ECONOMIC HEALTH CHECK
France: Good Progress But Credibility Needs To Be Cemented
Kevin C. Cheng and Erik de Vrijer
IMF European Department
July 27, 2011
- Recovery continues amid an unsettled external environment
- Strengthening the recovery and reducing unemployment are key priorities
- Further fiscal consolidation and public debt reduction needed
Supportive policies and reforms contributed to a gradual recovery from the global economic crisis, but France’s economic prospects are clouded by a challenging external environment, especially by possible spillovers from the euro area crisis.
The French economy started to expand in mid-2009 and its robust growth in early 2011 was a pleasant surprise, thanks to strong consumption and inventory-building. Unemployment remains high, but is coming down.
The IMF projects that the French economy will grow about 2 percent over the next two years, even as the country undertakes consolidation policies to reduce its deficit and public debt. Private consumption should remain the engine of growth and will be aided, as it was in the first quarter, by recovering investment spending.
But the country does face risks. Spillover from the sovereign debt crisis in some euro area countries such as Greece is a threat, as is uncertainty about energy and commodity prices.
“The Greek situation has increased markets’ attention to fiscal debt and deficits in all countries. It just further underlines the importance for France to continue on the fiscal consolidation path that it is already embarked on and to ensure that market credibility is maintained,” said Anne-Marie Gulde-Wolf, who heads the IMF team that conducted the annual review of the French economy.
Reforms to encourage growth
Although the near term is reasonably encouraging, over the medium term, France, like all other advanced European countries, has a problem with potential growth.
Its population is not aging as fast as in many other advanced economies, but France faces a number of structural issues with which it must deal, such as declining export market shares and high built-in unemployment, especially among young and unskilled workers. Furthermore, to protect macroeconomic stability, France needs to achieve taxing and spending levels that can be sustained over the long run and make its financial system more resilient to new crises.
Achieving fiscal sustainability
Costs incurred from the global recession—both revenue losses and stimulus spending as well as financial sector support—coupled with aging-related spending pressures have taken a heavy toll on public finances. The crisis brought France’s public debt to above 80 percent of gross domestic product (GDP), and debt servicing costs to about 2˝ percent of GDP in 2010 (see Chart 1). While the fiscal stimulus during the crisis was appropriate, France needs a credible consolidation to ensure fiscal sustainability and safeguard its AAA-rated borrowing status.
Against this backdrop, the consolidation targets set out in France’s Stability Program and the 2011-14 multi-year budget framework strike the right balance between speed and sustainability. A fiscal rule already passed by parliament would help to signal the authorities’ commitment to the adjustment path. Policymakers should also prepare specific contingency measures to ensure the 2012–14 fiscal targets are reached—for example how to stay on course if growth is lower than projected.
Making the financial system more resilient
The French banking sector has come through the financial crisis fairly well, and the financial sector has returned to profitability. Stress tests attest to the overall ability of the system to handle new shocks, such as those that could emerge from exposures to European crisis countries.
“The French banking system is robust and there is no danger that the Greek exposure would cause major problems. However, if the Greek situation were to cause further problems in other European countries, this could be more of an issue because, of course, France is very closely integrated with the rest of Europe,” Gulde-Wolf said.
France has also reformed its supervisory arrangement in response to the need to enhance systemic—as opposed to institution by institution—supervision. For example, the unification of banking and insurance supervision, the addition of a consumer protection mandate for the Autorité de Contrôle Prudentiel (ACP), and the creation of a national systemic risk board are clearly welcome steps. The French authorities have also requested a Financial Stability Assessment Program (FSAP) which should start this year.
It is also important that French banks continue to increase their capital, following the plans that they have already agreed upon to meet new international criteria by 2013-14. This will increase their ability to withstand shocks and, given their exposure to the rest of Europe, will make French banks more stable and more credible.
Overvalued housing market
The financial crisis had little impact on the French housing market. After a moderate decline, house prices in France rebounded in mid-2009 and have regained their pre-crisis peak. According to IMF estimates, France’s house prices were 10–25 percent overvalued at end-2010.
“However, there are a number of safeguards in place that limit the financial sector and macroeconomic risks” from this overvaluation, Gulde-Wolf said. For example:
•High house prices reflect some fundamental factors: Few houses have been built because of scarce of buildable land in dense area metropolitan areas and regulatory barriers to new housing construction while the strong increase in the number of households has increased demand for housing.
•Household debt is moderate. Despite an increase in household debts in recent years, household debt remains sustainable in France and is well below the levels in other advanced countries (see Chart 2).
•Bank lending practices are sound. Mortgage lending conditions in France are based on the borrower's capacity to service the loan until maturity, and therefore on the stability of the borrower's income, independent of changes in home prices. Moreover, most mortgages are at fixed rates and mortgage insurance is mandatory. Therefore, homeowners are less likely to default when interest rates rise.
Still, should increases in house prices continue and give rise to broader concerns, the authorities should be prepared to act, for instance by phasing out public policies to support house purchases to ease demand. Regulatory barriers and other disincentives to new housing construction should also be reviewed.
Promoting inclusive growth
Despite some recent decline in unemployment, its structural component remains high, particularly for the young and unskilled workers. Authorities should use such approaches as targeted job search support and training opportunities to help groups with the highest levels of unemployment. Continued moderation in the minimum wage would support employment creation. The low participation rate of older workers is another structural issue. There has been some recent increase in older worker participation that should be continued. The government should also support growth friendly tax reform to increase incentives to work. The difference between pre-tax and after-tax income in France is large.
Because the medium-term prospects for the French economy also depend on improved competitiveness, the government should take steps to keep real wage increases in line with productivity improvements, increase labor market participation, and raise productivity growth.