IMFSurvey Magazine: Countries & Regions
ECONOMIC HEALTH CHECK
France: Less Severe Recession but Tepid Recovery
By Erik De Vrijer and Boriana Yontcheva
IMF European Department
July 31, 2009
- Policies have softened downturn but recovery expected to be sluggish
- Banks holding up relatively well but risks remain
- Fiscal policy to counter crisis while safeguarding sustainability
The French economy is being affected by the global financial crisis and the contraction of world trade.
In its latest assessment, the IMF projects real GDP to drop by 3 percent in 2009, followed by a gradual recovery starting only in 2010. But even though the recession in France is severe, the country has been shielded from the worst effects of the crisis.
“France’s generous social safety net has protected domestic demand, and the country’s limited reliance on exports has shielded it from the worst effects of falling global demand,” Anne-Marie Gulde, the IMF’s mission chief for France, said July 31. “For these reasons, the recession in France is less severe than in other European countries.”
Global recession takes its toll
The global financial crisis and the contraction of world trade have pulled the French economy into a severe recession and has put its financial sector under strain. The downturn experienced by most of France’s trading partners has exerted a drag on activity, resulting in a steep rise in unemployment and a slump in confidence.
Although relatively resilient, private consumption could be affected by mounting job losses. Strong automatic stabilizers and France’s large social safety net have helped sustain domestic demand, and the country’s limited reliance on exports has softened the impact of falling global demand. For these reasons, the downturn has been somewhat less severe than in the euro area as a whole.
That said, relatively rigid labor markets and high social protection are likely to slow the pace of recovery. Overall, real GDP is projected to decline by 3 percent in 2009, followed by a tepid recovery in 2010. Risks to the outlook are mostly tilted to the downside given that the French economy would suffer from a worse-than-expected contraction in Europe and given its exposure to underlying risks, particularly in the financial sector.
Banks relatively resilient but risks remain
The crisis has resulted in a sharp drop in earnings and a significant rise in costs but losses of French banks have remained below those in other European countries. Valuations of French financial stocks have declined steeply since end-2006, but the deterioration was less steep than in the United States and other countries in Western Europe.
Reflecting rising global credit risk, credit default swap spreads of French banks have also increased considerably, but again on average somewhat less than for other European banks. The relative resilience of French banks can be partly attributed to their conservative lending practices and to the consistent supervision of all lending institutions. The authorities also undertook a number of measures to recapitalize banks and support liquidity. Those measures have helped stabilize the financial system and, thus far, no French bank has come under majority state ownership.
But risks remain elevated. Because French banks are exposed to mature markets, a worsening of the global financial crisis would hurt their balance sheets. The unfolding economic downturn and ensuing rise in defaults may increase risks and exert further stress on the financial system. Although capital adequacy ratios have improved and the banks have strengthened their shock-absorption capacity, some deleveraging may still be needed.
It will be important to undertake rigorous, preferably EU-wide stress tests to determine banks’ capital and liquidity needs. Maintaining adequate capital and continued supervisory vigilance will help sustain confidence. In addition, France’s continued strong support for reform of Europe’s financial stability rules is important to achieve European regulatory reform and to strengthen international coordination on financial sector exit strategies.
Tough fiscal policy challenges
Strong automatic stabilizers and appropriate fiscal stimulus measures have helped cushion the downturn in France. A fiscal stimulus package—worth more than 1½ percent of GDP for 2009–10—contains measures that are mostly front loaded and relatively well diversified, with an emphasis on temporary investment expenditures and various tax breaks. A modest additional temporary effort might be needed in 2010 in the event the downturn is more severe than currently anticipated. Since fiscal space in France is limited, it is important to ensure that all stimulus measures can be reversed.
Although the countercyclical fiscal stance is cushioning the downturn, it would increase the overall fiscal deficit to an uncomfortable 7½ percent of GDP in 2009, well above the Maastricht ceiling of 3 percent of GDP. Taking into account the upfront fiscal cost of the financial sector support measures, public debt is projected to increase significantly in 2009 and beyond. What’s more, the ageing of the population will result in further public spending increases.
In short, safeguarding medium-term sustainability is France’s main fiscal challenge. To tackle this challenge, the multi-year budget framework needs to be built on realistic growth assumptions, while clearly defining specific measures to contain spending at all levels of government, and streamlining tax expenditures and social contribution exemptions.
Because the ongoing consolidation efforts of the central government cover only about one-third of total expenditures, an effective consolidation strategy implies that fiscal responsibility of regions and local authorities also needs to be strengthened. Further efforts are also needed to keep social security outlays under control, including by raising the legal retirement age.
Need to continue structural reforms
Steadfast implementation of the structural reform agenda is key for boosting competitiveness and growth, as well as preserving fiscal sustainability and raising welfare. Important measures have been taken since the launch of the government’s 2007 economic program, but much remains to be done to reduce long-standing structural rigidities.
In view of the high returns such reforms would yield, further action should focus on job creation, and on improving market efficiency and productivity. International experience has shown that strengthening labor market activation and training policies can be successful even during difficult economic times.
Continued restraint on the minimum wage would support job creation for young and low-skilled workers, and would improve labor-cost competitiveness. Raising the legal retirement age would help promote senior employment. The recent establishment of a single Competition Authority should help to further strengthen competition policies, and the EU Services Directive provides an opportunity for deregulating professional services.
France faces a difficult road to recovery. But if the country continues to respond adequately to the crisis and carry out long-needed reforms, it should be able to return to economic growth, create more jobs, and continue to raise living standards.
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