Public Information Notices

France and the IMF




Public Information Notice (PIN) No. 02/129
November 13, 2002
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with France

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2002 Article IV consultation with France is also available.

On October 28, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with France.1

Background

A new center-right government took office in July 2002 and announced as central themes of its policy orientation the desire to boost the growth potential of the economy through tax cuts and structural reforms, and to refocus the role of the state through a shift in spending priorities and decentralization. The economy is facing a fast-approaching demographic turnaround—with the active population beginning to decline in 2007 and reducing annual per-capita-GDP growth by about half a percentage point for a few decades. Furthermore, pension and health care costs are projected to add over 5 percentage points of GDP to budgetary outlays by 2040, with much of the impact occurring within the next 10 years.

During the 1997-2000 upswing, economic growth was rekindled by the upsurge in world trade, facilitated by easy monetary conditions, and supported by the benefits of wage moderation, labor market reform, and earlier fiscal consolidation. By the first half of 2001, however, adverse price shocks and a deteriorating external environment caused sharp declines in investment growth, exports, and inventories. Further shocks and weakening confidence sapped previously resilient consumption demand, leading to a decline in activity in the fourth quarter of 2001. Since then, moderate growth has resumed and the staff projects output growth to pick up from 1.1 percent in 2002 to 2.3 percent in 2003. Despite the recent increase in oil prices, the staff's outlook for inflation remains benign as the effects of adverse price shocks, the euro depreciation and changeover, and cost pressures arising from the reduction of the workweek are set to wane.

In 2002, the general government budget deficit is expected to widen to 2.6 percent of GDP from 1.5 percent of GDP in 2001. The deterioration is in good part due to the cyclical downswing but also to structural factors, in particular to the trend increase in social security spending. The 2003 budget targets an unchanged deficit of 2.6 percent of GDP, reflecting further moderate cuts in taxes and social security contributions, and higher budgeting of health care expenditure. Spending priorities are being shifted toward security, justice, and defense, with some cutbacks on research and labor market programs. All in all, staff estimates that there would be virtually no structural improvement in 2003. The 2003 budget also presents an update of the authorities' medium-term plans for 2004-06, under which tax cuts would continue to be implemented, real expenditure growth kept to an annual average of 1.4 percent, and—under the central growth scenario (2.5 percent annual average)—the deficit decline to 1 percent of GDP by the end of the period. Higher growth (3 percent) is seen to create scope for greater deficit reduction but also for larger tax cuts, with a deficit of 0.5 percent of GDP thus still persisting in 2006.

On structural issues, a mid-2003 deadline has been set for pension reform, needed to mitigate the budgetary costs of ageing. In the labor market, overtime limits have been raised, the bias against part-time work of the earned income tax credit (Prime pour l'emploi) removed, and existing cuts in social security contributions simplified. Also, a new employment scheme targeted to young, unemployed, first-time job-seekers has been put in place. A solution has been found for the unification of the minimum wage and minimum monthly income guarantees which will result in a boost to the minimum wage and—to mitigate its impact—further targeted reductions in social security contributions. Divestiture by the state of remaining stakes in commercial enterprises is being pursued, and reform of network industries is set to continue, with the private sector gaining access to equity participation in the electricity and gas utilities. Given recent financial market turbulence, supervision in the financial sector is being intensified, in particular for insurance companies. Further streamlining of securities supervision is under way. Efforts to combat money laundering and terrorist financing are being strengthened on an ongoing basis.

Executive Board Assessment

Directors observed that recent economic performance in France has been relatively favorable, reflecting the benefits of earlier structural reforms and supportive policy conditions. In particular, labor market reforms together with wage moderation have contributed to strong employment growth over the past several years. While immediate growth prospects also appear more favorable than in other main euro area countries, the recovery is nevertheless expected to be only gradual, with tepid growth in the near term and downside risks stemming from the external environment and financial market turbulence. Directors agreed that the major challenge facing the French economy in the coming years will be the demographic change starting in 2007, which will reduce future GDP growth and threaten fiscal sustainability unless a timely, substantive set of reform measures is put in place. They noted that, while the French economy has notable strengths to meet this challenge, important remaining weaknesses—including low activity rates, an onerous tax burden, and a lack of fiscal consolidation since 1999—now need to be addressed.

Against this background, Directors urged the authorities to gear policies decisively toward strengthening the public finances and boosting the growth potential of the economy through comprehensive structural reforms. Critical elements of the reform effort will be to achieve an important relief of the budgetary burden of population aging and a substantial public expenditure reduction, which, in turn, will be key to ensuring the credibility and sustainability of needed tax cuts. Continued labor and product market reforms will also need to be given a high priority. Directors stressed that the design and implementation of fiscal consolidation and reform measures will need to be ambitious both in timing and substance, and accordingly, encouraged the new government to use the present window of opportunity to implement a well-sequenced and integrated strategy, while clearly explaining its benefits to the public at large.

Directors welcomed the authorities' re-affirmation of their commitment to the Stability and Growth Pact objective of achieving and maintaining a budgetary position close to balance or in surplus over the economic cycle, as well as their determination to hold the general government deficit below the 3 percent of GDP threshold. They noted that the 2003 budget contains a number of helpful features to enhance fiscal discipline, including improved transparency, prudent revenue budgeting and realism in health care budgeting, while tax measures should improve the functioning of the labor market and promote investment. At the same time, however, Directors observed that, following substantial spending overruns in 2002, real expenditure restraint in 2003 is set to fall short of previous intentions without achieving a significant improvement in the underlying balance.

While recognizing the challenge which the authorities are facing in pursuing fiscal consolidation in the current more difficult environment, many Directors were of the view that an early adjustment in the fiscal imbalance would be desirable. In particular, they considered that achieving sufficient expenditure restraint would enhance the scope for both deficit reduction and tax cuts that would support confidence and growth more effectively. A number of Directors also observed that the 2003 deficit is targeted to remain uncomfortably close to the 3 percent of GDP limit and thus vulnerable to cyclical risks, and that from a regional perspective, a stronger fiscal consolidation effort, starting in 2003, would help alleviate strains on the euro area's fiscal framework. These Directors therefore urged the authorities to seize every opportunity to bolster expenditure restraint in both the finalization and execution of the 2003 budget. Other Directors, however, considered that the 2003 budget is striking an appropriate balance between the need to arrest a further weakening of fiscal performance and concerns about the fragility of the recovery. They stressed the importance of a credible fiscal adjustment path over the medium term, and were reassured by the authorities' commitment to take additional corrective measures in 2003, if needed.

Regarding medium-term fiscal plans, Directors stressed that the imminent demographic shock requires the authorities to be ambitious in firmly committing to a fiscal consolidation effort that will make steady progress toward underlying fiscal balance while reducing the tax burden substantially. They looked forward, in this regard, to the early implementation of expenditure reforms supported by a strict monitoring framework, that will set the stage for an annual underlying fiscal adjustment of at least half of one percentage point of GDP until balance or even a small surplus is reached. While tax and other structural reforms will boost future growth, it will nevertheless be prudent to base future budgets on conservative growth assumptions, and to refrain from spending presumptive growth dividends prematurely on further tax cuts, or to cut taxes before spending is well under control. Directors, therefore, urged the authorities to explore the scope for up-front expenditure restraint that would enable them to be more ambitious in reducing the tax burden and improving growth potential. They encouraged the authorities to reflect these considerations in the update of their Stability Program.

Directors saw comprehensive pension reform as a key priority area for addressing the challenges of population aging and achieving expenditure restraint essential for sustainable fiscal consolidation. They welcomed the mid-2003 deadline for submitting reform proposals to Parliament, and encouraged the authorities to design a reform that will secure substantial long-term budgetary savings. Among the reform measures to be envisaged, Directors saw particular merit in linking the contribution period to life expectancy, phasing out the differences between public and private pension regimes, and raising the effective age at which people choose to retire.

In other areas, Directors welcomed the measures announced by the authorities to contain spending growth in the health care sector, including spending on pharmaceuticals, while emphasizing the need for effective control and incentive mechanisms applying to both providers and users. To make tax reforms more effective, they underscored the need to link tax and benefit reforms and to trim back generous social entitlement programs. Directors encouraged the authorities to step up reform efforts toward a smaller, more productive civil service. While welcoming the initial steps taken toward downsizing, many Directors saw scope for more ambitious measures using the opportunity afforded by the wave of civil servant retirements. In supporting the authorities' decentralization initiative and the related aim of a more responsive civil service, several Directors cautioned that attention continue to be paid to the need for leaner government and for firm budgetary control at all levels of government.

While commending the impressive employment growth achieved over the past several years, Directors called for further labor market reforms to raise participation rates and reduce structural unemployment. They welcomed the modification to the earned income tax credit, the cuts in social security contributions targeted to the low-skilled, and measures to lower the cost of the reduction of the workweek. Directors underscored the need to preserve the benefits of past wage moderation. While recognizing the need to harmonize minimum wages, they expressed concern about the impact of the substantial increase in the minimum wage on employment prospects for the low skilled. To improve labor market flexibility, Directors welcomed the authorities' intention to make dismissal rules less burdensome, and noted the importance of removing disincentives to part-time work and introducing actuarial fairness in pension regimes. A number of Directors also encouraged the authorities to streamline the multitude of active labor market programs.

Directors welcomed the authorities' new impetus to divestiture of the state from commercial activities and the decision to allow private participation in the capital of the electricity and gas companies. They saw scope for more rapid progress in subjecting network industries to competition, underscoring the benefits that this would bring in terms of improved economic efficiency and overall productivity. Some Directors urged the authorities to proceed cautiously in participating in capital increases in the telecommunications sector.

Directors noted that France's financial sector has weathered the economic slowdown and drop in equity valuations well, and they encouraged the supervisory authorities to remain vigilant in particular with respect to exposures to equities and highly leveraged enterprises. They also welcomed ongoing initiatives to strengthen corporate governance and accounting rules, and praised France's leading efforts to combat money laundering and terrorist financing. Many Directors encouraged the authorities to consider removing remaining administrative regulations on interest rates and checking accounts.

Directors supported the authorities' commitment to actively promote trade liberalization in a multilateral context and the emphasis on improved market access for developing countries' exports. Many Directors nevertheless called for greater readiness to accept an early reform of the Common Agricultural Policy. Directors welcomed France's commendable contribution to development assistance, and looked forward to a further increase toward the U.N. target level.



France: Selected Economic Indicators

(Annual percentage change, unless otherwise indicated)

 

1998

1999

2000

2001

20021/

           

Real economy (change in percent)

         

Real GDP

3.5

3.2

4.2

1.8

1.1

Domestic demand

4.1

3.7

4.3

1.6

1.0

CPI (year average)

0.7

0.6

1.8

1.8

1.9

Unemployment rate (in percent)

11.8

11.2

9.6

8.5

9.0

Gross national saving (percent of GDP)

21.8

22.5

22.4

21.8

21.1

Gross capital formation (percent of GDP)

19.1

19.6

20.9

20.0

19.1

           

Public finance (percent of GDP)2/

         

Central government balance

-3.0

-2.5

-2.4

-2.5

-3.4

General government balance

-2.7

-1.6

-1.3

-1.5

-2.6

Public debt

59.5

58.5

57.3

56.9

58.4

           

Money and interest rates

         

M3 (end of year, percent change)3/

2.7

5.2

4.2

10.7

6.7

Money market rate (in percent)4/

3.4

3.0

4.4

4.3

3.4

Government bond yield (in percent)5/

4.7

4.7

5.5

5.0

4.7

           

Balance of payments (percent of GDP)

         

Trade balance

1.8

1.2

0.0

0.3

0.3

Current account

2.8

2.9

1.5

1.8

2.0

Official reserves (US$ billion)6/

44.3

39.7

37.0

31.7

30.2

           

Fund position (as of August 31, 2002)

         

Holdings of currency (percent of quota)

       

59.9

Holdings of SDRs (percent of allocation)

       

40.8

Quota (SDRs million)

       

10,738.5

           

Exchange rates

         

Exchange rates regime

 

Participant in EMU

 

Euro per U.S. dollar (August 21, 2002)

       

1.02

Nominal effective exchange rate (1995=100)7/

97.2

95.8

92.7

93.0

94.2

Real effective exchange rate (1995=100)7/, 8/

92.5

91.8

88.2

87.2

88.4

           
 

Sources: Data provided by the authorities and IMF staff estimates

1/Staff projections.

2/Data for 2001-02 excludes the proceeds fro the sale of UMTS licenses, which amounts to about

0.1 percent of GDP.

3/Date for France until 1998 and for the euro area from 1999 onwards. The figure for 2002 refers to the

12-month percent change as of July.

4/Data refer to money market call rates up to 1998, and to the interbank rate from 1999 onwards. For 2002,

data are as of August.

5/Average yield to maturity on public sector bonds with original maturities of more than five years. The figure

for 2002 refers to August.

6/Excluding gold, end-of-period; from 1999, eurosystem definition. The figure for 2002 refers to August.

Euro is market determined. The franc will remain in circulation until end-2001, when euro banknotes and

7/While the franc to euro rate was irrevocably fixed on January 1, 1999, the external exchange rate of the

euro is market determined. The figure for 2002 refers to August.

8/Based on relative normalized unit labor costs in manufacturing.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.



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