IMF Survey : France: Policies On the Right Track
July 3, 2014
- Gradual recovery of economy underway
- Keep moderate pace of deficit reduction to restore sound public finances
- Tax cuts should be boosted by better functioning labor and product markets
The IMF welcomed the policy package put together by the authorities to steer the French economy toward a durable recovery, and urged full implementation of plans to reduce public spending coupled with deeper structural reforms.
ECONOMIC HEALTH CHECK
Compared to peers, the French economy has shown considerable resilience through the crisis, supported by steady private consumption, but the recovery faces a difficult take off, says the IMF in its latest annual assessment of the French economy.
Sizeable efforts to reduce the government deficit over the past three years and structural impediments, including a loss of external competitiveness, have created a drag on growth. But there are signs that a gradual recovery is taking hold. The IMF predicts that France will grow by 0.7 percent in 2014 and 1.4 percent in 2015. Still, the unemployment rate should begin to show an appreciable decline only in 2016, while inflation is expected to remain at around 1 percent.
The challenge for policies in the near term is to complete the ongoing repair of public finances while boosting the economy’s growth potential. Against this backdrop, the Government’s Stability Program and the National Reform Program lay out an ambitious agenda including public spending cuts of 50 billion Euros over 2015-2017—key to reducing the deficit and creating room for growth enhancing tax cuts. The IMF urged full implementation of these plans and recommended expanding competition in services and making the labor market more adaptable to increase productivity and job creation.
Spending outpacing GDP
Despite substantial adjustment, mostly on the tax side, the government deficit still stood at 4.2 percent of GDP in 2013. Efforts to reduce the deficit need to continue, albeit at a more moderate pace, so as to balance the need to restore fiscal space against the risk of undermining the recovery, according to the IMF.
“The long-standing tendency for public spending to outrun GDP has resulted in persistent fiscal deficits, even in good times, which have eroded the ability of the government to counter effectively possible future shocks,” said Edward Gardner, an assistant director in the IMF’s European Department and head of the mission that conducted the assessment. “The authorities’ plan to close the deficit by reducing expenditure is therefore not only appropriate but fundamental to restore sound public finances,” he said.
Tax cuts and structural reforms
In addition to restoring the health of public finances, the government faces the related challenges of weak employment and competitiveness. The employment rate in France remains among the lowest in the OECD, which reflects long-standing impediments to job creation and enterprise development.
The IMF supported the authorities’ fiscal plans which include sizeable tax cuts for enterprises with a view to restoring profit margins and thereby encouraging investment and job creation.
These supply side measures, the IMF recommends, should be boosted by deepening structural reforms. This includes opening protected sectors to greater competition and continuing down the path of labor market reforms, building on the actions already undertaken to give more scope for enterprise level negotiations over working conditions and thus enhance the ability of enterprises and their workers to adapt as conditions change.
Achieving the deficit objectives while delivering on the tax cut commitments leaves no room to deviate from the announced expenditure reductions, the IMF said. “The major risks are that the initial plans may be diluted in sequential annual budgets and that cuts in transfers to local governments may be compensated by unsustainable cuts in investment, higher taxes or higher debt,” said Gardner. “This would undermine the government’s fiscal rebalancing strategy.”
Financial sector well positioned
Financial sector policies have been guided by two objectives: ensuring the uninterrupted flow of credit to the economy and bolstering financial stability. On both counts, the French financial sector appears to be relatively well positioned. Credit conditions in France have remained relatively stable, even as banks adjusted to tighter market and regulatory conditions. Capital and liquidity positions have been strengthened significantly. These efforts increase the resilience of banks and thus better shield the economy and public finances from financial instability.
Still, the French financial system needs to adjust further to new international prudential norms, and this will require additional changes in the way banks raise funds, notably by lessening reliance on wholesale funding markets. Throughout this process it will be important to ensure that the financing of enterprises is not disrupted.