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France: 2014 Article IV Consultation—Concluding Statement
May 15, 2014
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Economic objectives are the right ones and policies to attain them have been correctly identified. Very substantial fiscal adjustment—3 percent of GDP in the past three years—has been achieved and the structural fiscal deficit has been halved since 2010. But the adjustment strategy followed until now—with an emphasis on raising revenue—has reached its limits. Against this backdrop, the Stability Program and the National Reform Program lay out a course for the next three years with expenditure reduction and measures to increase the supply response of the economy at its core.
In our view, the course for fiscal policy is appropriate. Over decades, a permanent structural fiscal deficit—driven by public spending that has outpaced GDP—has boosted public debt. The resulting erosion of fiscal space constrained the government’s ability to sustain demand as the economy slowed down in 2012-13. The concomitant rise in taxes has weighed on the capacity of the economy to grow. Recreating room for policy maneuver has become critical to enable the government to respond more flexibly in the face of possible future shocks. And cutting spending has become critical to help put social safety nets on a sound footing for future generations. For these reasons, we support continued adjustment as envisioned in the Stability Program.
However, the fiscal policy objectives are very challenging. First, the planned reductions in taxes mean that the cutbacks to spending relative to trend will need to be very large if public finances are to be brought back to balance over the medium term, as they should. The needed cuts have been put at euro 50 billion over the next three years. If achieved, these expenditure savings would be remarkable by historical standards. Second, the recovery of economic activity is likely to remain subdued. We project real GDP growth of 1 percent this year and 1.5 percent in 2015, as supply side measures will boost growth only gradually. Even so, risks of a weaker rebound persist. With the economy operating well below capacity, we also expect inflation to remain at around 1 percent. All of this will make the task of the authorities very difficult. More accommodative monetary conditions would help with the implementation of the fiscal program and bring forward the benefits of structural reforms.
Execution risks are sizeable. Achieving the deficit objectives while delivering on the tax cut commitments leaves no room to deviate from the announced expenditure reductions. The major risks are that the initial plans may be diluted in sequential annual budgets and that cuts in transfers to local governments may be compensated by unsustainable cuts in investment, higher taxes or higher debt. This would undermine the government’s fiscal rebalancing strategy. Also, if there is an overreliance on containment rather that structural measures, expenditure growth will bounce back once pressures subside.
We think that the following actions would reduce execution risks:
In addition to restoring the health of public finances, the government faces the related challenges of employment and competitiveness. The employment rate in France remains among the lowest in the OECD, which reflects long-standing impediments to job creation and enterprise development. A gap between productivity and wage growth in recent years has also resulted in a squeeze in profit margins that has hindered the capacity of enterprises to innovate, compete in foreign markets, and create jobs.
There is broad recognition of these challenges and appropriate actions have been deployed to address them. We take note of the renewed emphasis on making the enterprises the engine of growth. Cuts in taxes and social security contributions will enrich the employment content of growth and help enterprises rebuild their competitive capacity, provided they are used to boost investment. And the simplification shock is gaining strength through an approach that is well structured and promises to deliver meaningful gains for the private sector.
However positive, these measures may not be sufficient if not accompanied by a deepening of labor and product market reforms. We see scope to go further in making the labor market more adaptable in the following areas:
The renewed focus on fighting rents is a powerful guiding principle to spur economic activity. Apart from increasing the purchasing power of households, the elimination of barriers to entry stimulates the creation of new activities and jobs. The National Reform Program identifies a number of sectors in which competition can be accrued, and the consumer law reinforces the fight against anti-competitive practices. To better resist pressures from vested interests, we see merits in mobilizing the role of the competition authority and strengthening horizontal approaches that target general practices rather than specific sectors. Given the potentially large impact on employment, we also think that opening hours in commerce should be made more flexible. Similarly, investments and job creation could be stimulated by adapting urban planning rules to the needs of the housing market and to enterprises. Threshold effects that constrain enterprise growth should also be revisited.
Financial sector policies have been guided by two objectives: ensuring the uninterrupted flow of credit to the economy and bolstering financial stability. On both counts, the French financial sector appears to be relatively well positioned. Credit conditions in France have remained relatively stable, even as banks adjusted to tighter market and regulatory conditions. Capital and liquidity positions have been strengthened significantly. These efforts increase the resilience of banks and thus better shield the economy and public finances from financial instability. With respect to the European banking union, preparations for the Single Supervisory Mechanism are well underway.
Still, the convergence toward stricter global regulatory standards could create strains and require further adaptation of the French financial system. Although credit growth has remained positive, weak credit demand helped banks reduce the loan-to-deposit ratio faster than expected and converge towards new liquidity requirements. As the economy recovers and credit demand picks up, the ability of French banks to provide financing to the economy could be constrained. This risk can be mitigated by securitization of bank credit and market financing by large and intermediate size firms. However, these mechanisms will take time to develop and are themselves subject to risks. Therefore, a broader reform of tax incentives and regulated savings may become necessary to enhance the capacity of banks to raise deposits, and ensure the efficiency of financial intermediation and continued financing of enterprises.
The mission would like to thank the authorities for their welcome, the very open and constructive dialogue, and the high quality of the written analyses provided to the mission.
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