## _cr06389 — IMF Staff Report (Executive Summary and Selected Sections)

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### Macroeconomic outlook and short-run performance
- GDP growth is likely to average somewhat more than 2¼ percent per year during 2006–07.
- Staff projects GDP growth to remain broad-based and settle at an annual pace of about 2.5 percent during the second half of 2006, yielding average growth of 2.4 percent for the year.
- In 2007, higher oil prices and interest rates and lower trade partner growth will reduce growth slightly to about 2.3 percent.
- Recent outturns:
  - GDP growth picked up to a remarkable 4¾ percent (annualized) in the second quarter of 2006.
  - From a longer-term perspective, France’s per capita GDP (adjusted for purchasing power) fell from 12th to 16th position during the past five years.
- Labor market:
  - The unemployment rate is expected to continue a steady decline.
  - A counterfactual simulation suggests that employment growth would have been 1¼ percent higher during the past five years, had minimum wages not increased.
  - The real increase of the SMIC during this period amounted to 15.2 percent.
  - Structural component of unemployment has fallen much less than the overall unemployment rate.
- Inflation and prices:
  - Energy prices kept headline inflation up through the middle of 2006; core and headline inflation declined to slightly below the euro area average after mid-2005.
  - Headline inflation is expected to average about 2 percent for the next few years (slowing from 2.2 percent in July 2006).
  - Underlying inflation—at 1.3 percent in July 2006—is expected to edge up gradually.
  - Since January 2006, rents have been tied to a basket of prices comprising construction costs (with a 20 percent weight), consumer price inflation (60 percent), and maintenance costs (20 percent).

### Fiscal stance, governance, and fiscal projections
- Policy objectives and stance:
  - Fiscal adjustment remains high on the government’s agenda; the objective of balancing the budget by 2010 through expenditure restraint is appropriate.
  - The structural fiscal deficit decreased by about ¾ of 1 percentage point of GDP in 2005 and is likely to continue to fall, but by somewhat less than ½ of 1 percentage point in 2006.
  - Authorities aim to balance the budget by 2010; staff projects the structural balance to remain in a deficit of about 1¾ percent of GDP.
- Key projected fiscal indicators (in percent of GDP) — selected series as reported:
  - Revenue: 2005 = 50.9, 2006 = 50.9, 2007 = 50.6, 2008 = 50.3, 2009 = 50.3, 2010 = 50.3, 2011 = 50.3.
  - Tax revenue: 2005 = 44.0, 2006 = 44.3, 2007 = 44.0, 2008 = 43.8, 2009 = 43.8, 2010 = 43.8, 2011 = 43.5.
  - Expenditures: 2005 = 53.8, 2006 = 53.6, 2007 = 53.2, 2008 = 52.8, 2009 = 52.5, 2010 = 52.2, 2011 = 52.0.
  - Primary balance: 2005 = -0.2, 2006 = -0.1, 2007 = -0.1, 2008 = -0.1, 2009 = 0.3, 2010 = 0.6, 2011 = 0.9.
  - Overall balance (Maastricht): 2005 = -2.9, 2006 = -2.7, 2007 = -2.6, 2008 = -2.5, 2009 = -2.2, 2010 = -2.0, 2011 = -1.7.
  - Structural balance: 2005 = -2.2, 2006 = -1.8, 2007 = -1.8, 2008 = -1.8, 2009 = -1.8, 2010 = -1.7, 2011 = -1.7.
  - Gross debt: 2005 = 66.6, 2006 = 64.4, 2007 = 63.9, 2008 = 63.4, 2009 = 62.8, 2010 = 62.2, 2011 = 61.4.
- Budget developments:
  - 2006: budget deficit should come in at about 2¾ percent of GDP in 2006.
  - 2007 draft budget aims to reduce deficit from 2.7 percent to 2.5 percent of GDP while lowering the tax burden; assumes growth of 2¼ percent.
  - The 2007 budget envisages central government real spending to fall by 1 percent and general government spending to grow by 1.4 percent in real terms.
  - Authorities estimate the 2007 budget implies a structural adjustment of 0.4 percent of GDP; staff judges there would be virtually no underlying adjustment in 2007 under staff assumptions.

### Fiscal sustainability scenarios and aging costs
- Staff baseline on aging costs:
  - Aging costs under the staff’s baseline scenario are expected to add 4.5 percentage points of GDP to fiscal spending by 2050 (2.7 percent for pension and 1.8 percent for health), leading to unsustainable debt dynamics.
- Policy scenarios:
  - Upfront fiscal adjustment alone, consistent with authorities’ goal of reaching fiscal balance by 2010, would bring the debt-to-GDP ratio down to about 30 percent by 2030 but would not suffice to stabilize it.
  - A reform scenario in line with a (delayed) Lisbon agenda together with an upfront structural fiscal adjustment of 0.3 percent of GDP per year through 2011 would achieve sustainability at a public debt-to-GDP ratio of about 20 percent of GDP by 2050.
- Historical fiscal progress:
  - Between 2003 and 2006, the structural deficit has been reduced by more than 1½ percent of GDP.
  - France was the first of the large euro area countries under the excessive deficit procedure to have brought the deficit to less than 3 percent of GDP in 2005 (albeit with the help of a one-off transfer from the electricity sector against its future pension liabilities).
  - Public spending has been stuck at over 53 percent of GDP, with local and health care spending growing at about 4 percent per year during the past five years.

### Structural reform priorities and labor market diagnosis
- Overall priority areas:
  - Fiscal adjustment through expenditure reduction.
  - Labor market reforms to reduce judicial uncertainty around permanent contracts and to widen differentials among median wage, minimum wage, and out-of-work benefits.
  - Product market reforms: deregulation of the services sector and progressive disengagement of the state from commercial activities.
- Labor market features and constraints:
  - Laying off employees on permanent contracts is very costly due to cumbersome and lengthy legal procedures and the burden of proof on firms; judges ultimately decide validity and cost.
  - Firms respond by relying on fixed-term and temporary workers, producing a dual labor market with many precarious jobs.
  - High minimum wages price low-skilled workers out of jobs; generous benefits reduce job search incentives.
  - Employment rate of older workers remains very low due to special early retirement regimes and rigid tenure-related pay scales.
- Reform measures already implemented:
  - Tax and pension reforms, loosening of the 35-hour workweek, streamlining employment services, tightening job search requirements.
  - New labor contract for small enterprises (CNE): trial period up to two years for firms with 20 employees or less; by June 2006 CNE accounted to close to 10 percent of total employment intentions by small firms and net job creation close to 40,000 in its first six months (estimated to rise to 70,000 over the medium term).
  - Total budgetary burden of labor market policies in 2006 estimated at 2.39 percent of GDP (detailed composition below).
- Labor market policy recommendations:
  - Reduce employment protection of permanent contracts, in particular uncertainty surrounding the cost of terminating such contracts.
  - Tie the minimum wage henceforth to the core index of inflation only (staff suggestion).
  - Completely phase out special early retirement regimes and the exemption from job search for older workers.
  - Further increase the actuarial fairness of the regular pension system.
  - Pair reforms with highly visible quantitative objectives and coordinate among councils to build consensus.

### Labor market policies: composition and 2006 budgetary costs (in percent of GDP)
- Social security contribution exemptions 1.27
- Across the board exemptions for low wages 1.22
- Specific exemptions (services, catering sector) 0.05
- Subsidized jobs and aids to enterprise creation 0.41
- Promotion of life-long and vocational training 0.25
- Earned-income tax credit (PPE) 0.18
- PIT credit to promote labor supply 0.14
- CIT credit to promote labor demand 0.04
- Reduced VAT in cafeterias on work premises 0.05
- Total 2.39
- Notes: about half of the 2.4 percent of GDP total is devoted to across-the-board exemptions of employers’ social security contributions (SSC); the PPE will amount to 0.2 percent of GDP; other tax expenditures (after excluding SSC cuts) could reach 0.2 percent.

### External sector, competitiveness, and trade performance
- External performance and contributions to growth:
  - The external sector subtracted between 0.7-1 percent from annual growth in 2003–05.
  - Together with adverse terms-of-trade effects, this led to a shift in the current account into a deficit of about 1.5 percentage points of GDP.
  - Export volumes perked up markedly since mid-2005; the foreign balance contributed positively to growth in the first half of 2006.
- Exchange rate and competitiveness analysis:
  - Standard equilibrium exchange rate analysis indicates that the current real effective exchange rate is largely in line with fundamentals.
  - Econometric residuals indicate a substantial unexplained drag on exports since 2001, not attributable to standard global demand and price/cost factors.
  - Staff links relative export underperformance to structural factors, notably labor market rigidities and a high ratio of minimum to median wages.
- Selected external balances and indicators (selected series):
  - Trade balance (in percent of GDP): 2005 = -1.5, 2006 = -1.6, 2007 = -1.5, 2008 = -1.4, 2009 = -1.4, 2010 = -1.3, 2011 = -1.3.
  - Current account (in percent of GDP): 2005 = -1.6, 2006 = -1.7, 2007 = -1.7, 2008 = -1.6, 2009 = -1.6, 2010 = -1.5, 2011 = -1.4.

### Financial sector stability, efficiency, and policy scope
- Systemic condition and risks:
  - The financial system is highly stable, highly capitalized, and profitable.
  - Low provisioning and rapid credit growth mean a substantial part of recent rise in profits is likely transitory.
  - Nonperforming loans and provisioning are at historically low levels and thus prone to a rise.
  - Exposure to hedge funds has remained limited, at no more than 3.5 percent of balance sheet totals.
- Supervisory stress tests and results:
  - Under new accounting standards solvency ratios of French banks are lower by about 60 basis points, but solvency remains satisfactory.
  - Stress tests: shocks to the yield curve (shift up by 200 basis points, short rates up 200 plus long rates up 100 basis points), foreign demand (down 20 percent), house prices (40 percent decline in two years) would each reduce solvency (Basel II definition) by less than 1 percentage point.
- Efficiency and policy recommendations:
  - Staff sees scope to improve efficiency by phasing out administered schemes and accelerating financial integration in Europe.
  - Recommendations include standardizing financial products and documentation, integrating payments, clearing and settlement systems, harmonizing regulatory and supervisory practices, and expanding mortgage market reforms (real estate-backed credit lines, reverse mortgages) conditional on legal and collateral frameworks.
  - Suggested privatization and development: allow the postal bank to develop into a full-fledged bank and be privatized.

### Housing market and financial stability considerations
- Housing and credit:
  - After five years of strong increases, house prices show signs of cooling; construction activity is expected to slow.
  - Strong credit expansion to households accompanied the real estate boom; household indebtedness remains low by international comparison and equity withdrawal has been absent.
  - Authorities and staff agreed there was no evidence of any significant impact of housing wealth on consumption.
- Financial sector soundness indicators (selected):
  - Return on Equity (aggregated): 9.6; 9.1; 8.5; 10.6; 11.9 (annual series).
  - Nonperforming loans to total gross loans: 5.0; 5.0; 5.0; 4.8; 4.2; 3.5 (annual series).
  - FSAP conclusions: France’s financial sector is strong and well supervised; issues include concentration in banking, large portfolios of fixed-rate residential housing loans, and distortions from administered savings schemes.

### Policy recommendations and implementation approach
- Fiscal policy:
  - Continue fiscal consolidation with expenditure restraint aimed at balancing the budget by 2010.
  - Underpin fiscal rules and governance improvements with bold and specific political choices, including curbing social security and local authorities’ spending growth.
  - Make the provision to allocate revenue windfalls to deficit reduction effective by prohibiting tax expenditure outside the budget law.
- Tax policy:
  - Pursue further tax reform to reduce the tax burden conditional on additional spending cuts.
  - Stem proliferation of tax expenditures and consider prohibiting such measures from being introduced outside annual budget laws.
- Labor and product market reforms:
  - Promote labor market flexibility, including reducing judicial uncertainty surrounding permanent labor contracts.
  - Reduce employment protection, phase out special early retirement regimes, and increase actuarial fairness in pensions.
  - Deregulate the services sector, liberalize shop opening hours, shorten administrative procedures, and accelerate the disengagement of the state from commercial activities.
- Financial sector and markets:
  - Phase out administered savings schemes to increase competition and foster financial innovation.
  - Accelerate the integration of financial markets in Europe and harmonize infrastructure, products, and supervision.
- Political economy and sequencing:
  - Use the 2007 elections as an opportunity to build public support and understanding of reform benefits; implementation should start immediately following the 2007 elections.
  - Emphasize economic pedagogy, quantitative objectives for reforms, coordination among councils, and careful sequencing to build consensus.

### Risks to the baseline and contingencies
- Risks broadly balanced and related to external shocks and the impact of ongoing structural reforms.
- Fan chart scenarios include risks such as:
  - a 15 percent euro appreciation,
  - a 20 percent increase in oil prices,
  - a 1 percent higher trading partners growth,
  - a 1 percent lower household saving ratio,
  - an avian flu pandemic,
  - a disorderly unwinding of global imbalances.
- Staff notes France has become more sensitive to the global economy and reacts more through changes in employment and productivity than through wage flexibility.

*Source: IMF Staff — Executive Summary and selected sections from content unit _cr06389.*

### Executive Summary

### _cr06389 - Executive Summary

### Macroeconomic outlook and short-run performance
- GDP growth is likely to average somewhat more than 2¼ percent per year during 2006–07.
- The unemployment rate is expected to continue a steady decline.
- The budget deficit should come in at about 2¾ percent of GDP in 2006 and fall slightly further in 2007.
- The economy benefited from the cyclical recovery in Europe and improved demographics.
- GDP growth picked up to a remarkable 4¾ percent (annualized) in the second quarter of 2006.
- From a longer-term perspective, France’s per capita GDP (adjusted for purchasing power) fell from 12th to 16th position during the past five years.

### Fiscal stance, governance, and policy objectives
- Fiscal adjustment remains high on the government’s agenda.
- The objective of balancing the budget by 2010 through expenditure restraint is appropriate.
- Ongoing strengthening of fiscal governance will help achieve this goal, provided it is underpinned by bold and specific political choices.
- The government’s intention to curb social security and local authorities’ spending growth is key.
- Tax reforms have increased the incentives to work and invest, but a further reduction in the tax burden is desirable and dependent on additional spending cuts.

### Structural reform priorities and public debate
- Structural reforms must span several areas to exploit synergies and balance stakeholder interests; prioritization within these areas is important to secure fast progress.
- The authorities emphasize raising public awareness of the benefits of structural reforms; the upcoming 2007 elections provide an opportunity to place economic priorities at the center of public debate.

### External sector, competitiveness, and trade performance
- The external sector subtracted between 0.7-1 percent from annual growth in 2003–05.
- Together with adverse terms-of-trade effects, this led to a shift in the current account into a deficit of about 1.5 percentage points of GDP.
- Export volumes perked up markedly since mid-2005, in line with the rebound in partner demand; the foreign balance contributed positively to growth in the first half of 2006.
- Standard equilibrium exchange rate analysis indicates that the current real effective exchange rate is largely in line with fundamentals.
- Econometric residuals indicate a substantial unexplained drag on exports since 2001, not attributable to standard global demand and price/cost factors.
- Staff analysis links relative export underperformance to structural factors, notably labor market rigidities and a high ratio of minimum to median wages.

### Labor market developments and demographics
- All components of domestic demand contributed to the upswing; household consumption and investment in housing remained solid, helped by falling unemployment, real increases in the minimum wage (SMIC), and low interest rates.
- A counterfactual simulation suggests that employment growth would have been 1¼ percent higher during the past five years, had minimum wages not increased.
- The real increase of the SMIC during this period amounted to 15.2 percent.
- Labor market reforms (for example, the new contract for small enterprises (CNE) and reinforced job search requirements and employment services) have helped job creation but have not yet undone the adverse effect of high employment protection and the workweek reduction.
- Government-aided jobs, phased out during 2004–05, staged a comeback, contributing again to employment growth.
- The structural component of unemployment has fallen much less than the overall unemployment rate.
- Pension reform details: a normal pension vests after a career of 40 years, a duration that is being increased gradually to 41 years by 2012; earlier retirement is possible at an actuarially fair discount; working longer yields a less-than actuarially fair bonus. The parameters of the pension system are subject to 5-year reviews, with the next due in 2008.

### Financial sector stability and efficiency
- The financial system is highly stable and supervisors are responding to evolving risks.
- Staff sees scope to improve efficiency by phasing out administered schemes and accelerating financial integration in Europe.
- Low interest rates encouraged external financing, resulting in a declining self-financing ratio and rising debt, ending a four-year period of balance-sheet adjustment.

### Inflation and price dynamics
- Energy prices kept headline inflation up through the middle of 2006, while underlying inflation has been well-behaved.
- Core and headline inflation declined to slightly below the euro area average after mid-2005.
- Rents edged up as they are legally tied to the construction price index.
- Economy-wide unit labor costs have risen somewhat, in part because of a cyclical decline in productivity growth.
- Since January 2006, rents have been tied to a basket of prices comprising construction costs (with a 20 percent weight), consumer price inflation (60 percent), and maintenance costs (20 percent).

### Policy recommendations and reform areas
- Continue fiscal consolidation with expenditure restraint aimed at balancing the budget by 2010.
- Underpin fiscal rules and governance improvements with bold and specific political choices, including curbing social security and local authorities’ spending growth.
- Pursue further tax reform to reduce the tax burden contingent on additional spending cuts.
- Advance financial sector efficiency by phasing out administered schemes and accelerating financial integration in Europe.
- Promote labor market flexibility, including reducing judicial uncertainty surrounding permanent labor contracts; note limited prospects for consensus on widening differentials among median wage, minimum wage, and out-of-work benefits.
- Deregulate the services sector and accelerate the disengagement of the state from commercial activities to boost growth and consumer welfare.
- Use the 2007 elections as an opportunity to build public support and understanding of reform benefits.

*Source: IMF Staff — Executive Summary (content unit _cr06389).*

### 7.      Despite fiscal tightening, overall, policies have been supportive of growth

### 7.      Despite fiscal tightening, overall, policies have been supportive of growth

### Monetary and fiscal policy stance
- Monetary conditions remain accommodative as increases in real interest rates were partly offset by the depreciation of the real effective exchange rate, at least until very recently.
- The structural fiscal deficit decreased by about ¾ of 1 percentage point of GDP in 2005.
- The structural fiscal deficit is likely to continue to fall, but by somewhat less than ½ of 1 percentage point in 2006 (Table 3).
- Fiscal tightening had only limited impact on growth as private domestic demand continued to outpace GDP.

### Regional and structural performance
- GDP per capita is high, and growth per capita has been exceeding the euro area average, though the difference seems to be evaporating.
- France’s relative global position has deteriorated substantially, particularly as it failed to keep up with the United States.
- Pension reforms have limited the increase in age-related spending (excluding long-term care) to 2.9 percent of GDP between 2004 and 2050, compared to an EU average of 4 percent (according to the EC Aging Working Group).
- Pension spending level was 12.8 percent of GDP in 2004 and will remain above the EU average of 10.6 percent of GDP.
- Public debt has risen (to some 67 percent of GDP).
- Labor markets have become more flexible, though employment protection has increased.
- Taxes, unemployment benefits, and minimum wages are high; consequently, employment rates have improved much less than elsewhere.

### Near-term outlook and projections
- Staff projects GDP growth to remain broad-based and settle at an annual pace of about 2.5 percent during the second half of 2006, yielding average growth of 2.4 percent for the year.
- In 2007, higher oil prices and interest rates and lower trade partner growth will reduce growth slightly to about 2.3 percent.
- The staff does not expect households to further reduce their savings rate from current levels and sees residential construction growth slowing.
- The unemployment rate should decline, reflecting healthy growth, increased subsidized job creation, and the impact of pension and labor market reforms.
- Business investment is likely to keep expanding firmly while export growth should ease somewhat from its recent buoyant pace.
- Authorities expect that the economic impact on France of fiscal reforms and adjustment planned in Germany was likely to be small.

### Risks to the baseline
- Risks are broadly balanced and related to external shocks and the impact of ongoing structural reforms.
- Staff analysis suggests France has become more sensitive to the global economy and reacts more through changes in employment and productivity than through wage flexibility.
- The elections scheduled for the second quarter of 2007 constitute some source of uncertainty about the future course of economic policies.
- The fan chart includes the following risks to the baseline projections of growth (2.4 percent in 2006 and 2.3 percent in 2007): a 15 percent euro appreciation, a 20 percent increase in oil prices, a 1 percent higher trading partners growth, a 1 percent lower household saving ratio, an avian flu pandemic and a disorderly unwinding of global imbalances.

### Housing market and financial sector considerations
- After five years of strong increases, house prices show signs of cooling, which represents a small risk to the economy (Figure 7).
- Construction activity is expected to slow in line with the market for existing houses.
- Authorities and staff agreed there was no evidence of any significant impact of housing wealth on consumption.
- The real estate boom was accompanied by strong credit expansion to households, but authorities saw only limited risks to financial sector stability: house prices have been largely in line with fundamentals, household indebtedness has remained low by international comparison, and equity withdrawal has hitherto been absent.

### Inflation and potential growth
- Headline inflation is expected to average about 2 percent for the next few years (slowing from 2.2 percent in July 2006 as the pace of oil price increases eases).
- Underlying inflation—at 1.3 percent in July 2006—is expected to edge up gradually.
- Upside risks to inflation pertain to health care costs, discretionary minimum wage increases, and oil prices; additional structural reforms could have a dampening effect.
- Demographic trends and ongoing structural reforms suggest potential growth could be higher than previously estimated.
- Authorities estimate pipeline effects of structural reforms could add 0.1–0.2 percent to potential growth over the medium term.
- Together with recent uptick in investment, annual potential growth could temporarily rise to 2¼–2½ percent, before—in the absence of further reforms—settling at somewhat less than 2 percent per year in the long run.
- Staff revised its annual potential growth projections up from 1.9 percent to 2.2 percent for the next five years.

### Policy priorities, implementation approach, and recommendations
- Achieving fiscal sustainability, full employment, and higher trend growth remain priority objectives for economic policy.
- Fiscal adjustment has been progressing faster than expected, and institutional mechanisms have been put in place to secure further progress; however, the cyclical upswing and the upcoming 2007 elections will test consensus and mechanisms.
- The electoral debate is an opportunity to seek public endorsement of broader and faster structural reforms, particularly in the labor market.
- Authorities emphasize economic pedagogy and building consensus to promote structural reform (examples: Pébéreau report; annual national conference on public finances; new council on public finances (Cofipu)).
- Given public sensitivities, labor market reforms need to be approached cautiously and consensually; creation of a new council on employment (COE) to diagnose causes of unemployment among social partners and foster public debate was noted.
- Authorities balanced fiscal adjustment and pension and health care reforms with increases in the minimum wage and benefits (including the earned income tax credit), greater opportunities for worker profit participation, incentives for working longer, improved access to credit, tax cuts, and measures to prevent income loss for health care providers.
- Staff suggests extending the approach of pairing reforms with highly visible quantitative objectives to other areas (e.g., employment rates for labor market reforms; product market regulation indicators).
- Coordination among various councils and consistent pedagogic approach are important; avoid policies with a protectionist guise such as “economic patriotism.”

### Fiscal sustainability: current assessment and scenarios
- Rising costs of aging and high deficits constitute the main threats to fiscal sustainability.
- Pension reforms and the improved outlook for potential growth have significantly reduced the expected increase in the cost of aging, but current policies would still lead to unstable debt dynamics.
- Health care costs will continue to pressure the budget, rendering additional measures inevitable.
- The general government deficit is still too high to stabilize public debt.
- The decline in the debt ratio in the course of 2006 is due to asset sales and tighter cash and debt management.
- Between 2003 and 2006, the structural deficit has been reduced by more than 1½ percent of GDP.
- France was the first of the large euro area countries under the excessive deficit procedure to have brought the deficit to less than 3 percent of GDP in 2005 (albeit with the help of a one-off transfer from the electricity sector against its future pension liabilities).
- Public spending has been stuck at over 53 percent of GDP, with local and health care spending growing at about 4 percent per year during the past five years.
- Fiscal adjustment over recent years stemmed from higher revenues: two thirds was due to underlying dynamics of the tax base and tax elasticity slightly higher than one, which more than offset personal income tax cuts; the remainder resulted from increases in health care contributions, partly offset by declining social security contributions elsewhere.
- Box 4 staff baseline: aging costs under the staff’s baseline scenario are expected to add 4.5 percentage points of GDP to fiscal spending by 2050 (2.7 percent for pension and 1.8 percent for health), leading to unsustainable debt dynamics.
- Upfront fiscal adjustment alone, consistent with authorities’ goal of reaching fiscal balance by 2010, would bring the debt-to-GDP ratio down to about 30 percent by 2030 but would not suffice to stabilize it.
- A reform scenario in line with a (delayed) Lisbon agenda (expected to boost potential growth by at least ¼ percent after 2012) together with an upfront structural fiscal adjustment of 0.3 percent of GDP per year through 2011 would achieve sustainability at a public debt-to-GDP ratio of about 20 percent of GDP by 2050.

### Key fiscal projections and indicators (Text Table highlights)
- Revenue: 2005 = 50.9, 2006 = 50.9, 2007 = 50.6, 2008 = 50.3, 2009 = 50.3, 2010 = 50.3, 2011 = 50.3 (in percent of GDP).
- Tax revenue: 2005 = 44.0, 2006 = 44.3, 2007 = 44.0, 2008 = 43.8, 2009 = 43.8, 2010 = 43.8, 2011 = 43.5 (in percent of GDP).
- Expenditures: 2005 = 53.8, 2006 = 53.6, 2007 = 53.2, 2008 = 52.8, 2009 = 52.5, 2010 = 52.2, 2011 = 52.0 (in percent of GDP).
- Real growth rate (in percent) adjusted using CPI excluding tobacco prices: 2005 = 2.3, 2006 = 1.9, 2007 = 1.4, 2008 = 1.7, 2009 = 1.7, 2010 = 1.8, 2011 = 2.1.
- Primary balance: 2005 = -0.2, 2006 = -0.1, 2007 = -0.1, 2008 = -0.1, 2009 = 0.3, 2010 = 0.6, 2011 = 0.9 (in percent of GDP).
- Overall balance (Maastricht definition): 2005 = -2.9, 2006 = -2.7, 2007 = -2.6, 2008 = -2.5, 2009 = -2.2, 2010 = -2.0, 2011 = -1.7 (in percent of GDP).
- Structural balance: 2005 = -2.2, 2006 = -1.8, 2007 = -1.8, 2008 = -1.8, 2009 = -1.8, 2010 = -1.7, 2011 = -1.7 (in percent of GDP).
- Gross debt: 2005 = 66.6, 2006 = 64.4, 2007 = 63.9, 2008 = 63.4, 2009 = 62.8, 2010 = 62.2, 2011 = 61.4 (in percent of GDP).

*Source: IMF staff report content provided.*

### 23.      In response, plans for fiscal consolidation are being underpinned by ambitious

### _cr06389 - 23.      In response, plans for fiscal consolidation are being underpinned by ambitious

### Fiscal consolidation: objectives and staff projection
- Authorities aim to balance the budget by 2010.
- From 2007 onward:
  - Real spending at the central government level is set to decline by 1 percent per year.
  - Growth of social security spending will not exceed 1 percent in real terms.
  - Local authorities are expected to gradually move toward keeping real spending constant.
- For 2007:
  - There is a commitment on the central government’s objective, but little or no structural adjustment.
  - How spending objectives will be achieved for other components of government, and beyond 2007, remains to be spelled out.
- Staff projection:
  - The structural balance is projected to remain in a deficit of about 1¾ percent of GDP.

### Tax reforms: direction, measures, and concerns
- Reforms geared at promoting employment and investment include:
  - Increase in the earned income tax credit (PPE).
  - Introduction of a ceiling on tax payments as a share of current revenue (bouclier fiscal).
  - Reduction in marginal income tax rates in 2007.
  - Cap on a local tax on capital (taxe professionnelle) and extension of exemptions for new investments until they are on stream.
- Expected effects:
  - Measures will boost labor supply across the skills range.
  - Cap on local tax on capital and investment exemptions will help investment.
- Budgetary cost:
  - The reforms will have a budgetary cost of about ½ of 1 percent of GDP in 2007.
- Policy concern:
  - In response to tight spending limits, policy proposals are increasingly focused on granting tax exemptions and tax credits.
  - Authorities acknowledged the need to stem proliferation of tax expenditures; one option is prohibiting such measures from being introduced outside annual budget laws.

### Social security financing reform: assessment and staff recommendation
- Current proposals:
  - Further cuts in employers’ social security contributions are being considered, to be financed by an increase in taxes on consumption or capital.
- Staff and authorities’ technical assessment:
  - In France’s institutional context, there are virtually no benefits from shifting financing from labor to consumption or capital.
  - Shifting to consumption taxes:
    - Would allow a slight reduction in marginal tax rates.
    - No other gains because social benefits and the minimum wage are indexed to inflation and unions may demand compensation for loss of purchasing power.
  - Shifting to capital:
    - May have short-term benefits but at the cost of less investment and less output in the long run.
- Staff recommendation:
  - Rather than shifting the tax burden, finance the reform through additional expenditure cuts.

### Financial sector stability and efficiency: condition, risks, and policy scope
- Current condition and vulnerabilities:
  - Financial sector is highly capitalized and profitable.
  - A substantial part of the recent rise in profits is likely transitory, linked to reintegration of past provisions, low ongoing provisioning, and rapid credit growth.
  - Following rapid expansion of mortgage credit, lending is becoming more balanced as credit to the corporate sector has picked up; the real estate market shows some signs of cooling.
  - Insurance sector benefits from good stock market performance, rising interest rates, and reduced incidence of natural disasters.
- Supervisory assessment and stress tests:
  - Under new accounting standards solvency ratios of French banks are lower by about 60 basis points, but solvency remains satisfactory.
  - Nonperforming loans and provisioning are at historically low levels and thus prone to a rise.
  - Exposure to hedge funds has remained limited, at no more than 3.5 percent of balance sheet totals.
  - Banks have conducted stress tests on rising exposure to credit derivatives and on other shocks; supervisors were reassured by banks’ stress testing.
  - Specific stress test note: Shocks to the yield curve (shift up by 200 basis points, short rates up 200 plus long rates up 100 basis points), foreign demand (down 20 percent), house prices (40 percent decline in two years) would each reduce solvency (Basel II definition) by less than 1 percentage point.
- Structural changes and new instruments:
  - Emergence of the postal bank (state-owned) separating financial activities from the post office, leveling the playing field.
  - Introduction of real estate-backed credit lines and reverse mortgages to facilitate household wealth management.
  - Staff analysis suggests consumption in France is excessively sensitive to current income, possibly due to constrained access to financial markets.
  - New instruments unlikely to be a significant breakthrough; uptake depends on reductions in legal requirements for collateralized lending and on removal of repayment and cap constraints.
- Enhancing the sector’s contribution to growth:
  - Observations: mortgage products offered at unprofitably low interest rates; switching costs for existing customers are very high; elevated profits coincide with relatively high operating costs.
  - Pervasive administered deposit and savings schemes limit competition on banks’ liability side; authorities see little adverse impact and have no plans to phase them out.
  - Authorities have required more transparent display of costs of services and launched an Institute for the Financial Education of the Public to advance financial literacy.
  - Staff called for accelerating integration of financial markets in Europe:
    - Establish standardized financial products and documentation and underwriting practices.
    - Integrate payments, clearing and settlement systems and harmonize regulatory and supervisory practices.
    - Pointed to potential cost savings and an appreciable growth dividend from complete integration.

### Growth and job creation: reform progress, labor market diagnosis, and policy recommendations
- Structural reform progress and expected gains:
  - Breakup of public utilities, pension and health care reforms, and introduction of a new labor market contract are notable reforms.
  - Based on OECD product market regulation indicators, recent reforms are likely to boost annual growth by 0.1-0.2 percent over the medium term.
  - Authorities agreed much more remains to be done, particularly regarding employment rules, social security, and services sector.
  - Case for simultaneous product and labor market reforms and better coordination of timing of reforms in the EU.
- Labor market diagnosis:
  - Laying off employees on permanent contracts is very costly due to cumbersome and lengthy legal procedures and the burden of proof on firms; judges ultimately decide validity and cost.
  - Example: layoffs for economic reasons can be justified on the basis of the desire to “preserve” but not to “improve” profitability or competitiveness.
  - Firms respond by relying on fixed-term and temporary workers, producing a dual labor market with many precarious jobs.
  - High minimum wages price low-skilled workers out of jobs; generous benefits reduce job search incentives.
  - Employment rate of older workers remains very low due to special early retirement regimes and rigid tenure-related pay scales.
- Ongoing and past labor market measures:
  - Reforms and measures already implemented:
    - Tax and pension reforms and loosening of the 35-hour workweek promoting labor supply.
    - Streamlining of employment services and tightening of job search requirements.
    - New labor contract for small enterprises (CNE) facilitating hiring (trial period up to two years for firms with 20 employees or less).
  - The CNE:
    - Employment termination under the CNE is not subject to costly legal and administrative procedures; severance pay based on job duration.
    - Through June 2006, job intentions using the CNE accounted to close to 10 percent of total employment intentions by small firms.
    - Overall impact on net job creation: close to 40,000 in its first six months and estimated to rise to 70,000 over the medium term.
  - Subsidized employment programs are being ramped up again after their decline in 2004–05.
  - Total budgetary burden of labor market policies is estimated to amount to 2.4 percent of GDP in 2006.
- Staff policy recommendations to reinvigorate reform:
  - Reduce employment protection of permanent contracts, in particular uncertainty surrounding the cost of terminating such contracts; work started on streamlining the labor code.
  - Tie the minimum wage henceforth to the core index of inflation only (staff suggestion).
  - Completely phase out special early retirement regimes and the exemption from job search for older workers.
  - Further increase the actuarial fairness of the regular pension system.
  - Authorities indicated they would implement a package of measures to promote activity for older workers.
- Product and services market reform recommendations:
  - Replace administrative approval of retail outlet locations by zoning requirements as recommended by the OECD.
  - Liberalize shop opening hours and sales periods.
  - Shorten and simplify administrative procedures, especially for startups.
  - Swift adoption of the EU services directive would have benefits.

### Labor market policies: composition and budgetary costs (2006)
- Overview of the budgetary cost of labor market policies, 2006 (In percent of GDP):
  - Social security contribution exemptions 1.27
  - Across the board exemptions for low wages 1.22
  - Specific exemptions (services, catering sector) 0.05
  - Subsidized jobs and aids to enterprise creation 0.41
  - Promotion of life-long and vocational training 0.25
  - Earned-income tax credit (PPE) 0.18
  - PIT credit to promote labor supply 0.14
  - CIT credit to promote labor demand 0.04
  - Reduced VAT in cafeterias on work premises 0.05
  - Total 2.39
- Notes:
  - About half of the 2.4 percent of GDP total budgetary burden in 2006 is devoted to across-the-board exemptions of employers’ social security contributions (SSC).
  - The earned-income tax credit (PPE) will amount to 0.2 percent of GDP; other tax expenditures (after excluding SSC cuts) could reach 0.2 percent.
  - For households: support ranges from the personal income tax (PIT) credit for hiring an employee for personal services to partial PIT exemption for apprentices.
  - For firms: corporate income tax credits for life-long training, management of apprentices, or activities in special urban areas.

*Italic source: _cr06389 - 23.      In response, plans for fiscal consolidation are being underpinned by ambitious*

### 36.      The authorities acknowledged that the state’s presence in commercial activities

### _cr06389 - 36.      The authorities acknowledged that the state’s presence in commercial activities

### State presence in commercial activities
- The state’s presence in commercial activities "was still too pervasive, noting that it was steadily diminishing."
- Recent and planned withdrawals from commercial participation included:
  - Privatization of highways.
  - Partial flotation of the electricity and gas utilities.
  - Impending divestiture of the Paris airports operator.
- The planned merger of the gas utility with a domestic firm was described as "a mere acceleration of existing business plans, which would reduce the state’s stake in the utility," despite perceptions it aimed to prevent foreign takeover.
- Staff noted policy ambiguity, referencing a new law covering 11 "so-called sensitive sectors" adopted specifically "to limit the possibility of hostile takeovers."

### R&D, innovation, and public-private incentives
- Authorities have "started to provide R&D and infrastructure support to selected research clusters and have created a new agency for innovation."
- Staff supported the objectives but agreed with the OECD position calling for "limiting bureaucracy and budgetary costs."
- Emphasis on targeting measures because "it is mostly the private sector that lags in terms of R&D spending by international comparison."
- Recommended focus:
  - Public-private partnerships.
  - Increased incentives for individual researchers.

### Economic outlook and main reform priorities (Staff appraisal)
- Overall assessment: "The economic outlook is broadly positive thanks in part to policies of consolidation and reform, but significant structural weaknesses persist, requiring further growth-enhancing reforms."
- Key observations:
  - Greater flexibility in labor and product markets has increased economic efficiency.
  - Pension and health care reforms and ongoing fiscal consolidation have "brightened prospects for fiscal sustainability."
  - France’s relative position in the global economy "has deteriorated appreciably."
  - Projected age-related spending remains comparatively high; taxes, unemployment benefits, and minimum wages remain high—"compressing employment rates."
- Three main reform priorities:
  1. Fiscal adjustment through expenditure reduction.
  2. Two labor market reforms:
     - "A marked reduction in the judicial uncertainty surrounding permanent labor contracts."
     - "A widening of the differentials among the median wage, the minimum wage, and out-of-work benefits."
  3. Product market reforms:
     - "Deregulation of the services sector and full disengagement of the state from commercial activities."
- Political timing: "The electoral calendar provides an opportunity to place these economic priorities at the centre of an informed public debate. Implementation should start immediately following the 2007 elections."

### Growth prospects and risks
- Near-term projection: "growth is expected to continue in the range between 2 and 2½ percent per year, and unemployment is likely to decline appreciably."
- Risks: "Risks are broadly balanced and relate mainly to external developments, given the heightened sensitivity of the economy to global developments."
- Positive signs: exports have picked up; "the exchange rate appears broadly in line with fundamentals," reducing competitiveness concerns.
- Structural constraint: "the slow response to the global expansion still points to the presence of supply rigidities and the need for flexibility-enhancing structural reforms."
- Medium-term: "prospects are for potential growth to remain higher than previously expected because of improved demographics and the effects of structural reforms."

### Fiscal consolidation and fiscal policy recommendations
- Recent progress: "Underlying adjustment has been noteworthy, averaging slightly more than ½ of 1 percentage point of GDP per year and permitting the general government deficit to settle below 3 percent of GDP."
- Policy actions that enhanced credibility:
  - "Maintaining central government spending constant in real terms for four consecutive years."
  - "Bringing health care spending on track after years of overruns."
- Targets and recommendations:
  - Aim to "balance the budget by 2010" is appropriate.
  - Focus on "expenditure restraint" and stronger adjustment in 2007 would be desirable for a more evenly-paced consolidation path.
  - "Quickly make the specific policy choices necessary to keep spending within the proposed norms, especially for social security and local governments."
  - Strengthen the capacity of national fiscal institutions to contribute to public debate on fiscal policy.

### Tax reform observations
- Tax reform achievements: "improved the economy’s growth potential," with focus on "making work pay and fostering investment."
- Concerns and recommendations:
  - "The increasing recourse to tax expenditure needs to be stemmed to prevent the erosion of the benefits of improved spending discipline."
  - Shifting taxation to other tax bases to fund social security "will have negligible economic effects."

### Financial sector: resilience and reforms to boost growth
- Financial sector position: "profitability and capitalization put it in a good position to manage increasing risks," but supervisors should remain attentive.
- Key risks identified:
  - Transitory character of current low provisioning.
  - Possible relaxation of loan standards due to competition for market share.
  - Rising exposure abroad.
  - Search for profits in less liquid market segments.
- Positive assessment: "Stress tests conducted by banks and supervisors indicate considerable resilience to large shocks."
- Recommendations to raise growth contribution:
  - Phase out administrative savings schemes to increase competition for resources, foster financial innovation, and help development of risk capital markets.
  - Expand the mortgage market reform initiative to permit more flexible use of prudently-valued housing collateral.
  - Allow the postal bank to develop into a full-fledged bank and be privatized.
  - Swiftly harmonize financial products, regulation, and legislation and integrate financial market infrastructure across Europe.

### Labor and product market reforms to boost employment and welfare
- Labor market progress: "Following recent reforms, the labor market has become more flexible, raising supply."
- Persisting problems:
  - High minimum wage and its ongoing significant increases "continue to curb labor demand, lead to excessive wage compression, and require budgetary resources to keep labor costs manageable."
- Policy priorities:
  - "Drastically reducing the legal uncertainty surrounding permanent labor contracts."
  - "Increasing the wedge between the minimum wage and the median wage and between out-of-work benefits and the minimum wage."
  - Strengthen product and services market reform: "Deregulating the services sector, reducing the administrative burden on enterprises, and accelerating the withdrawal of the state from commercial activities will appreciably boost output and consumer welfare."
- International trade: "France should contribute actively within the EU to help revive multilateral trade negotiations."

*Source: IMF staff appraisal excerpts from content unit _cr06389 - 36.*

### 46.      It is proposed that the next Article IV Consultation take place on the standard 12-

### _cr06389 - 46.      It is proposed that the next Article IV Consultation take place on the standard 12-

### Executive summary and staff appraisal
- Growth is likely to reach 2.5 percent in 2006, slightly higher than anticipated in the staff report because of historical data revisions.
- Headline inflation fell to 1.5 percent in September 2006, helped by declining oil prices.
- The IMF staff projects general government deficits of 2.6 percent of GDP in 2006 and 2.4 percent of GDP in 2007.
- Official targets are deficits of 2.7 percent of GDP in 2006 and 2.5 percent of GDP in 2007.
- Tight spending control and slightly above-trend nontax revenues are expected to accommodate previously announced tax cuts of about 0.3 percent of GDP.
- In the staff’s estimates, the structural deficit is set to remain broadly constant in 2007, while the authorities see a continuing structural improvement.

### Growth, demand, and prices
- Real GDP and sectoral developments:
  - The recovery has gained momentum: charts indicate strengthening in Real GDP, Industry, and Services.
  - Private consumption remained steady; private consumption expenditure, real disposable income, and household savings ratio are highlighted in the figures.
  - Gross fixed investment picked up; business investment, residential investment, and public investment show increases in recent years.
- Projections (as presented in the main projection table):
  - Gross domestic product: 1.1; 1.1; 2.0; 1.2; 2.4; 2.3; 2.4; 2.4; 2.4; 2.4 (sequence as in the table).
  - Private consumption: 2.4; 2.2; 2.5; 2.1; 2.7; 2.5; 2.5; 2.5; 2.5; 2.5.
  - Gross fixed investment: -1.7; 2.3; 2.6; 3.7; 3.6; 3.0; 2.7; 2.7; 2.6; 2.7.
  - Exports of goods and NFS: 1.3; -1.1; 3.3; 3.2; 8.7; 7.0; 6.5; 6.5; 6.5; 6.5.
  - Imports of goods and NFS: 1.6; 1.5; 6.0; 6.5; 8.6; 6.8; 6.4; 6.4; 6.3; 6.3.
- Prices:
  - GDP deflator: 2.4; 1.8; 1.7; 1.8; 1.9; 1.8; 1.7; 1.7; 1.7; 1.7.
  - Consumer prices (average): 1.9; 2.2; 2.3; 1.9; 2.0; 1.9; 2.0; 1.8; 1.7; 1.7.
  - Consumer prices (end of period): 2.1; 2.4; 2.4; 1.7; 2.4 (2006 year-on-year April for 2006).

### Labor market and productivity
- Employment and unemployment (table series):
  - Employment (annual change): 0.6; 0.1; 0.0; 0.3; 0.6; 0.6; 0.5; 0.5; 0.5; 0.5.
  - Unemployment (percent of labor force, harmonized): 8.9; 9.5; 9.6; 9.5; 9.0; 8.5; 8.2; 7.8; 7.5; 7.0.
  - Productivity: 0.5; 1.0; 2.0; 0.9; 1.8; 1.7; 1.9; 2.0; 1.9; 1.9.
  - Unit labor costs (whole economy): 3.0; 1.8; 1.3; 1.7; 1.4; 1.7; 1.7; 1.5; 1.5; 1.5.

### Fiscal outlook and public sector accounts
- General government (percent of GDP, table excerpt):
  - Revenue: 49.5; 49.2; 49.6; 50.9; 50.9; 50.6; 50.3; 50.3; 50.3; 50.3.
  - Expenditure: 52.7; 53.4; 53.2; 53.8; 53.6; 53.2; 52.8; 52.5; 52.2; 52.0.
  - General government balance (Maastricht definition): -3.2; -4.2; -3.7; -2.9; -2.7; -2.6; -2.5; -2.2; -2.0; -1.7.
  - Central government balance: -3.7; -3.9; -3.2; -3.0; -2.5; -2.1; -2.0; -1.5; -1.0; -0.5.
  - Structural balance (percent of potential GDP): -3.1; -3.5; -3.0; -2.2; -1.8; -1.8; -1.8; -1.8; -1.7; -1.7.
  - Primary balance: -0.3; -1.4; -1.0; -0.2; -0.1; -0.1; -0.1; 0.3; 0.6; 0.9.
  - Gross debt (Maastricht): 58.2; 62.4; 64.4; 66.6; 64.4; 63.9; 63.4; 62.8; 62.2; 61.4.
- The 2007 budget raises spending on ODA (official description in the supplement).

### External sector and balance of payments
- Trade balance (in billions of euros): 8.0; 2.9; -6.9; -25.9; -28.0; -27.5; -27.7; -27.9; -28.0; -27.8.
  - (In percent of GDP): 0.5; 0.2; -0.4; -1.5; -1.6; -1.5; -1.4; -1.4; -1.3; -1.3.
- Current account (in billions of euros): 15.4; 7.0; -5.6; -27.0; -30.9; -31.4; -31.6; -31.5; -31.1; -30.5.
  - (In percent of GDP): 1.0; 0.4; -0.3; -1.6; -1.7; -1.7; -1.6; -1.6; -1.5; -1.4.
- Terms of trade: 2.6; -0.1; -0.3; -1.5; -0.6; 0.2; 0.2; 0.2; 0.2; 0.2.

### Monetary, financial conditions, housing, and banks
- Monetary and financial indicators:
  - Short-term real interest rates have been rising; yield curves and real effective exchange rate (REER) indicators show a withdrawal of monetary stimulus and slightly tighter monetary conditions.
  - Monetary conditions index: The MCI stabilized with a slight tightening (series shown in figure).
- Housing market (selected indicators):
  - Real house prices (2000=100) and price-to-rent, affordability ratios indicate rising house prices and lending to households.
  - Lending to households and housing loans recorded significant growth (figures show annual percentage changes and outstanding lending series).
- Financial sector soundness (selected indicators):
  - Credit increased, mainly due to mortgages; credit by sector shows strong increases in Consumption, Residential Mortgage, and Corporate credit (levels in billions of euro in figure).
  - Return on Equity (aggregated): 9.6; 9.1; 8.5; 10.6; 11.9 (annual series in tables).
  - Nonperforming loans to total gross loans: 5.0; 5.0; 5.0; 4.8; 4.2; 3.5 (annual series).
  - Provisioning and net allocations to provisions declined temporarily, contributing to improved profitability.
  - FSAP conclusions: France’s financial sector is strong and well supervised; no weaknesses that could cause systemic risks were identified. Issues noted include concentration in banking, large portfolios of fixed-rate residential housing loans, some distortions from administered savings schemes, coordination needs among specialized supervisors, and scope to improve retail payment and securities settlement safeguards.

### Data, transparency, and Fund relations
- Article IV schedule and Fund relations:
  - The previous Article IV Consultation concluded on November 2, 2005; France is on the standard 12-month consultation cycle.
  - France subscribes to the Fund’s Special Data Dissemination Standard (SDDS); comprehensive economic data are available on a timely basis.
- ROSC and FSAP findings:
  - Fiscal Transparency ROSC: France achieved a high level of fiscal transparency; Loi organique aux lois de finance (LOLF) has become fully effective on January 1, 2006, improving multi-annual frameworks, mission-based budgeting, performance indicators, and parliamentary oversight.
  - Transparency in Monetary and Financial Policies ROSC: Major agencies observe principles of transparency; the supervisory framework for mutual insurance firms was strengthened, including creation of CCAMIP in August 2003.
  - Data Module ROSC: France is in observance of the SDDS. Recommendations relate to clarifying INSEE’s role for government finance statistics, improving data sharing, balance-of-payments classification and consistency, and timing of revisions.
  - FSAP and Financial System Stability Assessment: The financial sector is strong and well supervised; a number of issues and recommendations are identified (concentration risks, housing loan exposures, administered savings schemes, supervisory coordination, clearing and settlement safeguards).

*Source: IMF staff report supplement to the 2006 Article IV Consultation with France (Staff Report approved October 19, 2006), as provided in the content unit.*

### 0.5 percent of GNI. On structural issues, privatization is continuing, but the removal of

### _cr06389 - 0.5 percent of GNI. On structural issues, privatization is continuing, but the removal of

### Output and inflation
- Authorities project growth in a range of 2–2½ percent in 2006 and 2007, based on robust consumer spending.
- Staff projections:
  - 2006: at the top end of the authorities' range.
  - 2007: 2.3 percent, above the Consensus forecast.
- Recent data indicate growth settling at about 2½ percent in the second half of 2006.
- Labor and demand developments:
  - Consumer confidence is up; spending on manufactured goods was exceptionally strong in August.
  - Industrial production weakened during the summer; business sentiment held up and the outlook improved.
  - Labor shortages emerged in a briskly expanding construction sector.
- External sector and prices:
  - Higher oil prices and buoyant imports widened the current account deficit in July despite strong export growth.
  - Employment edged up; unemployment rose marginally to 9 percent in August, after a 1 percentage point decline over the past 12 months.
  - Headline inflation moderated; underlying inflation trend reversed in August–September 2006, with a decline to 1.0 percent.

### 2006 Budget
- Stronger growth produced a larger-than-expected reduction in the 2006 general government deficit; underlying adjustment still expected to amount to 0.5 percent of GDP.
- Authorities' projections:
  - Deficit falls from 2.9 percent of GDP in 2005 to 2.7 percent of GDP in 2006, below the initial target of 2.9 percent of GDP.
- Composition of adjustment:
  - Structural adjustment arises from replacing one-off revenues (transfer of the energy utilities’ pension funds) with durable expenditure restraint.
  - Tight control of health care spending appears to more than offset higher-than-budgeted pension payments in social security.
  - Fiscal incentives favoring energy conservation strengthened, with marginal budgetary implications.
  - Tax expenditure approved outside the budget law is estimated to have reduced revenues by 0.1 percent of GDP in 2006.

### 2007 Budget
- Draft 2007 budget aims to reduce deficit from 2.7 percent to 2.5 percent of GDP while lowering the tax burden; assumes growth of 2¼ percent.
- Expenditure-side measures:
  - General government spending set to grow by 1.4 percent in real terms, producing a 0.4 percent decline in the expenditure-to-GDP ratio.
  - Central government expenditure planned to fall by 1 percent in volume terms after three consecutive years of zero real growth.
  - Number of civil servants to decline by 15,000 (in full-time equivalents), implying a replacement rate of four out of five retiring employees.
  - Nominal social security spending growth projected to stabilize at about 3¼ percent, anchored by a health care spending norm of 2.5 percent.
  - New measures to foster use of generic drugs and reduce fraud; pension payments will rise as baby boomers retire.
  - Local government expenditures expected to grow above nominal GDP due to strong investment and a rising wage bill.
- Revenue-side measures:
  - Revenues from taxes and social security contributions projected to fall by 0.3 percentage point to 43.7 percent of GDP.
  - Two thirds of the revenue decline stem from a preannounced income tax reform reducing the number of brackets and the highest marginal rates.
  - Earned income tax credit (prime pour l’emploi) raised further.
  - Firms benefit from capping taxe professionnelle at 3.5 percent of value added, exemption of new investment from this tax, and elimination of social security contributions for minimum wage workers in small firms.
  - Budget stipulates that all revenue windfalls be applied to deficit reduction.
  - Nontax revenues maintained at slightly above-trend levels.
- Structural adjustment assessment:
  - Authorities estimate the 2007 budget implies a structural adjustment of 0.4 percent of GDP.
  - On the basis of staff’s upward-revised estimates of potential growth and unit elasticity of revenues with respect to GDP, there would be virtually no underlying adjustment in 2007.

### Medium-term fiscal outlook (2008–10)
- Authorities’ intentions: pursue underlying adjustment through expenditure restraint while leaving the tax system unchanged.
- Authorities' "low-case" medium-term scenario:
  - Growth set to continue at 2¼ percent per year.
  - Real general government spending growth would decline to average 0.6 percent during 2008–10.
  - Central government spending decelerates to become constant in value by 2010.
  - Social security, health care, and local spending growth limited to 1.1 percent, 2.2 percent, and 2 percent per year in real terms, respectively.
  - Outcome: cumulative structural adjustment of 2.2 percentage points of GDP by 2010.
  - Measures to achieve these objectives have not been specified.
- Staff projection under current policies:
  - Real general government spending projected to average 1.8 percent per year beyond 2007.
  - Improvement of the structural balance limited to 0.3 percent of GDP by 2010.
- Authorities' high-case scenario:
  - Higher actual and potential annual economic growth of 3 percent due to structural reforms.
  - Excluding tax cuts and accounting for lower unemployment benefit spending, scenario would improve fiscal situation by almost 1 percent of GDP.
- Staff note: fiscal sustainability will only be achieved with further growth-enhancing structural reforms.

### Structural issues
- Parliament approved an energy law paving the way for divestiture of Gaz de France (GDF).
- Authorities sharply criticized EU attempts to challenge the distribution monopoly of an administered savings scheme (Livret A).
- Privatization is continuing, but removal of administered schemes in the financial sector is being resisted.

### Table and key projections (selected figures as reported)
- Budget 2007 (authorities' medium-term lower scenario):
  - Overall balance: -2.9 (2005), -2.7 (2006), -2.5 (2007), -1.8 (2008), -0.9 (2009), 0.0 (2010) — (In percent of GDP)
  - Tax revenue: 44.0 (2005), 44.0 (2006), 43.7 (2007), 43.5 (2008), 43.5 (2009), 43.5 (2010) — (In percent of GDP)
  - Expenditures: 53.8 (2005), 53.3 (2006), 52.9 (2007), 52.1 (2008), 50.3 (2009), 50.4 (2010) — (In percent of GDP)
  - Real expenditure growth (in percent): 2.3 (2005), 1.4 (2006), 1.4 (2007), 0.9 (2008), 0.7 (2009), 0.4 (2010)
  - Real GDP growth (in percent): 1.2 (2005), 2.3 (2006), 2.3 (2007), 2.3 (2008), 2.3 (2009), 2.3 (2010)
  - CPI inflation excluding tobacco (in percent): 1.8 (2005), 1.8 (2006), 1.8 (2007), 1.8 (2008), 1.8 (2009), 1.8 (2010)
- Staff projections (current policies):
  - Overall balance: -2.9 (2005), -2.6 (2006), -2.4 (2007), -2.2 (2008), -2.0 (2009), -1.7 (2010)
  - Structural balance (excluding the EDF pension transfer in 2005): -2.2 (2005), -1.7 (2006), -1.7 (2007), -1.7 (2008), -1.6 (2009), -1.4 (2010)
- Additional macro indicators (selected):
  - Unemployment (percent of labor force, harmonized index): 8.9 (2002), 9.5 (2003), 9.6 (2004), 9.5 (2005), 8.9 (2006), 8.4 (2007), 8.1 (2008), 7.7 (2009), 7.4 (2010), 7.0 (2011)
  - Trade balance (in billions of euros): 8.0 (2002), 2.9 (2003), -6.9 (2004), -25.9 (2005), -29.2 (2006), -29.8 (2007), -30.5 (2008), -30.7 (2009), -30.6 (2010), -30.2 (2011)
  - Current account (in percent of GDP): 1.0 (2002), 0.4 (2003), -0.3 (2004), -1.6 (2005), -1.9 (2006), -1.9 (2007), -1.9 (2008), -1.8 (2009), -1.7 (2010), -1.6 (2011)
  - Gross debt (Maastricht definition): 58.2 (2002), 62.4 (2003), 64.4 (2004), 66.6 (2005), 64.4 (2006), 63.3 (2007), 62.7 (2008), 61.9 (2009), 61.1 (2010), 60.0 (2011)

### Staff assessment and policy implications
- The 2007 budget continues spending restraint but partly funds tax cuts, creating an inopportune pause in underlying adjustment.
- Economic projections underlying the 2007 budget are cautious; planned 1 percent real reduction in central government expenditure is a welcome breakthrough.
- On staff’s more conservative estimates, virtually no structural adjustment occurs in 2007.
- Recommendation to make the budget provision to allocate revenue windfalls to deficit reduction effective by complementing it with a rule prohibiting tax expenditure from being implemented outside the budget law.
- For the medium term, significant spending reduction as a share of GDP requires adoption of durable expenditure measures.
- On current policies, staff projects structural balance to remain around a deficit of about 1½ percent of GDP over the medium term.
- Implementing authorities’ planned central government spending path, balancing social security budgets, and curbing local spending growth would eliminate this deficit, but fiscal sustainability also requires further growth-enhancing structural reforms.

*IMF Executive Board Concludes 2006 Article IV Consultation with France*

### 2.5 percent of GDP from 2.7 percent of GDP in 2006 and 2.9 percent of GDP in 2005.

### _cr06389 - 2.5 percent of GDP from 2.7 percent of GDP in 2006 and 2.9 percent of GDP in 2005.

### Fiscal developments and structural balance
- Structural balance improved by about 0.8 percentage point of GDP in 2005; staff estimates a further improvement of 0.5 percentage point of GDP in 2006.
- Structural adjustment achieved through expenditure restraint at the central government level and in health care.
- Net tax burden: roughly constant in 2006; expected to decline by 0.3 percent of GDP in 2007, largely due to tax relief favoring work income, investment, and a variety of smaller tax cuts in other areas.
- Directors urged maintaining the steady pace of fiscal consolidation until the general government budget is balanced.
- Directors supported the authorities’ objective of balancing the budget by 2010 and emphasized the need for ambitious medium-term expenditure restraint, especially by reducing spending growth for social security and local governments.
- Directors welcomed full implementation of the new objective-oriented budgeting framework for the central government and recommended that the provision to allocate revenue windfalls to deficit reduction become a standard feature.
- Directors underscored the need to formally prevent recourse to tax expenditure outside the framework of the budget law.

### Financial sector developments and risks
- Housing credit expanded strongly; bank profitability increased; nonperforming loans declined.
- Supervisors urged banks to strengthen loan standards and watch exposure to hedge funds and credit derivatives.
- New mortgage market instruments have been established.
- Directors observed the financial system is highly profitable, well capitalized, and in a good position to manage increasing risks, but urged supervisors to remain highly attentive to risks of relaxation of loan standards, rising exposures abroad, and to less liquid market segments.
- Policy recommendations to increase the financial sector’s contribution to growth:
  - Phase out administered saving schemes.
  - Promote competition and development of risk capital markets.
  - Advance complete integration of Europe’s financial markets.

### Structural reforms and labor market
- Authorities emphasized raising public awareness of the benefits of structural reforms.
- Measures to promote labor supply: increase in earned income tax credit and reduction in marginal income tax rates.
- Measures to promote labor demand: targeted reductions in social security contributions and introduction of a new labor contract for small enterprises (Contrat nouvelle embauche, CNE).
- Reorganization of employment services intended to improve labor market matching.
- Following withdrawal of the proposed Contrat première embauche (CPE) for the young, a council on employment (Conseil d’orientation pour l’emploi, COE) was created to establish a common diagnosis of unemployment causes and foster public debate on remedies.
- In product markets, divestiture from commercial activities continued, including in the energy sector.
- Directors’ priorities for further reforms:
  - Further labor market reform by reducing the judicial uncertainty surrounding permanent contracts and widening differentials between out-of-work benefits, the minimum wage, and the median wage.
  - Further product market reform through deregulation of the services sector and progressive disengagement of the state from commercial activities.
  - Make determined efforts on economic deregulation, divestiture from commercial activities, and further opening up of services markets to competition.
- Directors urged increasing the wedge between the minimum wage and the median wage and between out-of-work benefits and the minimum wage to reward return to work and career progression.

### Growth, external sector, and outlook
- Near-term outlook: positive, with growth becoming more vigorous and broad based; medium-term outlook brightened by improved demographics and structural reforms.
- Demand and inflation dynamics:
  - Falling unemployment, rising wages, and tax cuts supported private consumption.
  - Inflation remained low.
  - Favorable financing conditions and high capacity utilization are bolstering investment.
- External sector:
  - Exports strengthened noticeably since mid-2005 following earlier lackluster performance, but the current account deficit continued to widen.
  - Real effective exchange rate appears to be fairly valued; Directors did not see an immediate competitiveness problem, but noted exports’ earlier lack of dynamic response to global expansion.
  - Directors underscored the importance of flexibility-enhancing structural reforms to address risks from a possible disorderly unwinding of global imbalances.
- Directors urged France to contribute actively within the EU to help revive and bring to a successful conclusion the Doha round of multilateral trade negotiations and welcomed France’s planned increase in official development assistance.

### Executive Board recommendations and assessments
- Directors commended French authorities for skillful macroeconomic management and significant progress in fiscal consolidation and structural reform; they supported the authorities’ emphasis on building consensus.
- Key issues at the top of the agenda identified by Directors:
  - Further fiscal adjustment through expenditure restraint.
  - Further labor market reform to reduce judicial uncertainty over permanent contracts and widen wage/benefit differentials.
  - Further product market reform through deregulation and state disengagement from commercial activities.
- Directors welcomed that the 2006 deficit outcome appears set to come in below the budget target and noted the intention to reduce central government expenditures by 1 percent in real terms in 2007 and to sustain the decline in health-spending growth, while observing pension and local government spending remains buoyant.
- Directors saw merit in further reductions in the tax burden, to be funded by additional declines in spending and a broadening of the tax base.
- Directors recommended exploiting synergies across reforms, careful sequencing, and continued consensus-building to extend public support beyond public finances to labor and product market reforms.

### France: Selected Economic Indicators (key figures)
- Real GDP: 1.1 (2002), 1.1 (2003), 2.0 (2004), 1.2 (2005), 2.5 (2006)
- Domestic demand: 1.2 (2002), 1.9 (2003), 2.8 (2004), 2.1 (2005), 2.7 (2006)
- CPI (year average): 1.9 (2002), 2.2 (2003), 2.3 (2004), 1.9 (2005), 2.0 (2006)
- Unemployment rate (in percent): 8.9 (2002), 9.5 (2003), 9.6 (2004), 9.5 (2005), 8.9 (2006)
- Gross national savings (percent of GDP): 20.0 (2002), 19.3 (2003), 19.1 (2004), 18.6 (2005), 18.4 (2006)
- Gross domestic investment (percent of GDP): 19.0 (2002), 18.9 (2003), 19.4 (2004), 20.2 (2005), 20.3 (2006)
- Central government balance (percent of GDP): -3.7 (2002), -3.9 (2003), -3.2 (2004), -3.0 (2005), -2.5 (2006)
- General government balance (percent of GDP): -3.2 (2002), -4.2 (2003), -3.7 (2004), -2.9 (2005), -2.6 (2006)
- General government gross debt (percent of GDP): 58.2 (2002), 62.3 (2003), 64.5 (2004), 66.7 (2005), 64.3 (2006)
- Money market rate (in percent) 3/: 3.3 (2002), 2.3 (2003), 2.1 (2004), 2.2 (2005), 3.4 (2006)
- Government bond yield (in percent) 4/: 4.9 (2002), 4.2 (2003), 4.2 (2004), 3.5 (2005), 3.8 (2006)
- Trade balance (percent of GDP): 0.5 (2002), 0.2 (2003), -0.4 (2004), -1.5 (2005), -1.6 (2006)
- Current account (percent of GDP): 1.0 (2002), 0.4 (2003), -0.3 (2004), -1.6 (2005), -1.9 (2006)
- Official reserves (US$ billion): 28.4 (2002), 30.2 (2003), 32.5 (2004), 27.8 (2005), ...
- Fund position (as of August 31, 2006):
  - Holdings of currency (percent of quota): 87.0
  - Holdings of SDRs (percent of allocation): 58.0
  - Quota (SDRs million): 10,738.5
- Exchange rate regime: Participant in EMU
- Euro per U.S. dollar (September 28, 2006): 1.27
- Nominal effective rate (2000=100): 100.4 (2002), 101.7 (2003), 106.2 (2004), 107.6 (2005), 107.5 (2006)
- Real effective exchange rate (2000=100): 98.7 (2002), 99.8 (2003), 103.5 (2004), 104.4 (2005), 102.8 (2006)

*Source: IMF staff report contained in the provided PDF content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06389.pdf_