## _cr11211

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### Executive Summary — Context, Performance, and Outlook
- Recovery and growth:
  - Real GDP growth of 1½ percent in 2010.
  - Strong growth in 2011:Q1; staff projects real GDP to grow by about 2 percent in both 2011 and 2012.
  - Output and employment remain below pre-crisis levels.
- Recovery drivers:
  - Robust consumption and stock-building in 2010 and early 2011; car scrapping scheme expired end-2010.
  - Fixed investment began to pick up from 2010:Q2.
  - Net exports contributed positively in 2010 but were a drag in 2011:Q1.
- Unemployment dynamics:
  - Unemployment rate fell from above 9½ percent by 2009:Q3 to around 9 percent by early 2011, after a trough of around 7¼ percent in 2008:Q1.
  - Staff estimates structural component of unemployment increased since 2008:Q2, holding back potential growth.
- External environment and inflation:
  - Headline inflation reached 2 percent in March 2011; annual headline inflation rose to 2.1 percent in June (mainly higher food prices).
  - Staff pass-through estimates (1995–2010): a 1 percent increase in domestic energy inflation ultimately raises core inflation by 0.02 percent; a 1 percent increase in food price inflation ultimately raises core inflation by 0.2 percent.
- Short-term growth composition and staff contributions to GDP (staff calculations):
  - Consumption: 2009 = 0.7, 2010 = 1.1, 2011 = 1.0, 2012 = 1.0, 2013 = 1.3
  - Investment: 2009 = -1.8, 2010 = -0.2, 2011 = 0.5, 2012 = 0.6, 2013 = 0.7
  - Stockbuilding: 2009 = -1.3, 2010 = 0.5, 2011 = 0.7, 2012 = 0.1, 2013 = 0.0
  - Net Exports: 2009 = -0.2, 2010 = 0.1, 2011 = -0.1, 2012 = 0.1, 2013 = 0.0
  - GDP: 2009 = -2.6, 2010 = 1.4, 2011 = 2.1, 2012 = 1.9, 2013 = 2.0
- Key policy imperatives:
  - Strengthen recovery and reduce unemployment while safeguarding financial stability.
  - Bring down public debt sustainably.
  - Implement regulatory reform to improve financial sector resilience.
  - Pursue structural policies to enhance competitiveness and inclusive growth.

### Risks and Financial Market Signals
- Risk assessment:
  - Risks tilted to the downside: renewed sovereign concerns in the euro area; spillovers from Spain and Italy; higher commodity prices; second-round inflation effects.
  - Upside risks: stronger-than-expected recovery in trading partners; stronger business investment; visible progress on reforms boosting confidence.
- Sovereign spreads and CDS:
  - France’s sovereign CDS spread increased during 2010 by around 80 basis points from trough to peak.
  - 10-year bond yield spread increases for France were much more moderate than CDS increases.
  - In early 2011 French and German spreads moved differently from Greece/Ireland/Portugal; co-movement increased in June 2011.
- Recent market developments (since staff report):
  - Equity prices for major French banks declined by over 15 percent since July 1 (period referenced).
  - Major French banks’ CDS spreads widened by more than 40 basis points during the period.
  - Sovereign CDS spreads reached over 100 basis points in mid-July.
  - The 10-year bond yield spread widened to over 70 basis points in mid-July, with some retraction more recently.
  - Despite turbulence, France’s financing costs remain among the lowest in the euro area.

### Fiscal Policy, Consolidation Strategy, and Institutional Reform
- Fiscal targets and projections:
  - Staff projects central government balance (percent of GDP): 2011 -4.4; 2012 -3.8; 2013 -3.0; 2014 -2.5.
  - General government gross debt (Maastricht): 2010 82.3; 2011 85.2; 2012 87.2; 2013 88.1; 2016 84.4.
- Policy recommendations:
  - Prepare specific contingency measures to ensure reaching the 2012–13 fiscal targets if growth is less strong than authorities foresee.
  - Adopt a fiscal rule to enhance credibility of the consolidation strategy.
  - Use independent macroeconomic forecasts and contingency spending and revenue plans.
  - Establish an independent public institution or fiscal council to provide or review forecasts.
- Fiscal rule and draft law:
  - Draft law envisages enshrining a fiscal rule comprising the general government in the constitution.
  - Draft law approved by the National Assembly and being considered by the Senate; constitutional change requires a three-fifths majority vote in Congress once passed by the Senate.
- Expenditure-based adjustment package (Option 6 summary; total savings reported):
  - Central government measures: close one-third of the VAT policy gap with respect to the G-20 average 1/-7.5; introduce a carbon tax 2/1.3-; further reduce tax expenditures 3/2.4-
  - Local government measures: higher revenue from property taxes 4/-1.6; freeze spending in real terms in 2012, thereafter in nominal terms11.2-; freeze spending in real terms from 2012-6.7
  - Social security measures: improve targeting of social transfers 5/1.0-
  - Total savings: Total savings15.815.8
  - Notes: Implementing a carbon tax gradually over 2013-15; one-third of impact of raising VAT C-efficiency from 0.48 to 0.55; expenditure measures account for 61 percent (52 percent) of overall adjustment under the expenditure-based (balanced) option.

### Box 5 — Carbon Tax: Design, Revenue, and Distribution
- Scope and rationale:
  - Economy-wide carbon pricing strategy coordinated with the EU ETS.
  - Fuel used in homes, small- and medium-sized companies, and motor vehicles account for around two-thirds of CO2 emissions in France.
- Proposed tax and revenue:
  - 2009 proposal rate: €17 per ton of CO2.
  - Annual revenue projected around €4 billion (about 0.2 percent of GDP).
  - EU proposal (April 2011): minimum carbon tax of €20 per ton for heating and transport fuels.
  - Country comparators: Denmark €12 per ton, Ireland €15 per ton, Finland €20 per ton, Sweden €108 per ton.
- Distributional and competitiveness considerations:
  - 2009 proposal rejected by Constitutional Court in 2010 due to exemptions and adverse effects; majority of exempt sources already covered by ETS.
  - Mitigation options: targeted transfers and more finely-tuned fuel taxes.
- Motorist and fuel-tax interactions:
  - Tax would increase burden on motorists by about €0.04 per liter.
  - Current excise taxes: €0.61 per liter for gasoline and €0.43 per liter for diesel.
  - Fuel taxes could be partly replaced with per mile tolls varying with location and time of day.
- Other benefits:
  - Reduces uncertainty about future emissions prices, potentially encouraging clean technology investments.

### Long-term Sustainability — Pensions and Health Care
- Pensions:
  - Further increases in legal retirement age in line with life expectancy recommended to prevent fiscal pressures.
  - French workers now spend about two and half times as many years in retirement as in the early 1970s.
  - Effective retirement age will remain below OECD average even with planned increase to 62.
  - Another evaluation of long-term financial viability planned for 2013.
  - Recommendation: increase senior workers’ labor force participation, including through targeted tax incentives.
- Health care:
  - Rising living standards and technical progress will pressure public expenditures; per capita spending already higher than predicted by income levels.
  - Continued efficiency gains necessary to prevent unsustainable rises in health and long-term care spending.
  - Planned reform of long-term care to be initiated in 2012.

### Financial Sector: Performance, Risks, and Regulatory Reform
- Banking sector profitability and capital:
  - Operating profit more than doubled in 2010 to reach 14 percent of equity.
  - Return on equity averaged 9.5 percent for the largest French banks.
  - Core Tier 1 ratio improved to 8.8 percent; market participants increasingly use a 10 percent core Tier 1 threshold for large banks.
  - Major French banks to reach Basel III capital levels by 2013/14 (supervisors and banks agree on timetable).
- Funding, liquidity, and exposures:
  - Deposits account for 85 percent of loans.
  - Share of wholesale funding in total bank funding remained above average of euro area, U.K., and U.S. banks by mid-2010.
  - Short-term funding relies heavily on U.S. dollar liabilities from U.S. money market funds.
  - French banks’ exposures to peripheral euro area countries (end-2010):
    - Total exposure to Greece, Ireland, and Portugal: $179 billion (7½ percent of GDP or 1¾ percent of bank assets).
    - Total claims on Spain and Italy, excluding other exposures: $531 billion (22 percent of GDP or 5 percent of bank assets).
    - Exposure to southern Europe when only sovereign debt is considered: 38 percent of Tier 1 capital (excluding Italy: 13 percent) as of April 2011.
- Asset quality and credit:
  - Impaired loans at main banking groups increased slightly in 2010 to about 5 percent of gross loans.
  - Coverage ratios decreasing as banks expect recovery to improve credit risk.
  - Residential mortgage loans grew by 8.3 percent in February 2011 (y-o-y, from 4.1 percent a year ago).
  - Mortgage loans account for about 40 percent of French GDP in 2010; household debt level 93 percent of disposable income.
- Stress tests and supervisory views:
  - 2010 CEBS stress tests: adverse shocks would reduce Tier 1 capital of the four largest French banks by 0.5–0.7 percentage points relative to end-2009 start level.
  - National stress tests indicate resilience to direct exposures; indirect effects not fully taken into account.
  - Basel III liquidity requirements differ from current Banque de France rules; off-balance sheet commitments under LCR carry 100 percent factor vs 5 percent under current French rules.
  - Basel Committee observation period until 2013 to perform quantitative impact studies for possible recalibration.
- Regulatory reform and international role:
  - CRD4 should implement Basel III swiftly and without exceptions; capital requirements set ambitiously high.
  - Capital regulations should be flexible to allow macro-prudential tools.
  - France’s major banks are G-SIFIs; international discussions point to tailored and internationally consistent measures (including additional CET1 capital requirements and phase-in arrangements).
  - Authorities support improving global and European regulatory standards but caution on scope and timing given potential economic costs.

### Housing Market and Macro-/Micro-prudential Considerations
- Market rebound and valuation:
  - House purchases doubled during 2010.
  - House prices grew by 8.5 percent to reach pre-crisis peak; regional increases: Ile de France 12.8 percent; 20 Paris arrondissements 18.7 percent.
  - Staff estimates house prices were 10–25 percent overvalued at end-2010.
  - Pre-crisis increase: 44 percent from 2004 to pre-crisis peak; crisis decline less than 10 percent from pre-crisis peak.
- Household indebtedness and lending practices:
  - Household debt level 93 percent of disposable income; mortgage loans account for about 40 percent of GDP in 2010.
  - French lending relies more on borrower income; mortgages mostly long-term fixed-rate; maximum mortgage service payment ratio commonly one-third of household disposable income.
  - Mortgage insurance mandatory; no home equity loans or mortgage equity withdrawals.
  - Residential mortgage loss rates have been structurally low.
- Policy advice and risks:
  - Financial stability risks contained but vigilance required.
  - Authorities should be ready to use micro-prudential tools; macro-prudential measures (such as loan-to-value ratios) could be useful if prices continue to rise broadly.
  - Review public policies that support house purchases and regulatory barriers to new housing construction.
  - Build macro-prudential framework to contain risks.

### Structural Reforms, Competitiveness, and Growth Potential
- Growth lift estimates:
  - Staff estimates that bringing France in line with best practices via labor and product market reforms could raise growth by about ¾ percent per year over the medium term.
- Innovation and non-price competitiveness:
  - Existing support: Crédit Impôt Recherche and Grand Emprunt.
  - Recommendation: evaluate cost effectiveness of these measures; address paucity of medium-sized firms.
- Product and services market competition:
  - Regulation more restrictive in France than many countries; EU Services Directive not fully transposed.
  - Recommendation: Competition Authority focus on areas with limited progress; increase competition in professional services.
  - Empirical estimates: alignment to best practices in the OECD would increase long-run employment rate by 1.2 percentage point and multifactor productivity by between 0.2 and 0.6 percent per year over the medium term.
- Tax and labor policy priorities:
  - Reduce labor tax wedge; corporate tax reform with lower statutory rate and base broadening; reduce debt bias from interest deductibility.
  - Targeted tax-benefit reforms: more generous earned income tax credits for older workers and women with school-aged children; employer credits for social security contributions for these categories.
  - Labor market measures: strengthen activation policies and Pôle Emploi; foster apprenticeships; consider easing employment protection; reduce duration or level of unemployment benefits over time; review SMIC indexation.
  - SMIC factual level: increased in January 2011 to €9 per hour (€1,365 gross or €1,073 net for a 35 hour work week).
  - Senior participation: rose from 38.1 percent at end-2007 to 40.3 percent in early 2011 (EU average 46.5 percent; Euro area average 46.0 percent).

### Macro Indicators, Projections, and Selected Tables (excerpted figures)
- Real GDP (change in percent): 2008 -0.2; 2009 -2.6; 2010 1.4; 2011 2.1; 2012 1.9; 2013 2.0; 2014 2.1; 2015 2.1; 2016 2.1
- CPI (year average): 2008 3.2; 2009 0.1; 2010 1.7; 2011 2.2; 2012 1.7; 2013 1.8; 2014 1.9; 2015 1.9; 2016 1.9
- Unemployment rate (percent): 2008 7.8; 2009 9.5; 2010 9.7; 2011 9.3; 2012 8.8; 2013 8.6; 2014 8.2; 2015 7.9; 2016 7.8
- General government gross debt (Maastricht definition, percent of GDP): 2008 68.2; 2009 79.0; 2010 82.3; 2011 85.2; 2012 87.2; 2013 88.1; 2014 87.8; 2015 86.5; 2016 84.4
- Financial soundness indicators (selected):
  - Regulatory capital to risk-weighted assets: 2009 12.4; 2010 12.5
  - Nonperforming loans to total gross loans: 2009 3.6; 2010 3.5
  - Return on equity (ROE, aggregated): 2009 8.2; 2010 7.9
  - Household debt to GDP (Core Set): 2009 52.8; 2010 53.5
  - Real estate prices (annual change): 2009 -4.4; 2010 9.4
- External sector (percent of GDP):
  - Current account: 2008 -1.7; 2009 -1.5; 2010 -1.7; 2011 -2.1
  - Exports of goods (percent of GDP): 2010 20.2; 2011 22.6
  - Imports of goods (percent of GDP): 2010 23.0; 2011 25.8

### Mission, Authorities’ Response, and Next Steps
- Mission team: Ms. Gulde-Wolf (head), Mr. De Vrijer, Mr. Cheng, Ms. Poirson Ward, Mr. Hallaert (all EUR), and Mr. Sy (MCM).
- Authorities’ views:
  - General agreement on required policy measures and commitment to fiscal consolidation objectives.
  - Draft law to establish fiscal rule introduced; authorities agree in principle on “green taxes” but cautious on raising consumption taxes due to demand and inflation effects.
  - Committed to financial sector resilience; noted international regulatory discussions ongoing and potential negative impacts of some proposals.
  - Structural reforms intended to continue, with acknowledgment of political challenges.
- Proposed timing:
  - Next Article IV to be held on the standard 12-month cycle; last Article IV concluded July 28, 2010; 2011 discussions held May 31–June 14, 2011.
- Executive Board and Directors’ views:
  - Supported front-loaded, expenditure-based consolidation with contingency planning, independent forecasting, and complementary entitlement reforms to lower public debt toward 60 percent of GDP by the middle of the next decade.

*Source: IMF staff report excerpts and informational annexes for the 2011 Article IV Consultation (document _cr11211).*

### Executive Summary

### Executive Summary

### Context and Recent Performance
- Supportive policies and reforms contributed to a gradual recovery from the crisis; recovery has been gradual and uneven across indicators.
- Real GDP growth of 1½ percent in 2010 was below that in other core euro area countries.
- Strong growth in 2011:Q1, but both output and employment remain below pre-crisis levels.
- Recovery drivers:
  - Robust consumption and stock-building in 2010 and early 2011, including purchases/orders of automobiles related to the car scrapping scheme (expired end-2010).
  - Fixed investment began to pick up from 2010:Q2 as construction spending recovered and purchases of new houses increased.
  - Net exports contributed positively in 2010 but were a drag in 2011:Q1.
- Unemployment dynamics:
  - Unemployment rate fell from above 9½ percent by 2009:Q3 to around 9 percent by early 2011, after a trough of around 7¼ percent in 2008:Q1.
  - Staff estimates that the increase in the unemployment rate since 2008:Q2 has resulted in some further increase in its structural component, holding back potential growth.

### External Environment and Inflation
- External risks remain significant:
  - Euro area financial risks: sovereign bond spreads (vis-à-vis Germany) and sovereign CDS spreads are somewhat higher than in early 2010; French banks have exposures to some euro area crisis countries.
  - Commodity price hikes: world oil and food price increases pushed annual headline inflation in France to 2 percent in March 2011.
- Inflation pass-through (Box 2 findings):
  - For 1995–2010 data, staff estimates that for every one percent increase in domestic energy inflation, core inflation would ultimately increase by 0.02 percent.
  - For every one percent increase in food price inflation, core inflation would ultimately increase by 0.2 percent.
  - Headline inflation risk is on the upside; core inflation should remain relatively moderate given the large output gap and historically low pass-through.

### Key Structural Challenges
- Need to:
  - Lift structural obstacles to stronger competitiveness on world markets.
  - Facilitate employment of young and low-skilled workers.
  - Deal with the impact of an aging population in a sustainable manner.
- Recent pension reform is noted as an important step.

### Challenges for Policy Makers
- Main challenges: strengthen the recovery and reduce unemployment while safeguarding financial sector stability.
- Additional imperatives:
  - Bring down public debt in a sustainable manner.
  - Implement regulatory reform to improve financial sector resilience and remain vigilant on housing market developments.
  - Pursue structural policies to enhance competitiveness and boost inclusive growth.

### Policy Recommendations
- Fiscal policy:
  - Prepare specific contingency measures to ensure reaching the 2012–13 fiscal targets if growth is less strong than authorities foresee.
  - Adopt a fiscal rule to enhance credibility of the consolidation strategy.
- Financial sector resilience:
  - Implement Basel III regulatory reforms.
  - Reduce the contribution to systemic risks from global systemically important financial institutions.
- Structural reforms:
  - Strengthen incentives for work.
  - Increase economic efficiency and innovation to enhance competitiveness and boost inclusive growth.

### Authorities’ Response
- General agreement on required policy measures.
- Authorities determined to achieve fiscal consolidation objectives and have introduced a draft law to establish a fiscal rule.
- Committed to making the financial sector more resilient, but noted international discussions are ongoing and cautioned about possible negative impacts of some regulatory reform proposals.
- Intended to continue structural reforms, while noting some reforms are politically challenging.

### Outlook and Risks (Short Term)
- Growth projections:
  - Staff projects real GDP to grow by about 2 percent in both 2011 and 2012.
- Fiscal consolidation impact:
  - Planned fiscal consolidation in France and the rest of the euro area estimated to have a combined negative effect on France’s GDP growth that increases from about ½ percent to 1¼ percent during 2011–16, of which two-thirds originates from France’s own fiscal tightening.
- Demand composition:
  - Domestic demand is expected to remain the engine of growth; net exports will play a minor role in the near term.
  - Private consumption expected to remain dynamic in 2011–12 but faces headwinds from expiration of the car scrapping scheme, high unemployment, and uncertainty about headline inflation.
  - Business and household investment expected to increase in 2011 as construction and housing recover, but excess capacity and credit uncertainty may weigh on business investment.
- Contributions to growth (staff calculations):
  - Consumption: 2009 = 0.7, 2010 = 1.1, 2011 = 1.0, 2012 = 1.0, 2013 = 1.3
  - Investment: 2009 = -1.8, 2010 = -0.2, 2011 = 0.5, 2012 = 0.6, 2013 = 0.7
  - Stockbuilding: 2009 = -1.3, 2010 = 0.5, 2011 = 0.7, 2012 = 0.1, 2013 = 0.0
  - Net Exports: 2009 = -0.2, 2010 = 0.1, 2011 = -0.1, 2012 = 0.1, 2013 = 0.0
  - GDP: 2009 = -2.6, 2010 = 1.4, 2011 = 2.1, 2012 = 1.9, 2013 = 2.0

### Risk Assessment
- Risks are tilted to the downside:
  - Renewed sovereign concerns in the euro area could affect financing availability and cost for banks and the sovereign; French banks’ exposure to the euro area periphery is significant.
  - A slower-than-expected recovery in trading partners linked to European debt turbulence and intensified fiscal consolidation would weaken exports and growth.
  - Growth spillovers from shocks in Spain and Italy during financial stress would be significant (Box 3).
  - Higher commodity prices, heightened geopolitical risks, or second-round effects could undermine consumer confidence and the recovery; if realized, they could prompt an earlier ECB rate response.
- Upside risks include a stronger-than-expected recovery in trading partners and stronger business investment, or visible progress on reforms (fiscal consolidation, financial regulation, structural measures) boosting confidence.

### Financial Market Signals
- Sovereign spreads and CDS (Box 1 findings):
  - France’s sovereign CDS spread increased during 2010 by around 80 basis points from trough to peak, compared with increases of between 180 and 800 basis points for Greece, Ireland, and Portugal.
  - The 10-year bond yield spread increases for France were much more moderate than CDS increases.
  - Co-movement between French sovereign CDS spreads and those of some euro area countries has increased in recent years; co-movement of bond yield spreads increased much less.
  - In early 2011, French and German spreads moved differently from Greece/Ireland/Portugal; but co-movement increased in June 2011 amid renewed concerns about the euro area sovereign debt.

### Mission Team
- Ms. Gulde-Wolf (head), Mr. De Vrijer, Mr. Cheng, Ms. Poirson Ward, Mr. Hallaert (all EUR), and Mr. Sy (MCM).

*Source: Executive Summary.*

### Box 3. Growth Spillovers to France

### Box 3. Growth Spillovers to France

### Overview
- In the context of the crisis, examining international economic and financial linkages has become more important.
- France’s growth performance is affected by growth shocks from abroad through both trade and financial linkages.
- Growth spillover risks from the U.S. and large southern euro area countries to France are significant.

### Key findings on vulnerabilities and transmission
- France is highly vulnerable to growth spillovers from a shock in Spain while spillover effects from Italy are also relatively large.
- The contagion threat from the U.K. is generally small, except during financial crises when U.K. growth spillovers become more elevated.
- As autonomous domestic demand in Germany is rather stable and its final domestic expenditure has a low import propensity, the impact of growth shocks originating in Germany has historically been small.
- However, Germany, by far France’s largest trade partner, is an important transmitter to France and its other trading partners of shocks originating both within and outside the EMU, given its relatively high sensitivity to external shocks and high import propensity exports.
- France has little exposure to growth shocks originating in Japan in view of the limited trade linkages.

### Quantitative measure shown
- Figure: "Cumulative Peak Impulse Response of France to 1 percent Growth Shock, 1993Q1-2010Q3 (Percent)"
  - Two conditions depicted: "During financial stress" and "During normal times".
  - (Sources cited for the figure: OECD; and staff calculations.)

### Methodology (summary from source)
- Results are based on a reduced form VAR estimation for 17 countries, which allows for both trade and financial channels of transmission.
- Identification is obtained via weighting different plausible orderings, and results are summarized by the average impulse response.
- Results for “normal times” are based on regressions that include a crisis dummy for 2008Q4–2009Q1, while the framework without the crisis dummy also reflects the relationship across growth rates in crisis times.
- The estimate of the role of third-country effects in the transmission of U.S. shocks for France and other European countries is based on a counterfactual analysis.

*Italic: Source: Box 3. Growth Spillovers to France, _cr11211 - Box 3. Growth Spillovers to France_*

### 3.3 percent of GDP and be combined with the introduction of a carbon tax (Box 5),

### _cr11211 - 3.3 percent of GDP and be combined with the introduction of a carbon tax (Box 5)

### Expenditure-based (Option 6) fiscal adjustment measures and quantified savings
- Central government measures:
  - Close one-third of the VAT policy gap with respect to the G-20 average 1/-7.5
  - Introduce a carbon tax 2/1.3-
  - Further reduce tax expenditures 3/2.4-
- Local government measures:
  - Higher revenue from property taxes 4/-1.6
  - Freeze spending in real terms in 2012, thereafter in nominal terms11.2-
  - Freeze spending in real terms from 2012-6.7
- Social security measures:
  - Improve targeting of social transfers 5/1.0-
- Total savings:
  - Total savings15.815.8

Notes from the source table:
- 2/ Implementing a carbon tax gradually over 2013-15.
- 3/ Over and above already announced reductions.
- 4/ One-third of the impact of increasing revenue-to-GDP to the average of the US, UK, and Canada levels.
- 5/ Spending freeze on family, housing, and other transfers from 2013.
- 1/ One-third of the impact of raising VAT C-efficiency from 0.48 to 0.55, slightly above average for the Group of Twenty countries (G20).
- 6/ Expenditure measures account for 61 percent (52 percent) of the overall adjustment under the expenditure-based (balanced) option.

Source line in table: From Stimulus to Consolidation; and IMF staff calculations.

### Box 5 — Should France Introduce a Carbon Tax?
- Rationale and scope:
  - A carbon tax would initiate an economy-wide carbon pricing strategy coordinated with the EU Emissions Trading Scheme (ETS).
  - Fuel used in homes, small- and medium-sized companies, and motor vehicles account for around two-thirds of CO2 emissions in France.
- Proposed tax and revenue:
  - The 2009 proposal rate was €17 per ton of CO2.
  - The tax would provide annual revenue of around €4 billion (about 0.2 percent of GDP).
- Distributional and competitiveness considerations:
  - The 2009 proposal was rejected by the Constitutional Court in 2010 on grounds of too many exemptions and adverse distributional and competitiveness effects; the majority of exempt sources were already covered by the ETS.
  - Mitigation options include targeted transfers and more finely-tuned fuel taxes to help vulnerable categories and motorists.
- Comparative and policy context:
  - In April 2011, the EU proposed a minimum carbon tax (for heating and transport fuels) of €20 per ton.
  - Denmark, Ireland, and Finland impose carbon taxes of €12, €15, and €20 per ton, respectively; Sweden imposes €108 per ton.
- Motorists and fuel-tax interactions:
  - The tax would increase the burden on motorists by about €0.04 per liter.
  - Current excise taxes on fuels: €0.61 per liter for gasoline and €0.43 per liter for diesel.
  - Fuel taxes could be partly replaced with per mile tolls that vary with location and time of day to address congestion and other side-effects.
- Other benefits:
  - A carbon tax removes uncertainty related to future emissions prices, reducing price volatility that can deter clean technology investments.
- References cited in Box 5:
  - Prepared by Ian Parry, FAD.
  - U.S. Interagency Working Group on Social Cost of Carbon, 2010.
  - Goulder, Lawrence, 2002 (ed.). “Environmental Policy Making in Economies with Prior Tax Distortions.” Edward Elgar.

### Institutional reforms to aid fiscal sustainability
- Fiscal rule proposal:
  - Staff encouraged adoption of a fiscal rule consistent with the planned EU directive to entrench fiscal credibility and support euro area-wide fiscal discipline.
  - The draft law envisages enshrining a fiscal rule comprising the general government in the constitution.
- Elements recommended for the draft law (in line with the Camdessus working group):
  - A binding medium-term budget framework, including multi-year expenditure ceilings and minimum annual revenue measures, and restriction of new tax measures to budget laws.
  - A post-consolidation anchor for fiscal policies: medium-term projections consistent with a return to general government structural balance.
- Institutional support and independent forecasting:
  - The multi-year budget should be based on independent macroeconomic forecasts and be backed by contingency spending and revenue plans.
  - Staff encouraged establishing an independent public institution or fiscal council to provide forecasts mandatory for budget preparation and medium-term planning, or to review ex ante government projections to ensure realism and credibility.
- Constitutional and legislative status:
  - The draft law has been approved by the National Assembly and is being considered by the Senate. Once passed by the Senate, the constitutional change will require a three-fifths majority vote in Congress to become law.

### Long-term sustainability: pensions and health care reforms
- Pension system:
  - Further increasing the legal retirement age in the future in line with life expectancy would prevent continued fiscal pressures from increases in time spent in retirement.
  - French workers now spend about two and half times as many years in retirement as they did in the early 1970s.
  - The effective retirement age will remain below the OECD average even with the planned increase in the retirement age to 62 (assuming labor market exit continues to occur close to the retirement age).
  - Another evaluation of long-term financial viability of the pension system is planned for 2013.
  - Further efforts to increase senior workers’ labor force participation, including through targeted tax incentives, are recommended.
- Health care:
  - Rising living standards and technical progress will continue to put pressure on public expenditures, which is already higher in per capita terms than predicted by France’s income levels.
  - Continued efficiency gains are necessary to prevent an unsustainable rise in health and long-term care spending while maintaining high-quality health services.
  - A planned reform of long-term care would be initiated in 2012.

### Authorities’ views (summarized)
- Commitment and outlook:
  - Authorities reaffirmed full commitment to the fiscal adjustment path in France’s Stability Program and considered that growth could surprise on the upside.
  - Strong revenue performance from increasing employment could yield a slightly better-than-expected budgetary outcome in 2011.
  - Should downside risks materialize, there was room for contingency measures, including further cuts in tax expenditures.
- Position on green taxes:
  - Authorities agreed in principle on the desirability of “green taxes”, including a carbon tax, but viewed the scope for raising consumption taxes as limited due to potential negative impacts on demand and inflation.
- Local government and social security:
  - Authorities were confident that the 2010 reform of the local business tax and the legislated freeze in transfers would limit local government spending growth.
  - Social security finances would benefit from recent pension reforms, labor market recovery, and cost containment measures in health care.
- Market perceptions:
  - Although current borrowing costs were still exceptionally low historically, authorities considered current spreads versus Germany to be higher than warranted by France’s credit fundamentals and expected tighter spreads as the crisis is resolved.

### Financial stability: banking sector performance and risks
- Profitability and earnings:
  - Operating profit more than doubled in 2010 to reach 14 percent of equity.
  - Return on equity averaged 9.5 percent for the largest French banks.
- Funding and liquidity:
  - By mid-2010, the share of wholesale funding in total bank funding remained above the average level of euro area, U.K., and U.S. banks.
  - Deposits account for 85 percent of loans.
  - Short-term funding relies heavily on U.S. dollar liabilities from U.S. money market funds.
  - One-fourth of the 2011 medium- and long-term issuance needs of the major French banks were already covered by mid-February.
- Capital adequacy:
  - Core Tier 1 ratio improved to 8.8 percent.
  - Market participants increasingly use a 10 percent core Tier 1 threshold for large banks; French banks have among the largest capital deficit to this threshold in their peer group.
- Asset quality:
  - Impaired loans at the main banking groups increased slightly in 2010 to reach about 5 percent of gross loans.
  - Coverage ratios have been decreasing as banks expect the economic recovery to improve borrowers’ credit risk.
  - French (and Belgian) authorities have a guarantee mechanism for potential losses on legacy assets of a small bank if such losses would exceed $4.5 billion.
- Credit growth and mortgages:
  - Corporate and consumer credit growth moved to positive territory in 2011.
  - Residential mortgage loans grew by 8.3 percent in February 2011 (y-o-y, from 4.1 percent a year ago).
  - Households benefited from low fixed-term interest rates and fiscal incentives such as the 2009 Loi Scellier.

*Source: From Stimulus to Consolidation; and IMF staff calculations.*

### 30.      House purchases have rebounded in 2010 and the first part of 2011, bringing

### House purchases have rebounded in 2010 and the first part of 2011, bringing

### Housing market rebound and valuation
- House purchases doubled during 2010.
- Housing supply increased inadequately relative to the growth in the number of households.
- House prices grew by 8.5 percent to reach their pre-crisis peak.
- Regional price increases in 2010:
  - Ile de France: 12.8 percent.
  - 20 Paris arrondissements: 18.7 percent.
- Staff estimates: France’s house prices were 10–25 percent overvalued at end-2010.
- The assessment of house price valuation is based on a methodology developed in Deniz, I. and P. Loungani, Global Housing Cycles, forthcoming IMF Working Paper.
- Box 7 key stylized facts:
  - Pre-crisis increase: 44 percent from 2004 to the pre-crisis peak.
  - During the crisis, decline in house prices was less than 10 percent from the pre-crisis peak.
  - Duration of downturn in housing prices: 4 quarters.
  - Ratio of house prices to household disposable income (affordability ratio) was one of the highest among advanced economies; France saw a small increase in the affordability ratio after the crisis.
- Drivers of resilience:
  - Fundamental factors: structurally constrained housing supply; scarcity of buildable land in dense metropolitan areas; regulatory barriers; strong increase in number of households due to de-cohabitation and an aging population.
  - Macroeconomic factors: very low interest rate environment; tax incentive schemes such as the Loi Scellier.
  - Asset allocation factors: limited financial investment opportunities and heightened risk aversion made real estate an attractive safe haven.

### Household indebtedness and lending practices
- Mortgage loans account for about 40 percent of French GDP in 2010.
- Household debt level: 93 percent of disposable income (noted as sustainable and well below levels in other advanced countries).
- French banks’ lending practices:
  - Rely less on collateral value and more on borrower income to assess credit risk.
  - Do not extend home equity loans; borrowers cannot make mortgage equity withdrawals.
  - Mortgages have long-term fixed-rates, reducing interest rate risk for borrowers.
  - Mortgage lending conditions are based on borrower's capacity to service the loan until maturity.
  - French banks tend to set a maximum mortgage service payment ratio equal to one-third of household disposable income.
  - Most mortgages have fixed rates and mortgage insurance is mandatory.
  - Residential mortgage loss rates incurred by lending institutions have been structurally low in France.
- Implication: adverse macro-financial repercussions of a price drop should be limited because loans are recourse and borrowing incentives to default are low.

### Financial stability risks and policy recommendations
- Despite moderate financial stability risk, in a highly competitive mortgage finance market risks need containment.
- Recent bank behavior: extending mortgages at historically record low interest rates and lengthened maturities.
- Authorities should stand ready to use appropriate micro-prudential tools in an environment of monetary tightening to ensure sound lending practices and sound risk management.
- If house price increases continue and cause broader concerns, macro-prudential measures (such as loan-to-value ratios) could be useful.
- Recommendations on housing supply and public policy:
  - Further work to build a macro-prudential framework would be helpful.
  - Public policies that support house purchases may need to be reviewed to avoid putting additional pressures on already high prices.
  - Regulatory barriers and other disincentives to new housing construction should be reviewed.

### Bank exposures, stress tests, and liquidity/capital implications
- French banks’ exposures to peripheral euro area countries (end-2010):
  - Total exposure to Greece, Ireland, and Portugal: $179 billion (7½ percent of GDP or 1¾ percent of bank assets).
  - Total claims on Spain and Italy, excluding other exposures: $531 billion (22 percent of GDP or 5 percent of bank assets).
- Exposure of French banks to the southern part of Europe when only sovereign debt is considered: 38 percent of Tier 1 capital (excluding Italy: 13 percent) as of April 2011.
- Indirect exposures are not taken into account in these figures; Belgian and Portuguese banks’ exposures to Greece reached 14 and 9 percent of Tier 1 capital, respectively, according to last year’s CEBS stress test.
- French banks also have large global banking and capital markets activities, with subsidiaries in Russia, other Central and Eastern European countries, Turkey, and North Africa—constituting an outward spillover channel.
- Stress test findings and plans:
  - 2010 CEBS stress tests: adverse shocks would lead to a limited reduction in the Tier 1 capital of the four largest French banks of 0.5–0.7 percentage points relative to their starting level at end-2009.
  - The European Banking Authority (EBA) is coordinating new stress tests assessing credit and market risks under hypothetical adverse economic conditions in 2011–12 with a special focus on sovereign risk; publication of results expected in mid-2011.
  - National stress tests by French authorities indicate resilience to shocks from direct exposures to European crisis countries, but indirect effects are not taken into account and may pose additional downside risks.
  - The forthcoming FSAP will provide an opportunity to further review resilience to a wide range of shocks.
- Liquidity and Basel III calibration issues:
  - Basel III liquidity requirements differ from current Banque de France rules and would require French banks to raise additional liquidity.
  - Example: off-balance sheet commitments under the Basel III Liquidity Coverage Ratio (LCR) carry a 100 percent factor compared to 5 percent under current French rules.
  - Basel III Net Stable Funding Ratio (NSFR) implications: French practice of booking life assurance products (42 percent of overall household financial investments at end-2009) in insurance arms rather than on bank balance sheets will require additional liquidity.
  - Basel Committee observation period in place until 2013 will perform quantitative impact studies based on country submissions to determine whether recalibration is needed.
- Capital adequacy:
  - Major French banks have increased capital since the crisis but need to increase further to reach Basel III levels.
  - Banks and supervisor agree on a timetable to reach Basel III capital levels by 2013/14; supervisors should ensure implementation of capital augmentation programs.
  - Front-running Basel III capital targets in timing and magnitude would add credibility and reduce downside risks from exposures to European program countries.
  - France’s major banks are G-SIFIs; international discussions point to tailored and internationally consistent measures to mitigate systemic risk (including additional CET1 capital requirements and phase-in arrangements).

### Regulatory reform, international role, and authorities’ views
- France’s role in reform:
  - Range of Basel III rules, in particular on liquidity, and the EU Capital Requirement Directive 4 (CRD4) remain to be agreed.
  - CRD4 should implement Basel III swiftly and without exceptions with capital requirements set ambitiously high.
  - Capital regulations must be flexible enough to allow introduction of macro-prudential tools.
  - International collaboration between macro-prudential bodies will be important for home-host coordination and reciprocity.
  - France should work toward an ambitious package of international reform to help achieve early clarity for the French financial sector.
- Authorities’ stance:
  - Authorities supported improving global and European regulatory standards and view Basel III capital standards as a significant advance.
  - They emphasized the key role of supervisory arrangements, the importance of an internationally level playing field, and the need for sufficient phase-in time to adapt without excessive economic costs.
  - They remain actively involved in discussions on globally systemically important financial institutions.
  - Authorities agreed that house prices were relatively high but stressed that the risk of negative fallout from a correction was low given sound lending practices and intrusive banking supervision.
  - The systemic risk board (Conseil de Régulation Financière et du Risque Systémique) is a useful forum to monitor property market developments and consider tools, including macro-prudential ones, to manage associated risks.

*IMF staff report content (selected excerpts).*

### 42.      Lifting inclusive trend growth will have significant effects on living standards

### 42.      Lifting inclusive trend growth will have significant effects on living standards

### Summary findings on growth and competitiveness
- Lifting inclusive trend growth requires a comprehensive strategy that shifts incentives toward work, investment in more productive activities, and innovation.
- Staff estimates: further labor and product market reforms that bring France in line with best practices could raise growth by about ¾ percent per year over the medium term.
- French export performance over the last decade lagged main competitors; relatively few new products gained market share.
- CGER-based assessment suggests some real effective exchange rate (REER) overvaluation, driven in part by euro dynamics and indicating the need for wage moderation and cost containment.
- Non-price factors were significant in explaining French export performance until the crisis when demand factors became dominant.
- Restoring competitiveness requires promoting innovation and creating favorable conditions for business to penetrate growth markets and sectors.

### Strengthening innovation and non-price competitiveness
- Existing measures:
  - Tax credit for research and development activities (Crédit Impôt Recherche) provides generous incentives.
  - Grand Emprunt supports university-based and other research efforts.
- Recommendation: evaluate cost effectiveness of these measures within an appropriate time frame.
- Other obstacles to innovation to be evaluated include the relative paucity of medium-sized firms.

### Product and services market competition
- Regulation of product and services markets remains more restrictive in France than in many other countries; professional services have become more regulated over the past decade.
- France is transposing the EU Services Directive into national law but has not yet fully done so.
- Recommendation: Competition Authority should focus on areas where progress has been limited; increasing competition in services, particularly professional services, would significantly boost productivity and job creation.
- Empirical estimates: if France aligned its regulation to best practices in the OECD,
  - long-run employment rate would increase by 1.2 percentage point, and
  - multifactor productivity would increase by between 0.2 and 0.6 percent per year over the medium term.

### Tax reform: objectives and key concerns
- Pressures from EU integration and globalization argue for reforming labor and business income taxation.
- Last year’s reform of the local business tax (taxe professionnelle) is an important first step.
- Main concerns with current system:
  - Still high labor tax wedge at the average wage level due to heavy reliance on social security contributions, hampering job creation and participation.
  - Relatively high corporate tax rate faced by firms not benefiting from special allowances and incentives.
  - System bias toward certain sources of finance and sectors, encouraging excessive financial leverage, contributing to a dearth of equity financing for innovative projects, and discouraging firm growth.
- Recommendation: offset tax cuts by base broadening and improved compliance, including removal of the least efficient tax expenditures, to ensure growth-friendly tax reforms support fiscal consolidation.

### Tax wedge and labor supply effects
- France has the fourth-highest tax wedge for singles in the OECD because of welfare arrangements requiring a relatively high level of social security contributions and social welfare taxes.
- Empirical finding: a reduction in labor taxes by 1 percentage point could lower unemployment by 0.3 percentage points.
- The impact of the tax wedge on unemployment is larger when high and long-lasting unemployment benefits reduce incentives for job search.

### Targeted tax-benefit reforms to raise participation
- Participation problems:
  - Workers aged 55–64: participation rate is the lowest among advanced countries.
  - Prime-aged women (30–54): employment rate has increased in line with other OECD countries, but mean hours worked have declined markedly since the late 1970s.
- International experience: U.S. example shows almost a quarter of the increase in hours worked between 1977 and 2007 explained by higher participation of older workers (55–74 years) and about 10 percent by higher hours worked of employed prime-aged women.
- Policy options:
  - More generous earned income tax credits for older workers (as in the Netherlands) and for women with school-aged children.
  - Employer credits for social security contributions paid for these worker categories.
  - Further increases in the retirement age (as done in some EU countries) could have favorable impacts on labor force participation.

### Corporate tax reform recommendations
- A corporate tax reform that reduces the statutory rate along with base broadening would:
  - Make the system fairer and simpler.
  - Deter profit- and investment-shifting.
- Note: relatively large elasticity of profit shifting argues for harmonization; authorities intend to seek convergence with Germany.
- Lower statutory rate across the board would reduce the need for special rates and tax treatments for SMEs and innovative firms and reduce complexity.
- Recommendation: reduce debt bias from interest deductibility to facilitate banks’ deleveraging and promote greater reliance on equity finance.

### Labor market reforms: priorities and measures
- Overall focus: re-absorb the unemployed and increase labor force participation.
- Key measures:
  - Further strengthen activation policies and the unified job placement agency (Pôle Emploi) to support job search and broaden training opportunities; accompany with strict enforcement of job-search requirements.
  - Foster apprenticeship programs.
  - Consider easing high employment protection to entice firms to create more jobs.
  - Reduce the comparatively long duration of unemployment benefits or lower benefit levels over time to strengthen job-search incentives and increase effective labor supply.
  - Draw young and low-skilled workers into the labor force: the high minimum wage (SMIC) bars especially young and low-skilled workers from employment.
    - Recent measures: tax relief and reduced social contributions lowered labor cost for low-skilled workers and halted the decline in their employment share.
    - Indexation issue: SMIC is indexed on inflation; current inflationary pressures and a civil servant wage freeze risk jeopardizing progress; recommendation to review the indexation formula of the SMIC.
    - SMIC factual level: increased in January 2011 to €9 per hour (€1,365 gross or €1,073 net for a 35 hour work week).
  - Continue phasing out pre-retirement benefits, relax constraints on combining employment and retirement benefits, and pursue pension reform to raise seniors’ participation; senior participation rose from 38.1 percent at end-2007 to 40.3 percent in early 2011 (EU average 46.5 percent; Euro area average 46.0 percent).

### Authorities’ views
- Authorities broadly agree on the need for structural reform to boost competitiveness and growth but note political constraints.
- They support measures to stimulate innovation and agree cost effectiveness needs evaluation.
- They reiterated commitment to transpose the EU Services Directive but noted sectoral, political challenges to liberalization of regulated services.
- While acknowledging labor market reforms beginning to bear fruit, authorities stressed difficulty of assessing their contribution to the recovery and noted political difficulties in reforming unemployment benefit schemes.
- On tax modernization, authorities concur with need but are cautious on timing amid fiscal consolidation; they noted limited scope to further decrease the tax wedge for low-wage earners and questioned the employment impact of reducing the tax wedge for higher-earning workers.
- Authorities reaffirmed commitment to lift tax obstacles to competitiveness, seeking increased harmonization of corporate tax base and statutory tax rates with Germany and other European countries.

### Staff appraisal and fiscal outlook
- Supportive policy measures and key reforms contributed to a gradual recovery beginning mid-2009; 2011 outcomes to date surprised on the upside.
- Unemployment remains a problem, but employment is increasing and confidence benefited from stronger activity in core Europe.
- Pension reform in 2010 and earlier structural measures are starting to bear fruit.
- Macroeconomic risks persist due to European sovereign debt market problems and uncertainty about energy and commodity prices.
- Fiscal position:
  - Crisis weakened fiscal position, bringing the debt burden to above 80 percent of GDP and debt servicing costs to about 2½ percent of GDP in 2010.
  - As an AAA-rated country, France remains under high scrutiny; banks’ exposures to some euro area crisis countries renewed market attention to French sovereign debt.
- Fiscal consolidation:
  - The consolidation targets in France’s Stability Program and 2011–14 multi-year budget framework strike a balance between speed and sustainability.
  - 2010 fiscal outcome was better than foreseen; sizeable upfront adjustment in 2011 to restore public finances.
  - Recommendation: prepare specific contingency measures to ensure reaching 2012–14 fiscal targets if growth is weaker or local government/social security spending is more buoyant.
  - Achieving fiscal targets and further entitlement reform are important to lower public debt to 60 percent of GDP by the middle of the next decade.
  - Suggested credibility-enhancing measures: a fiscal rule (currently debated in the Senate), use of independently prepared growth forecasts to estimate future adjustment needs, and establishing an independent fiscal council.

*Source: IMF staff report excerpt (section 42–55).*

### 56.      The French banking sector has overcome most of the crisis legacies and has

### _cr11211 - 56.      The French banking sector has overcome most of the crisis legacies and has

### Banking sector resilience and supervision
- The French banking sector "has overcome most of the crisis legacies and has returned to strong profitability."
- Stress tests undertaken by the French authorities and shared with the mission "attest to the overall resilience of the system, including to shocks that could emerge from exposures to European crisis countries."
- Institutional improvements:
  - "The unification of banking and insurance supervision and the addition of a consumer protection mandate in the Autorité de Contrôle Prudentiee (ACP) and the creation of a national systemic risk board have further strengthened the supervisory arrangements in France."
  - "The newly created European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB) will have additional benefits for the operating environment."

### Housing market risks and macro-/micro-prudential policy
- Current assessment:
  - "Financial stability risks linked to rapid house price increases seem at this stage contained but vigilance is required."
  - "House prices in France increased rapidly over the past year, particularly in urban areas where supply remains constrained."
  - "While low household debt and conservative lending practices limit risks, supervisors should continue to use appropriate micro-prudential tools."
- Policy guidance:
  - "Should house price increases continue and cause broader concerns, the authorities’ intention to use macro-prudential tools is appropriate."
  - "In the context of limited supply, public policies to support house purchases may need to be phased out."
  - "Regulatory barriers and other disincentives to new housing construction should also be reviewed."

### Capital, liquidity, and international regulatory adaptation
- Capital adequacy:
  - "All French banks have increased capital since the crisis. But capital levels need to increase further, and should reach Basel III levels by 2013/14, a timeframe well before the end of the phase-in period, but nevertheless sufficiently long to avoid excessively negative impact on lending."
  - "Both banks and the supervisor support this timetable; the supervisor should continue to ensure that banks implement their announced capital augmentation plans."
- Liquidity and systemic risk:
  - "Liquidity risk should be limited by reducing reliance on wholesale funding markets."
  - "France’s major banks are large and of global systemic importance."
  - "Ongoing international discussions point to the need to mitigate systemic risk through tailored and internationally consistent measures, including capital surcharges."

### Labor market challenges and policy recommendations
- Key challenges:
  - "Broad efforts are needed to increase employment, especially for the young, unskilled, and senior workers."
  - "Structural unemployment remains high and, in the context of falling unemployment, renewed emphasis should be placed on addressing the particular problems of groups with the highest levels of unemployment, including through targeted job search support and training opportunities."
- Policy recommendations:
  - "While the employment of seniors has increased, efforts to further lift the participation rate of senior workers should be sustained."
  - "Continued minimum wage moderation would support employment creation."
  - "Further modernization of the French tax system could reduce reliance on labor based taxes and help increase labor demand."

### Medium-term growth and competitiveness
- Diagnosis:
  - "The medium-term prospects for the French economy depend on improved competitiveness."
  - "Exchange rate based measures of competitiveness suggest only a minor overvaluation, driven in part by the dynamics of the euro."
  - "Yet, the world market share of French exports has been declining and comparatively few new French products gain market share."
- Strategy to lift potential growth:
  - "A multipronged strategy is needed to improve competitiveness of the economy and lift potential growth, including through keeping real wage increases in line with productivity improvements, increasing labor market participation and raising productivity growth."
  - "Critical elements of a growth strategy are already under way, in particular in supporting innovation."
  - "Fostering more competition in growth-critical services would increase potential growth."

*Source: IMF staff report text (paragraphs 56–60).*

### 61.      It is proposed that the next Article IV should be held on the standard 12-month

### _cr11211 - 61.      It is proposed that the next Article IV should be held on the standard 12-month cycle.

### Article IV consultation timing and Fund relations
- France is on the standard 12-month consultation cycle.
- The last Article IV consultation was concluded on July 28, 2010.
- The discussions for the 2011 Article IV consultation were held in Paris during May 31–June 14, 2011.
- Staff team: Ms. Gulde-Wolf (head), Mr. De Vrijer, Mr. Cheng, Ms. Poirson Ward, Mr. Hallaert (all EUR), and Mr. Sy (MCM).
- Country interlocutors included: Mr. Baroin (Minister of the Economy, Finance, and Industry); Mr. Noyer (Governor of the Banque de France); director general of the treasury; directors of budget, taxation, labor and social affairs; INSEE; ACP; AMF; FBF; representatives of labor unions, employer organizations, the financial sector, and academics.
- Fund holdings and quota (as of May 31, 2011):
  - Quota: 10,738.50 (SDR Million) — 100.00 percent of quota
  - Fund holdings of currency: 7,852.13 (SDR Million) — 73.12 percent of quota
  - Reserve position in Fund: 2,886.46 (SDR Million) — 26.88 percent of quota
- SDR Department:
  - Net cumulative allocation: 10,134.20 (SDR Million) — 100.00 percent of allocation
  - Holdings: 9,745.09 (SDR Million) — 96.16 percent of allocation
- Outstanding Purchases and Loans: None
- Latest Financial Arrangements: None
- Projected payments to Fund (SDR million; based on existing use of resources and present holdings of SDRs):
  - Charges/interest: 1.02 (2011); 2.16 (2012); 2.16 (2013); 2.16 (2014); 2.16 (2015)
  - Total: 1.02 (2011); 2.16 (2012); 2.16 (2013); 2.16 (2014); 2.16 (2015)

### Exchange rate arrangements and restrictions
- France’s currency is the euro, which floats freely and independently against other currencies.
- Certain restrictions are maintained on payments and transfers for current international transactions with respect to specified countries and persons in accordance with EU regulations and UN Security Council resolutions (listed in the source text).
- Measures have been taken to freeze accounts of listed persons and entities linked to terrorists pursuant to relevant EU regulations and UN Security Council resolutions.
- Restriction with respect to the Socialist People’s Libyan Arab Jamahiriya has been notified under Decision No. 144-(52/51).

### Macroeconomic outlook and selected indicators (2008–16, as presented)
- Real economy (change in percent):
  - Real GDP: 2008 -0.2; 2009 -2.6; 2010 1.4; 2011 2.1; 2012 1.9; 2013 2.0; 2014 2.1; 2015 2.1; 2016 2.1
  - Domestic demand: 2008 0.1; 2009 -2.4; 2010 1.3; 2011 2.2; 2012 1.7; 2013 2.0; 2014 2.1; 2015 2.1; 2016 2.1
  - CPI (year average): 2008 3.2; 2009 0.1; 2010 1.7; 2011 2.2; 2012 1.7; 2013 1.8; 2014 1.9; 2015 1.9; 2016 1.9
  - Unemployment rate (in percent): 2008 7.8; 2009 9.5; 2010 9.7; 2011 9.3; 2012 8.8; 2013 8.6; 2014 8.2; 2015 7.9; 2016 7.8
- Savings and investment (percent of GDP):
  - Gross national savings: 2008 20.1; 2009 17.5; 2010 18.6; 2011 18.6; 2012 19.2; 2013 19.5; 2014 19.7; 2015 20.0; 2016 20.2
  - Gross domestic investment: 2008 21.9; 2009 19.0; 2010 20.4; 2011 20.8; 2012 21.2; 2013 21.4; 2014 21.5; 2015 21.8; 2016 22.0

### Public finance indicators and projections (percent of GDP)
- Central government balance: 2008 -3.3; 2009 -6.2; 2010 -6.3; 2011 -4.4; 2012 -3.8; 2013 -3.0; 2014 -2.5; 2015 -1.8; 2016 -1.2
- General government balance: 2008 -3.3; 2009 -7.5; 2010 -7.1; 2011 -5.7; 2012 -4.8; 2013 -3.8; 2014 -2.9; 2015 -2.0; 2016 -1.1
- Structural balance (percent of potential GDP): 2008 -2.9; 2009 -4.8; 2010 -4.6; 2011 -3.9; 2012 -3.3; 2013 -2.6; 2014 -2.2; 2015 -1.6; 2016 -1.0
- Primary balance: 2008 -0.6; 2009 -5.3; 2010 -4.9; 2011 -3.1; 2012 -2.0; 2013 -0.9; 2014 0.1; 2015 1.2; 2016 2.1
- General government gross debt (Maastricht definition): 2008 68.2; 2009 79.0; 2010 82.3; 2011 85.2; 2012 87.2; 2013 88.1; 2014 87.8; 2015 86.5; 2016 84.4

- Government revenue and expenditure projections (percent of GDP):
  - Revenue: 2008 49.9; 2009 48.8; 2010 49.7; 2011 50.1; 2012 50.4; 2013 50.6; 2014 50.6; 2015 50.7; 2016 50.7
  - Expenditure: 2008 53.2; 2009 56.5; 2010 56.8; 2011 55.9; 2012 55.2; 2013 54.4; 2014 53.5; 2015 52.7; 2016 51.8
  - Net lending (+)/borrowing (–): 2008 -3.4; 2009 -7.6; 2010 -7.1; 2011 -5.7; 2012 -4.8; 2013 -3.8; 2014 -2.9; 2015 -2.0; 2016 -1.1

### External sector and balance of payments (percent of GDP)
- Current account: 2008 -1.7; 2009 -1.5; 2010 -1.7; 2011 -2.1; 2012 -1.9; 2013 -1.9; 2014 -1.8; 2015 -1.8; 2016 -1.7
- Trade balance: 2008 -3.1; 2009 -2.3; 2010 -2.8; 2011 -3.1; 2012 -3.0; 2013 -2.9; 2014 -2.9; 2015 -2.8; 2016 -2.8
- Exports of goods (percent of GDP): 2008 21.3; 2009 18.1; 2010 20.2; 2011 22.6; 2012 23.0; 2013 23.0; 2014 22.9; 2015 23.0; 2016 23.0
  - Volume growth of exports (in percent): 2008 -0.6; 2009 -12.2; 2010 9.4; 2011 6.4; 2012 4.6; 2013 3.8; 2014 3.9; 2015 3.9; 2016 3.8
- Imports of goods (percent of GDP): 2008 24.3; 2009 20.4; 2010 23.0; 2011 25.8; 2012 26.0; 2013 25.9; 2014 25.8; 2015 25.8; 2016 25.8
  - Volume growth of imports (in percent): 2008 0.6; 2009 -10.6; 2010 8.3; 2011 6.5; 2012 3.9; 2013 3.7; 2014 3.8; 2015 3.8; 2016 3.8
- FDI (net, percent of GDP): 2008 -3.2; 2009 -2.6; 2010 -2.0; 2011 -1.9; 2012 -1.8; 2013 -1.7; 2014 -1.6; 2015 -1.5; 2016 -1.4
- Official reserves (US$ billion): 2008 33.6; 2009 46.6

### Financial markets and high-frequency indicators
- Money market rate and government bond yield series are cited without full series in source tables (examples shown: Money market rate 3.8, 1.0, 0.8; Government bond yield 4.2, 3.6, 3.1).
- Financial institution equity prices (selected changes): BNP Paribas 51.6; Credit Agricole 10.1; Societe Generale 39.2 (date headers in source).
- Credit default swap spreads (5 Yr CDS) examples: BNP Paribas 119.7; Credit Agricole 152.7; Societe Generale 146.4.
- High-frequency indicators (selected):
  - Exports (annual percentage change, in U.S. dollars): 2008 6.8; 2009 1.4 (Q1)
  - Imports (annual percentage change, in U.S. dollars): 2008 8.0; 2009 3.8 (Q1)
  - Total reserves minus gold (end-of-period, billions of U.S. dollars): 2003 30.2; 2004 35.3; 2005 27.8; 2006 42.7; 2007 45.7; 2008 33.6; 2009 46.6; 2010 48.1 (March)
  - Euros per U.S. dollar (period average): 2003 0.8; 2004 0.7; 2005 0.8; 2006 0.8; 2007 0.8; 2008 0.8; 2009 0.7; 2010 0.7 (March)

### Financial sector soundness and vulnerabilities
- Regulatory capital to risk-weighted assets (deposit-taking institutions): 2003 11.9; 2004 11.5; 2005 11.3; 2006 10.9; 2007 10.2; 2008 10.5; 2009 12.4; 2010 12.5
- Nonperforming loans to total gross loans: 2003 4.8; 2004 4.2; 2005 3.5; 2006 3.0; 2007 2.7; 2008 2.8; 2009 3.6; 2010 3.5
- Return on assets (ROA, aggregated data): 2003 0.4; 2004 0.5; 2005 0.6; 2006 0.6; 2007 0.4; 2008 0.0; 2009 0.4; 2010 0.3
- Return on equity (ROE, aggregated data): 2003 8.5; 2004 10.6; 2005 11.8; 2006 14.0; 2007 9.8; 2008 -1.0; 2009 8.2; 2010 7.9
- Core Set of Financial Soundness Indicators (examples):
  - Household debt to GDP: 2003 37.8; 2004 40.0; 2005 43.0; 2006 45.5; 2007 48.0; 2008 50.0; 2009 52.8; 2010 53.5
  - Real estate prices (annual change): 2003 12.3; 2004 15.9; 2005 14.8; 2006 9.8; 2007 5.6; 2008 -3.0; 2009 -4.4; 2010 9.4

### FSAP, ROSC findings, and statistical capacity
- FSAP Assessment (publication references in source): concluded France’s financial sector is strong and well supervised; no weaknesses identified that could cause systemic risks.
- FSAP issues highlighted (summarized in source):
  - Possible concerns from high banking concentration and “too big to fail” dynamics.
  - Large and growing portfolios of fixed-rate residential housing loans pose longer-term risks if funding costs rise or real estate prices fall.
  - Administered savings schemes and policy measures may impede financial market innovation and are not well targeted to social goals.
  - Rapid accumulation of bank capital increases resilience but may encourage expansion through expensive takeovers and risky ventures.
  - Supervisory system segmentation requires improved coordination as cross-sectoral financial groups become more prevalent.
  - Consolidation of markets increases need for effective cross-jurisdictional cooperation.
  - Clearing and settlement infrastructure is generally sound; some room for improvement in retail payment and securities settlement safeguards.
- ROSC Data Module and statistical issues:
  - France observes the Fund’s Special Data Dissemination Standard (SDDS).
  - Data provision is comprehensive and timely; INSEE and Banque de France are principal producers.
  - Recommendations included clarifying INSEE responsibility for government finance statistics, improving data sharing, reviewing classification and valuation in balance-of-payments statistics, improving coherence between current account and rest of world account, and aligning timing of revisions in quarterly and annual national accounts.
  - Work under way to improve transportation account and portfolio investment income recording.

### Institutional and operational notes
- France subscribes to the Fund’s Special Data Dissemination Standard.
- Data are accessible through the Economic Data Sharing System.
- The concluding statement of the 2011 mission is available at the URL provided in the source text.
- Annexes in the source include: Fund relations, Statistical Issues, Table of Common Indicators Required for Surveillance, and detailed high-frequency and financial soundness tables.

*Prepared by the European Department; Staff Report for the 2011 Article IV Consultation — Informational Annex (July 8, 2011).*

### 1.      This note reports on information that has become available since the staff report

### _cr11211 - 1.      This note reports on information that has become available since the staff report

### Recent economic developments
- Staff revised 2011 real GDP growth to 2.0 percent from 2.1 percent, reflecting an official downward revision of first quarter growth by 0.1 percent.
- Following stronger-than-foreseen activity in early 2011, growth appears to have weakened over the second quarter:
  - Incoming data indicate a slowdown in household consumption and industrial production.
  - Business confidence weakened.
- Annual headline inflation rose to 2.1 percent in June, mainly reflecting higher food prices.
- Unemployment rate remains high at 9½ percent, but employment has been increasing.
- Growth in early 2011 was led by robust private consumption and stock-building, supported by a recovery in investment; net exports remained lackluster.
- Risks to the outlook: possible spillovers from lingering euro area sovereign debt problems, and uncertainty about energy prices.
- The gradual recovery of the French economy is progressing, with growth in 2011 expected to be around 2 percent.

### Financial markets and banking sector
- Recent market turbulence related to the euro area crisis and U.S. sovereign debt problems affected French sovereign and banks CDS spreads:
  - Equity prices for major French banks declined by over 15 percent since July 1.
  - Major French banks’ CDS spreads widened by more than 40 basis points during the period.
  - Sovereign CDS spreads reached over 100 basis points in mid-July.
  - The 10-year bond yield spread (relative to the Bund) widened to over 70 basis points in mid-July, but both measures have somewhat retracted more recently.
- Despite these developments:
  - France’s financing costs remain among the lowest in the euro area and yield spreads remain tight relative to other core euro area countries.
  - Aside from banks and insurance companies, there have been no signs of significant negative spillovers to the nonfinancial corporate sector.
- Banking sector strength and reforms:
  - All four banks subject to the European stress tests passed by a significant margin, with a post-stress test core tier 1 ratio of 7.5 percent versus the 5-percent threshold.
  - The French banking sector has overcome most crisis legacies and returned to strong profitability.
  - Bank capital remains below some European peers but is increasing; major French banks should be able to meet the Basel III capital requirements by 2013/14.
  - Large French banks remain highly reliant on wholesale funding and exposed to peripheral Euro countries.
  - Institutional reforms: unification of banking and insurance supervision; inclusion of consumer protection mandates; creation of a national systemic risk board.

### Fiscal policy and consolidation
- The fiscal deficit in 2010 was 7.1 percent, better than foreseen.
- A sizeable fiscal consolidation has been set in motion:
  - The overall budget deficit is to be reduced to 3 percent of Gross Domestic Product (GDP) by 2013 and 2 percent of GDP by 2014.
  - The planned adjustment is to be implemented through binding multi-year restrictions on more than three-quarters of central government expenditures and minimum yearly targets for the reduction in tax expenditures.
- Authorities approved a draft bill to incorporate a national fiscal rule in the constitution on July 13; the draft law will require either a three-fifths majority vote by Congress or a national referendum vote, both to be called by the President, to enter into force.
- Directors’ fiscal recommendations and observations:
  - Credible fiscal consolidation is necessary for debt sustainability.
  - The consolidation targets in France’s Stability Program and the 2011–14 multi-year budget framework strike the right balance, with front-loaded and expenditures-based measures.
  - Prepare specific contingency measures in case growth outcomes fall short of expectations.
  - Use windfall revenue to accelerate deficit and debt reduction.
  - Enactment of a fiscal rule would signal France’s commitment to fiscal sustainability.
  - Using conservative growth forecasts and capping the autonomous spending of local governments and social security would further enhance credibility.
  - Encourage deeper reforms of the pension and health care systems.

### Structural reforms, labor market, and competitiveness
- Challenges: lift potential growth and reduce unemployment, particularly for young, unskilled, and senior workers.
- Progress and measures:
  - Labor market reforms have contributed to some reduction in unemployment.
  - Government programs provide incentives for education and innovation.
  - Efforts under way to improve competition in product and services markets where progress remains limited.
- Directors’ structural reform priorities:
  - Build on recent pension and labor market reforms to promote competitiveness and inclusive growth.
  - Key elements: keep real wage increases in line with productivity improvements; increase labor force participation; foster competition in the service sector.
  - Sustained efforts needed to reduce high structural unemployment by focusing on targeted job search support and training opportunities, and modernization of the tax and benefit systems.

### Executive Board assessment
- Directors noted supportive policy measures and key reforms underpinned a gradual, more broad-based recovery:
  - Consumption robust, investment picked up, employment rising.
- Outlook and risks:
  - Economic outlook favorable but risks tilted to the downside amid the sovereign debt crisis in the euro area and uncertainty about energy and commodity prices.
- Financial stability view:
  - Directors welcomed the resilience of the French financial system and the strengthening of supervisory arrangements.
  - Called for continued vigilance on rapid house price increases and readiness to take measures as necessary, including macro-prudential tools.
  - Agreed banks would benefit from swiftly raising capital levels with aim of meeting Basel III requirements by 2013/14, ahead of official implementation.
  - Noted the need for tailored and internationally consistent measures, including capital surcharges, given the global systemic importance of France’s major banks.
- Structural reform view:
  - Directors highlighted importance of pressing ahead with structural reforms to boost competitiveness, job creation, and productivity growth.
  - Supported an ambitious multi-pronged strategy carefully articulated in light of ongoing fiscal consolidation.

### Selected economic and social indicators (2008–16) — key figures (as presented)
- Real GDP change (percent): 2008 -0.2; 2009 -2.6; 2010 1.4; 2011 2.1; 2012 1.9; 2013 2.0; 2014 2.1; 2015 2.1; 2016 2.1
- Domestic demand (percent): 2008 0.1; 2009 -2.4; 2010 1.3; 2011 2.2; 2012 1.7; 2013 2.0; 2014 2.1; 2015 2.1; 2016 2.1
- CPI (year average): 2008 3.2; 2009 0.1; 2010 1.7; 2011 2.2; 2012 1.7; 2013 1.8; 2014 1.9; 2015 1.9; 2016 1.9
- Unemployment rate (percent): 2008 7.8; 2009 9.5; 2010 9.7; 2011 9.3; 2012 8.8; 2013 8.6; 2014 8.2; 2015 7.9; 2016 7.8
- Gross national savings (percent of GDP): 2008 20.1; 2009 17.5; 2010 18.6; 2011 18.6; 2012 19.2; 2013 19.5; 2014 19.7; 2015 20.0; 2016 20.2
- Gross domestic investment (percent of GDP): 2008 21.9; 2009 19.0; 2010 20.4; 2011 20.8; 2012 21.2; 2013 21.4; 2014 21.5; 2015 21.8; 2016 22.0
- Central government balance (percent of GDP): 2008 -3.3; 2009 -6.2; 2010 -6.3; 2011 -4.4; 2012 -3.8; 2013 -3.0; 2014 -2.5; 2015 -1.8; 2016 -1.2
- General government balance (percent of GDP): 2008 -3.3; 2009 -7.5; 2010 -7.1; 2011 -5.7; 2012 -4.8; 2013 -3.8; 2014 -2.9; 2015 -2.0; 2016 -1.1
- Structural balance (percent of potential GDP): 2008 -2.9; 2009 -4.8; 2010 -4.6; 2011 -3.9; 2012 -3.3; 2013 -2.6; 2014 -2.2; 2015 -1.6; 2016 -1.0
- Primary balance (percent of GDP): 2008 -0.6; 2009 -5.3; 2010 -4.9; 2011 -3.1; 2012 -2.0; 2013 -0.9; 2014 0.1; 2015 1.2; 2016 2.1
- General government gross debt (percent of GDP): 2008 68.2; 2009 79.0; 2010 82.3; 2011 85.2; 2012 87.2; 2013 88.1; 2014 87.8; 2015 86.5; 2016 84.4
- Exports of goods (percent of GDP): 2008 21.3; 2009 18.1; 2010 20.2; 2011 22.6; 2012 23.0; 2013 23.0; 2014 22.9; 2015 23.0; 2016 23.0
  - Volume growth (percent): 2008 -0.6; 2009 -12.2; 2010 9.4; 2011 6.4; 2012 4.6; 2013 3.8; 2014 3.9; 2015 3.9; 2016 3.8
- Imports of goods (percent of GDP): 2008 24.3; 2009 20.4; 2010 23.0; 2011 25.8; 2012 26.0; 2013 25.9; 2014 25.8; 2015 25.8; 2016 25.8
  - Volume growth (percent): 2008 0.6; 2009 -10.6; 2010 8.3; 2011 6.5; 2012 3.9; 2013 3.7; 2014 3.8; 2015 3.8; 2016 3.8
- Trade balance (percent of GDP): 2008 -3.1; 2009 -2.3; 2010 -2.8; 2011 -3.1; 2012 -3.0; 2013 -2.9; 2014 -2.9; 2015 -2.8; 2016 -2.8
- Current account (percent of GDP): 2008 -1.7; 2009 -1.5; 2010 -1.7; 2011 -2.1; 2012 -1.9; 2013 -1.9; 2014 -1.8; 2015 -1.8; 2016 -1.7
- FDI (net, percent of GDP): 2008 -3.2; 2009 -2.6; 2010 -2.0; 2011 -1.9; 2012 -1.8; 2013 -1.7; 2014 -1.6; 2015 -1.5; 2016 -1.4
- Official reserves (US$ billion): 2008 33.6; 2009 46.6
- Holdings of currency (percent of quota, as of April 30, 2011): 2008 86.3; 2009 80.8; 2010 79.7; 2011 73.1
- Holdings of SDRs (percent of allocation): 2008 58.1; 2009 95.9; 2010 96.1; 2011 96.1
- Quota (SDRs million): 2008 10739; 2009 10739; 2010 10739; 2011 10739
- Euro per U.S. dollar, period average: 2008 0.68; 2009 0.72; 2010 0.75; 2011 0.70
- Nominal effective rate, ULC-styled (2000=100): 2008 113.8; 2009 113.7; 2010 110.4; 2011 111.2
- Real effective exchange rate, ULC-based (2000=100): 2008 113.9; 2009 115.2; 2010 109.8; 2011 111.5
- Potential output (percent): 2008 1.2; 2009 1.0; 2010 0.8; 2011 1.1; 2012 1.3; 2013 1.4; 2014 1.5; 2015 1.5; 2016 1.6
- Output gap (percent): 2008 -0.7; 2009 -4.2; 2010 -3.6; 2011 -2.7; 2012 -2.1; 2013 -1.6; 2014 -1.0; 2015 -0.4; 2016 0.0
- Social indicators:
  - Per capita GDP (2006): US$35,471
  - Life expectancy at birth (2006): 77.2 (male) and 84.1 (female)
  - Poverty rate (2005): 12.1 percent (60 percent line), 6.3 percent (50 percent line)
  - Income distribution (ratio of income received by top and bottom quintiles, 2004): 4.2

*International Monetary Fund — Public Information Notice (PIN) No. 11/99, July 27, 2011; IMF Executive Board concluded 2011 Article IV Consultation with France on July 25, 2011.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11211.pdf_