation of a clear consolidation strategy at all levels of government needs to be anchored in the 2010 budget. Historical experiences show that successful fiscal consolidations were often launched in the midst of economic downturns or the early stages of recovery. Consolidations were also more successful and durable when focusing on current expenditure reduction rather than on revenue measures.
12. The recent adoption of a multiyear budgeting framework provides a good opportunity to undertake fiscal consolidation in a credible manner and should be strengthened. Ensuring that the multiyear budget projections are based on realistic macroeconomic assumptions would avoid setting spending targets too high. In addition, it is important to clearly articulate specific measures to limit outlays at all levels of government, in line with the consolidation objectives. Hence, it would be important to develop contingent expenditure reduction plans. Increased ownership of the consolidation goals at all levels of government would help achieve the necessary expenditure restraint.
13. The consolidation progress already achieved by the central government is encouraging. The objective of zero growth of real expenditures by the central government would need to be maintained even when rising debt service would force a compensating reduction of other expenditures. We commend the authorities for having achieved the objective of non-replacement of every second retiring civil servant and encourage them to pursue this policy consistently. Caution should be given not to erode the benefits of improved spending discipline through further recourse to already very large tax expenditures and social contribution exemptions (niches fiscales et sociales). In this respect, completion of the general review of the tax system (RGPO) would help streamline tax expenditures. A key element is to undertake annual reviews, incorporated in the government budget, that assess these policies on their relevance, effectiveness, and cost-efficiency.
14. Greater fiscal responsibility at the local government level is vital to healthy public finances. Increased devolution of responsibilities to local governments has so far failed to deliver more fiscal discipline through a clearer connection between the cost and the benefits of public services. The civil service reduction implemented at the central level was broadly balanced by hiring at the local government level. The spending drift by overlapping regional and local government structures would need to be reassessed. In this respect, the arrival of large cohorts of local civil servants to retirement age after 2010 provides an opportunity for savings by extending the policy of non-replacement of every second retiring civil servant to local governments.
15. With an aging population, continued efforts are necessary to ensure the sustainability of the social security system. The reform of special pension regimes in 2007 and the gradual increase of the contribution period needed for entitlement to a full pension in line with the rising life expectancy, will slightly reduce the significant projected financing gaps in the period ahead. Reforming the structure of the pension system could limit its fiscal cost for new entrants in the labor market. However, to improve the soundness of the current system, we encourage the government and the social partners to give serious consideration, as part of the “Rendez-vous 2010”, to raising the legal pension age, which at 60 years remains considerably below that in other euro area countries. With respect to health costs, expenditure control has helped to reduce spending slippages, but not fully eliminated them, and further action is needed. It is also important to adequately take account of rising long-term health expenditures resulting from technical progress in health services and to start preparing an appropriate policy response.
16. Pursuing forcefully structural reforms is essential for increasing competitiveness and growth, tackling the challenges in the public finances, and raising the purchasing power of households. The government has launched a vigorous reform agenda in 2007. In view of the high possible returns, further action should focus on job creation, and on improving productivity and market efficiency. Lifting the French employment rate (65.2 percent of the labor force) to the European average (67.3 percent) could boost potential growth by up to ½ percent over the medium-term and reduce unemployment-related expenditures by up to 1 percent of GDP.
17. Important labor market measures have been implemented, but additional efforts, particularly in this time of crisis, should be considered to increase employment. The merger of the national employment agency (ANPE) and the unemployment insurance scheme (UNEDIC) holds the promise of improving placement services for job seekers but its effectiveness will depend on successful integration of the two entities into the new Pôle emploi, and on the strict enforcement of job-search requirements and sanctions. Cooperation with private placement agencies could also be enhanced. In addition, international experience has shown that activation policies can be very successful, even if implemented under difficult economic conditions. It would be helpful if the authorities could study and implement such measures, which need to be combined with further training to reduce skill mismatches in a rapidly evolving economy.
18. Unemployment among the young, seniors, and low-skilled workers remains a particular concern. The government’s strategy of implementing a partial unemployment scheme and temporary employment support measures should benefit these vulnerable workers. The recently introduced earned-income supplement (Revenu de solidarité active, RSA) is also a step in the right direction to remove inactivity traps that keep potential low-skilled workers out of the labor force. The absence of a coup de pouce to the minimum wage (SMIC) in recent years should be continued, in order to enhance employment prospects for young and low-skilled workers, improve labor-cost competitiveness, and ease the burden on the public finances. In order to promote senior employment, the government and the social partners should also seek to reach an understanding about the need to increase the legal retirement age.
19. In spite of ongoing reforms, the labor market remains restrictive and the high fiscal cost of some measures should be addressed. Following negotiations with the social partners, laws were adopted that have brought some easing of labor contract regulations, in particular with regard to trial periods and mutually agreed separations (ruptures conventionelles), and have strengthened the role of elections in determining the representativeness of trade unions. Also, regular working time and overtime can now be adjusted more flexibly within the framework of the 35-hours workweek. To gain political acceptability for these measures, overtime work benefits from significant tax and social contribution exemptions. The need for fiscal consolidation highlights the importance of conducting a thorough cost-benefit analysis of these exemptions.
20. Competition in product and services markets is improving, but more remains to be done. We welcome the recent establishment of a single and reinforced Competition Authority, which should help to implement stronger competition policies and increase the visibility of the resulting benefits. In addition, we recommend stepping up the efforts by the newly created price observatory with a view to providing better transparency for end-users. Restrictions on the establishment of new retail outlets have been eased somewhat but further steps are needed to allow discounters broader entry into the French market. Deregulating opening hours and sales periods of stores would promote a competitive environment leading to lower prices for consumers. In addition, further liberalizing some key markets—for example for over-the-counter drugs—would be a valuable complement to deregulating prices. Finally, the EU Services Directive provides an opportunity for deregulating professional services for which entry barriers are currently much higher than needed for consumer protection.
1 The mission would like to thank the French authorities for their hospitality and the frank discussions.