France: Staff Concluding Statement of the 2022 Article IV Mission

IMF News, November 21, 2022

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Published: November 21, 2022

Mission overview

IMF mission led by Mr. Jeffrey Franks conducted a staff visit during November 7-18 as part of the 2022 Article IV consultations.
Key near-term themes: strong post-Covid recovery followed by an energy shock from Russia’s invasion of Ukraine; high inflation and a sharp slowdown in economic activity.
Policy emphasis: begin a multiyear, expenditure-based fiscal consolidation in 2023; better focus fiscal support for the energy shock; pursue structural expenditure reforms (e.g., pensions); boost worker skills and education efficiency; accelerate green transition opportunities; maintain financial-sector vigilance.

Economic outlook: an energy crisis on the heels of the pandemic

Findings

GDP rebounded by 6.8 percent in 2021; by end-Q3 2022 output had recovered to pre-crisis levels.
Recovery was broad-based: consumption, investment, employment, and labor force participation rebounded more quickly than in most other European countries.
France is less directly exposed to the energy shock due to reliance on nuclear energy and low dependence on Russian gas, but the energy crisis reduces purchasing power, dents confidence, and exacerbates supply-side difficulties.
IMF staff now forecast GDP growth of around 2½ percent for 2022 and around ¾ percent for 2023.
Long-run convergence: potential rate of 1.3 percent; scarring leaves output some 2 percentage points below the pre-pandemic trend.

Inflation

Twelve-month inflation rate of consumer prices (HIPC) reached 7.1 percent in October.
Price controls and subsidies have kept price increases an estimated 2-3 ppts lower than the EU average and lowered passthrough into food and goods prices.
Wage increases remain below headline inflation; year-ahead wage expectations were below overall inflation expectations in Q3 2022.
Automatic indexation (minimum wage, pensions, social benefits) and one-off indexation measures could create second-round pressures.
Inflation is expected to peak in the coming months but will remain near 5 percent in 2023 on average; persistent in 2024; decline to around 2 percent in 2025.

Risks

Risks are high and tilted to the downside: prolonged war, escalation of sanctions, further spikes in gas and electricity prices, renewed inflationary pressures, risk of a wage-price spiral.
Faster-than-expected monetary tightening, or deeper slowdowns in the US or China, could further depress output.
Upside: swift adjustment accelerating the green transition could ease energy shock risks and boost investment.

Fiscal policy: focusing crisis support and reducing the deficit

Findings on recent measures

Measures implemented in 2021-22 totaled over 2 percent of GDP and included: gas and electricity price freezes (bouclier tarifaire), cash transfers to households (chèque énergie, indemninité inflation), a fuel price rebate (remise carburant), and support for enterprises.
Two-thirds of the measures reflect untargeted price and purchasing power interventions that pushed up costs and reduced incentives to lower energy consumption.

Recommendations for 2023

Accelerate phase-out of price controls while increasing targeted assistance to the most affected to reduce fiscal costs and incentivize energy savings.
IMF staff welcomes additional upfront support through the chèque énergie foreseen by the end of this year.
Consider a tiered pricing mechanism with the bouclier tarifaire covering only basic energy needs as a second-best to a swift phase-out.
Fiscal policy should take advantage of the phase-out of pandemic support to begin reducing the deficit in 2023.
The 2023 budget does not target a reduction in the deficit; IMF staff projects modestly expansionary policy in 2023 likely producing a slight increase in the deficit.
IMF staff recommends a modest fiscal tightening of ¼ ppt of GDP relative to 2022 (just above ½ ppt. of GDP compared to the current IMF forecast).
- Largely achievable by better targeting energy support and limiting its size to savings from lower subsidies and windfall revenues from renewable energy producers (under the CSPE).
- If additional savings are needed, postpone production tax cuts until compensatory measures are in place or use other measures.
- If the economy deteriorates significantly below current forecasts, allow automatic stabilizers to cushion the fall; any discretionary support should be well-targeted and offset by compensatory measures.

Medium-term consolidation path

IMF staff projects the deficit to decline in the medium term but to remain above its debt-stabilizing level; public debt ratio will remain on an upward path, widening the debt differential with European peers.
Recommendation: sustained adjustment to bring the deficit down to 0.4 percent of GDP by the end of the decade.
- This target is one year later than staff advised last year, reflecting accommodation for the energy shock response.
- Adjustment path implies a cumulative effort of about 5 percentage points of GDP over 7-8 years, for an average annual effort of 0.7 percent of GDP.
Consolidation should center on reducing current spending growth, underpinned by structural reforms, while preserving space for green and digital investment.

Structural expenditure reform priorities (examples listed by IMF staff)

Comprehensive pension reform to enhance labor participation of older workers by gradually increasing the effective retirement age, improve equity and sustainability, and account for specific situations (e.g., interrupted careers, arduous jobs).
Completion of the unemployment benefits reform, introducing countercyclicality in eligibility and/or benefit duration to strengthen automatic stabilizers and labor incentives while generating savings.
Rationalizing tax expenditures (e.g., fossil fuels and housing) and redesigning others (e.g., R&D).
Streamlining the public sector workforce; reducing overlap between levels of government; simplifying social minima schemes.

Fiscal governance

Adoption of the medium-term fiscal programming bill is critical to implementing the new fiscal framework; the December 2021 organic budget law requires programming bills to include annual real spending targets and corresponding nominal amounts for each level of government over a full 5-year horizon, with deviations reported in annual budgets and assessed by the Fiscal Council (HCFP).

Maintaining financial sector stability in choppy waters

Findings

French banks performed well but financial stability risks have increased amid a worsening growth outlook and increased market volatility.
Vulnerabilities in the corporate sector are reemerging; some firms face liquidity pressures from energy price volatility.
Authorities provided guaranteed loans and grants; staff encourage further targeted liquidity support for critically integrated energy producers if energy market volatility escalates.
Banks posted higher profits at the beginning of 2022 but face weaker prospects from worsening growth and higher credit risk; higher net interest margins could offset some effects.
Housing market beginning to cool due to interest rate rises and tighter prudential standards; banks comply with borrower-based limits on loan maturity and debt-service-to-income ratio (legally binding effective January 1, 2022).
Mortgage-related losses are mitigated by mortgage insurance and prevalence of fixed-rate loans, but high inflation threatens borrower affordability.
Authorities adjusted the usury rate mechanism in April 2022; IMF staff encourage further adjustments as needed to enable full pass-through of monetary policy and prevent exclusion of marginal borrowers.

Macroprudential recommendations

Support for progressive tightening of the counter-cyclical capital buffer (CCyB).
- Credit-to-GDP gap exceeds pre-crisis level; credit growth resumed increasing at start of the year.
- IMF staff support HCSF decision to raise the CCyB rate (currently 0.5 percent) by 0.5 percent towards the end of the year.
- Staff believe targeting a CCyB rate between 1 to 1.25 percent is appropriate at this juncture.
- Raising CCyB now leaves banks with ample buffers and room to lower it in future downturns; HCSF should be ready to reconsider if financial conditions deteriorate.
Given concentration of corporate-sector vulnerabilities, authorities could explore a sectoral systemic risk buffer directed at corporate exposures.

Structural reforms to increase growth potential

Labor market and skills

Labor market performed very well with historically high employment and participation and historically low unemployment, but participation remains below many peers and challenges persist for low-skilled and young workers.
Policies to alleviate skills shortages: combine job-search assistance with training; improve training quality.
Continued efforts by France Compétence to enhance certification of training and professional qualifications will be important to contain fiscal cost.
Monitor apprenticeship system to ensure smooth transitions into permanent work.
Improve job-to-job and geographical mobility.
Pension and unemployment benefit reforms will boost participation and growth.

Education

Educational attainment and student performance are relatively low compared to peers while spending is relatively high, indicating scope for efficiency gains.
Options include rebalancing spending from upper secondary to primary, rationalizing non-teaching staff spending, improving teacher training, aligning compensation with performance, incentivizing teachers to work in disadvantaged areas, and giving more responsibilities and autonomy to school administrations.

Green transition

Energy price shock presents opportunity to accelerate green transition: promote energy conservation and renewables, invest in low-carbon energy to achieve an efficient and low-carbon energy mix over the medium-term.
IMF staff support draft legislation to streamline regulatory and judicial procedures to accelerate renewable energy development.
Use any future moderation in global energy prices to increase carbon taxation without further retail price hikes; scale-up carbon pricing must be accompanied by support for vulnerable households.
Financial support for capital-intensive conservation measures (thermal renovation, heat pumps) and renewables (rooftop solar) is appropriate; France 2030 plan investments are welcome.
Non-pricing instruments (feebates, regulations) can reinforce incentives for low-carbon investments, especially in transport and buildings.

Conclusion

IMF staff recommend beginning multiyear expenditure-based fiscal consolidation in 2023, initially by better focusing energy support and later by structural expenditure reforms (notably pensions), while supporting vulnerable populations and accelerating the green transition.
Financial sector has performed well but rising risks warrant continued vigilance and calibrated macroprudential policy (including raising CCyB).
Structural reforms in labor markets, education, and energy will raise potential growth and resilience.

Source: Mission Concluding Statement, France: Staff Concluding Statement of the 2022 Article IV Mission