France: Concluding Statement of the 2010 Article IV Consultation Mission
June 17, 2010
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.
The French economy weathered the “great recession” better than most peers. Yet, in a turbulent European environment, France’s recovery is challenged by possible spillovers from the sovereign debt crisis. Market confidence and ultimately growth will benefit from decisive actions to strengthen domestic policy frameworks and implementation at the national level, while France should remain a driving force for Europe-wide reforms.
A Fragile Recovery
1. Adequate policies helped France to exit early from the recession, but the recovery is fragile and now being challenged by weakening domestic and European demand. Growth is expected to be sluggish in 2010 and to pick up only slightly over the course of 2011. The high unemployment rate, the gradual withdrawal of stimulus measures, and imminent fiscal consolidation in France and her trading partners will weigh on demand, while the depreciation of the euro will provide some relief. Potential growth is expected to remain subdued, reflecting both aging pressures and the impact of the past global recession. Against this background, inflation is expected to remain moderate.
2. With turbulences in European sovereign debt markets and a challenging domestic reform agenda, the outlook for France is subject to high uncertainty. Lingering concerns about sovereign risks in the Euro Area are weighing on confidence. If not resolved, these could continue to impact negatively on activity through pressure on bank credit, and depress demand in France and her main trading partners. Strong fiscal consolidation across the Euro Area— while confidence enhancing—could put additional short-term strains on the recovery. At the same time, the depreciation of the euro could have a stronger-than-expected impact on exports. Visible progress in the fiscal and structural reform agenda would inspire confidence and boost demand.
3. What should be done? Policies will need to focus on three priority areas:
- In the fiscal area, laying out a credible multi-year consolidation strategy underpinned by a pension reform;
- Financial sector policies should support the full recovery of the financial system and further strengthen financial stability;
- “Going for growth” calls for visible and accelerated progress on structural reforms.
Fiscal Consolidation for Sustained Medium-Term Growth
4. Fiscal stimulus was successful, but volatile markets and sharply-increased public debt call for a credible consolidation embedded in a forward-looking strategy. The fiscal stimulus in 2009-10 was temporary, well targeted, and helped sustain domestic demand and avoid a sharper recession. However, rapidly-rising debt and recent developments in Southern Europe are forcing a Europe-wide reconsideration of fiscal strategies. For France —in the context of still low growth prospect— this requires a delicate balance between fiscal sustainability and confidence-enhancing measures on the one hand, and growth considerations on the other.
5. The fiscal strategy should target medium-term sustainability while minimizing downside risks to the recovery. Under the Stability and Growth Pact (SGP), the authorities have committed to an ambitious and front-loaded consolidation process which aims to reach an overall deficit of 3 percent of GDP by 2013. In the context of current market developments, this path should be followed to anchor expectations. To achieve the desired consolidation path, adjustment efforts should focus on measures that enhance efficiency and have the least detrimental impact on economic activity. Important longer-term reforms—most notably of the pension and health care systems—may provide only limited immediate savings but will have a positive and sizeable effect on credibility in financial markets and on domestic demand. The fiscal strategy will also need to give adequate attention to limiting the disproportionate growth of local government spending.
6. The consolidation effort should be based on realistic macroeconomic assumptions. While the size of the needed fiscal efforts remains subject to uncertainty, having the official medium-term growth projections at the upper margin of consensus forecasts risks significantly underestimating the size of the required fiscal efforts. To avoid early disruption of the consolidation process and the attendant loss in momentum, the fiscal adjustment package should rely on an independent counsel validating macroeconomic forecasts. In addition, the authorities should prepare a set of pre-specified contingency measures that could be implemented in case the recovery is more sluggish than expected.
7. The announced fiscal consolidation strategy has a range of necessary elements in place, but controlling social spending is key. Stringent spending efforts of the central government, including continuous personnel reduction (replacing only one in two retiring civil servants) and the recently announced nominal spending freezes, will limit spending growth at the general government level. A successful consolidation must include strengthening control over transfers of resources from the central government to both the social security administration and local governments. The proposed ban on off-budget introduction of new tax expenditures and exonerations from social security contributions – de facto implemented as of mid-2010 and to be inscribed into the Constitution at a later stage – marks an encouraging progress in improving fiscal discipline.
8. Pension and health care reforms need to be the cornerstone of the medium-term fiscal strategy. In 2009-10, deficits of the social security administration have been adding almost 1.5 percent of GDP per year to the overall deficit. The Government is therefore rightly placing emphasis on a pension reform that aims at increasing the effective retirement age, with concrete plans scheduled to be unveiled shortly. Public consultation on a key reform of this nature is important, although pressures to avoid addressing the underlying imbalances and rely too much on revenue measures should be resisted. The fast rising debt of France’s health care system and other parts of the social safety net calls for bold and urgent measures to reestablish balance in the social security system.
9. Efforts to control local government spending are underway but need to be forcefully maintained over the medium term. While a large part of the pre-crisis expansion of government spending originated at the local level, a high degree of spending autonomy complicates consolidation. Nevertheless, the recent local business tax reform, together with efforts to increase transparency and accountability, including by tying future increases in the local tax burden on firms to those on households, are welcome steps. The planned territorial consolidation reform would provide incentives for more responsible fiscal behavior. The planned freeze of central government transfers to local governments in nominal terms over 2011-13 will encourage realization of efficiency gains, including by reducing the size and duplication of tasks for each of the four layers of the local government.
10. A more rules-based fiscal framework will support consolidation and add credibility to the broader European fiscal governance reforms. Early steps in the right direction include the successful implementation of a multiyear fiscal framework, as well as limiting parliament’s ability to add spending outside the formal budget process. More far- reaching steps contemplated at this stage include adoption of a fiscal rule. This would be a significant reform, especially if formulated in structural terms to ensure continuous fiscal efforts once the crisis is over. To be fully credible, the rule will have to be enshrined into the highest legislation. Most importantly, the rule needs to cover the central government and social security systems and have an efficient mechanism to enforce responsible behavior of local governments. Such an approach — already taken by other European countries —would send an important confidence-boosting signal. For a structural fiscal rule to work properly, potential output calculations should be prepared or validated by an independent agency.
Return to Financial Sector Strength in a Well Regulated Environment
11. French banks weathered the financial crisis comparatively well, but low growth and concerns about European sovereign debt post new risks. State aid effectively supported French banks during the crisis. Banks have significantly shored up capital adequacy ratios and gradually exited from the state support. Mainly as a result of the recession, non-performing loans (NPLs) are higher, and—while the increase is reported to have leveled off – low growth might soon put renewed pressure on loan quality and require additional provisions. In spite of manageable and diverse exposures, French banks suffer from market perceptions of holdings to sovereign and country risk in Southern Europe, which is likely to increase refinancing cost. Like other European banks, they face pressure on longer-term dollar liquidity.
12. Lending growth has turned positive but remains low. To avoid a credit crunch during the crisis, the authorities put in place several measures to support lending. Those included the requirement for banks that availed themselves of state aid to pledge a lending growth of three to four percent, and the creation of the position of “médiateur du crédit” with a mandate to ensure fair treatment of potential borrowers. In part due to these efforts, lending growth throughout the recession did not fall as much as the Euro Area average. However, overall credit growth reflects, to an extent, increased lending to households, including for mortgages. The ultimate reason for low lending to the corporate sector remains difficult to assess, but survey-based indicators show that French banks have eased credit conditions, and that low demand is a more important factor. Nevertheless, the authorities remain vigilant and concerned that regulatory uncertainty (see also below) may soon put downward pressure on lending.
13. Reform in the supervisory arrangements has progressed well and systemic risks are better controlled. The recent unification of banking and insurance supervision and licensing in the Autorité de contrôle prudentiel (ACP) was an important step. The new institution ensures better consolidated supervision and helps to reduce systemic risk. Coordination with the Banque de France’s macroprudential supervision is essential to address macro-financial linkages. Given the strong ties with other European countries, it will now be important to put in place the national systemic risk board to ensure close coordination and cooperation with the European Systemic Risk Board to be established at the ECB.
14. More transparency and better communication may help the market assessment of the French financial system. In the context of the sovereign debt crisis, earlier calls for better information on European – including French – banks reemerged. The authorities’ and market participants’ are rightly concerned that certain types of stress tests – in particular those stressing sovereign risk – could contribute to a deepening of the crisis. However – with CEBS coordinated stress tests well under way – there may be merits in revisiting what information could be released. Similarly, appropriate and coordinated disclosure of key exposures, preferably in a European context, may also provide better guidance to market than publicly available but possibly misleading figures. Supervisors could support bank’s own efforts by including higher frequency (e.g. quarterly) data for key financial stability indicators in the newly-created supplement to the thematic Financial Stability Report.
15. France has been active on international regulatory reform, but authorities and market participants alike question some elements in the current draft proposals. The financial crisis has spurred efforts to better manage key financial sector risks. Like other G20 countries, France has fully endorsed these efforts and contributed in all relevant fora. While there is an agreement on a key set of necessary steps, there is also a fear that some provisions in the Basel III and Solvency II frameworks, which are macro-critical, may – in their current version – impose disproportionately higher costs on systems with the characteristics seen in France. With efforts still ongoing it will be important for France to remain engaged in the process; ideally by reaching an agreement in the European context to advance with the less controversial elements as soon as possible, while ensuring a careful calibration and robust assessment of the impact on the real economy in further studies of the other elements.
An accelerated Agenda of Structural Reforms to Enhance Potential Growth
16. A more competitive and growth-oriented economy is essential for recouping the loss in potential output incurred during the recession. Compared with other European countries, France has extensive labor and product market restrictions and a relatively low employment rate. Further labor and product market reforms that would bring France in line with the best practices in the region could raise growth by as much as ¾ percent per year.
17. France is more competitive than many countries in the euro zone, but there is a widening competitiveness gap with the best performers in the union. To maintain its position within the currency area, and for the euro zone as a whole to hold its share in global markets, France will need to catch up with the most competitive nations in the euro zone. In addition to product and labor market policies (see below), it is critical to put more emphasis on research, development, and innovation. Efforts undertaken in the context of the sizeable (euro 35 billion) “Grand emprunt” rightly aim in this direction, but close monitoring will be needed to maximize the benefits from the program.
18. Increased domestic competition would enhance economic efficiency. The establishment of a unified competition authority in 2009 was a significant step and progress has been made in granting more flexibility to distributors in retail trade. Yet, regulatory entry barriers in potentially competitive sectors, restricted price competition in some parts of the retail sector, and limits on opening hours and sales periods remain, and should be further deregulated. In the services sector, the EU Services Directive should be followed to achieve further liberalization, including in professional and health-related services.
19. The crisis-induced sharp rise in unemployment calls for measures to stimulate job creation and to step up activation policies. The temporary employment support measures adopted under the “Plan de relance” need to be phased out as planned, to avoid lasting damage to incentives and economic efficiency. At the same time, job creation measures, such as temporary hiring incentives for vulnerable categories of workers, could be considered. The unified job placement agency (Pôle emploi) needs to support unemployed workers in their job search, including through training, while strictly enforcing job-search requirements. In addition, steps to reduce the dualism between fixed-term and permanent contracts would improve both the motivation for employment and social fairness.
20. Beyond cyclical factors, emphasis will also need to be placed on increasing France’s low employment rate, especially among the youth and senior workers. The moderation of the minimum wage (SMIC) by not granting a “coup de pouce” should continue, in order to gradually reestablish a motivating pay scale for young and low-skilled workers. To support senior employment, the government has reduced financial obstacles to combining earned income with a pension and forced retirement has been abolished. The policy efforts to improve incentives for continued work, including effective implementation of job-search requirements, need to be pursued. Increasing the minimum age for pension eligibility, which will be part of the planned pension reform, is a critical step toward raising senior employment.