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Transcript of a Conference Call on France’s 2012 Article IV Consultation and Financial System Stability Assessment
December 27, 2012
MS. GAVIRIA: Good morning and good afternoon to those dialing in from Europe. This is the conference call on France’s 2012 Article IV Consultation and Financial System Stability Assessment. The documents were published last Friday and are available in our website.
Let me introduce our speakers: Edward Gardner, who is Assistant Director in the European Department of the IMF, and Mission Chief for France; and Robert Sheehy, Deputy Director in the Monetary and Capital Markets Department. Both Edward and Robert will make brief statements and will then take your questions.
MR. GARDNER: I trust most of you have read extensively the reports. I’ll be very brief. I think the main findings of our consultation are that France’s economy was, in fact, more resilient than most during the crisis and that the balance sheet problems that appeared in 2011 in the financial sector have largely been addressed. But I’ll leave that to my colleague, Robert Sheehy, to comment on. The longstanding fiscal structural deficit problem that France faced overtime is being tackled; however, as you read in the report, our assessment is that the outlook remains very weak, not only because of external conditions, but also an internal lack of dynamism or a competitiveness problem which is slowing the rebound. I think that is a theme that has been extensively commented on domestically by the Gallois Report, which we followed up on in our consultation report.
In terms of the policies, I think a lot of the press has already picked up on the fact that our deficit projection for next year diverged from the government, but I think the story is broader than that. I think the story from the Article IV Consultation is that the medium term targets of a balanced budget are now much more credible and anchored into stronger policies than we saw before. France has passed legislation to make its medium term adjustment trajectory more secure and stronger, and I think this is a theme that is worth noting.
The other aspect of fiscal policy, which we put some emphasis on, is that the speed of adjustment is one issue, but more important is the quality of adjustment. And in that respect, we discussed the importance of rebalancing adjustment towards expenditure containment starting in 2014.
Finally on structural policies, I think the report covers many of the issues that are now the object of negotiations and object of studies, including the Gallois Report, so I will not go into detail on those issues. But let me now turn to my colleague, Robert Sheehy, who can comment on the financial sector aspects.
MR. SHEEHY: Certainly. Thank you, Ed. We found that the French financial system, regulatory and supervisory system, was of a very high standard. We thought that the regulators probably know as much or more about the details of bank balance sheets than in any other country that we reviewed recently. It was excellent. We thought that the issues that face the French banking system were… number one, they have a high reliance on wholesale funding. So they’re quite vulnerable to a closing of funding markets in Europe, and that means that any worsening of the euro zone crisis would cause them potentially severe difficulties. We are not seeing that. In fact, we’re seeing the euro zone situation move in the opposite direction, but that is a vulnerability.
We do think that there are a few minor adjustments that could be made in terms of the governance system because there’s a quite extensive interrelationship at the governance level among different government agencies, including in particular the Treasury, which is quite widely involved. And we thought that there might be a better form of having that happen, so you could still get the benefits of all of the interconnections, but not have the appearance that other supervisory agencies were not completely independent.
We thought that overall the capital situation of the banks is actually in a reasonable position. We can always ask for more on this sort of situation. But we thought that some of the public presentations were a little bit confusing, so you would get in some cases a presentation on the basis of individual institutions within a group, in other places the group as a whole, and it made it rather difficult for an outside observer to actually ascertain the total detailed financial situation. So we thought that some improvement on the disclosure side might be warranted.
But overall our assessment was that this is a very well-regulated, well-supervised financial system. It has some vulnerabilities, but we think the authorities are very conscious of those vulnerabilities and are working to resolve them.
QUESTIONER: You mention in the report that respecting the 3 percent rule would be… that there’s a risk that it could be too pro-cyclical for the economy. So I was just wondering, then, does that mean in your view that France should open discussions with its European partners about pushing back the 3 percent target later?
MR. GARDNER: Yes, our view is that at this point, given our own growth assumption, reaching to 3 percent would require significant additional measures and that given cyclical conditions that would really turn fiscal policy into an overly pro-cyclical stance. So our recommendation is that France discuss, in fact, in the broader European context the appropriate stance for 2013. And we were quite keen to stress the European dimension in that; I think that was also a concern of the French authorities, namely that changes in fiscal policy relative to commitments should be seen as consistent with the European stabilization strategy. In that regard, they would be more effective and more credible if not done unilaterally, but in a coordinated fashion. And I think the European Commission has already opened the door in recent comments that I’ve read in the press to that effect. So I think there is already a movement possibly in this direction.
But as I mentioned, I think the importance is really the credibility of the medium term orientation of policies. I think that whether the deficit is 3 or 3.5 percent next year matters less as long as France can give reasonable and credible assurances about the direction of policies. And in that respect, a lot has been done in terms of transposing into French law the fiscal compact and setting up a fiscal council and binding policies to a medium term balanced position. I think those are much more significant measures than whether the deficit is 3 or 3.5 percent next year.
QUESTIONER: I was just wondering if you could elaborate on your comments on the adverse supply side effects of the high tax ratio that you made in the report. How much of a detrimental effect do you think this 75 percent higher tax rate will have on the French economy?
MR. GARDNER: Well, our comment on the tax policy is sort of a more general comment, a more general observation about the level of taxation at all levels. But on the 75 percent itself, I don’t have the specific effect, I mean, I don’t have specific estimates of what that might do. All I do know is that it is a temporary measure. It is not in and of itself expected to be a massive source of revenue. And that there are, in fact, a lot of exceptions and adjustments made to it. So I think there’s been a lot of attention to that particular issue, but certainly on a macroeconomic point of view, the bigger issue is the overall tax ratio in terms of GDP in all its various forms. And it’s in that respect that we think that France is hitting a limit where there is very little scope for raising taxes further without dampening initiative and economic activity.
QUESTIONER: As you probably know there’s a big debate in France right now about whether the lack of competitiveness is a cost issue, a labor cost issue, or whether it’s a question of a lack of innovation and France sort of being in the wrong market sectors and things like that. I’m just wondering where you guys stand on this debate?
MR. GARDNER: Well, I think it’s really a bit of both. It’s not a cop out answer, but it is really a bit of both in a sense that cost is an issue, although not in all sectors of the economy. There are many sectors of the economy, particularly the services sector, where French labor costs are much higher than in partners. And high labor costs also means narrower profit margins, which in turn means less capacity to invest and innovate.
But I think equally important and perhaps in our view more important over the medium term is the fact that the non-cost factors are very severe impediment in terms of the implicit cost of hiring, be it because of the limited flexibility with which you manage work time or the cost of separation and firing, which means that incentives to hire in the first place are much lower than elsewhere.
So I think really it’s a combination of the two and that’s why I think in our report we do emphasize the need to act jointly on both fronts.
QUESTIONER: Under your bank stress tests there are eight major banks that you looked at. And it looks like one consistently failed -- on page 24 -- throughout the cycle, if you include ECB support, which I would assume would be the more likely scenario unless you disagree. I’m wondering which of the eight banks it was that failed.
And secondly, can you elaborate on the high likelihood of further downgrades by rating firms?
MR. SHEEHY: Well, first of all, just in terms of identification, we don’t actually identify individual banks in the report, and I’m afraid I need to leave it that way. What I would say, and you hit the point that banks survive very well with ECB funding, I think the basic underlying weakness in the French banking system is the overreliance on wholesale funding. They’re trying to get that down, but they still have a relatively large reliance. So when you do a stress test in that kind of circumstance, you do automatically lead to a situation where some banks are going to have trouble because what you do is basically interrupt the funding. So that’s a general comment.
On the rating point of view, I think the banks themselves are in relatively good shape in terms of an overall rating. They are all going to be subject to the sovereign ceiling at some point. And that’s probably a greater concern because we’ve had two of the three major agencies already downgrade France from AAA to AA+, but still that potentially over the longer run could actually become a binding constraint. It is not at the moment.
QUESTIONER: And could I just follow up on the budget deficit. You said that the targeted growth is lower than the current official forecast of 1.7 percent and will have to take additional efforts, and you project French growth next year at 0.4 percent, significantly lower. So can you give sort of a quantification of how much, in terms of additional efforts, would be needed? Can you quantify that?
MR. GARDNER: Well, roughly speaking you would need measures of the difference, half a percent of GDP under our growth scenario, yes.
QUESTIONER: Okay, half a percent. Any specific areas where you would recommend that they meet that half a percent?
MR. GARDNER: No, because as I mentioned, I think the report’s point of view is that the preferred policy would be not to take additional measures at this stage given that the structural adjustment that’s underlying the scenario is already very large. If you adjust for the economic cycle, the change in the deficit is already quite substantial relative to 2012. And the path towards a balanced budget over the medium term is already quite credible. So in that sense, the report’s point of view is that there isn’t much of a case for accelerating things further in response to a weak economic environment.
QUESTIONER: In the near term, but are you recommending something more in the longer term?
MR. GARDNER: Yes, over the medium term I think our recommendation is that, to the extent that growth remains below the authorities’ projection, there might be indeed a need for more adjustment starting in 2014. But that would have to be done mostly on the expenditure side given the limited room France has to raise taxes any further.
So I think that’s where the additional effort should come from in our perspective, and there are sources to achieve that. We believe that, for one, the Social Security System, which has recently been assessed as being in a bigger deficit than it was thought, still has to undergo some reforms. There is scope for containing local government spending, which has been the main source of expenditure growth in the last decade. So I think there are a number of areas where additional expenditure savings can be realized.
QUESTIONER: In the report you talk about a risk of a loss of competitiveness, vis-à-vis Italy and Spain. Usually, when we talk about lost competitiveness for France, it’s vis-à-vis Germany. And so I was wondering if you could just elaborate on France losing ground towards Italy and Spain. What are the particular sectors that you have in mind? Is it low value-added manufacturing, for example? Are we talking about a general loss of market share? And is simply lowering labor costs the answer to not losing that ground?
MR. GARDNER: Yes, I think the loss relative to Germany has already occurred and France was in the past in terms of competitiveness positioned between Germany and Spain and Italy in many ways. But when we look at unit labor cost, which is one of the many competitiveness indicators, one of the many cost competitiveness indicators, we see that Spain is catching up very fast. And, of course, a lot of the adjustment in Spain is the result of the very severe crisis and very drastic measures that have been taken to reduce labor costs and make the labor market more flexible.
The result, nonetheless, is that in those terms France has lost relative to Spain in terms of competitiveness. Italy is also undergoing reforms, not at the same speed as Spain, but nonetheless with some significant labor market reforms. We haven’t seen the result of those yet in Italian cost competitiveness, but if pursued, we would expect that to be the case. And so I think it’s in that perspective that France is losing ground in a relative sense to these other countries.
I think in terms of actual export performance, Spain has been doing quite well recently. And that’s another example of one of how the crisis-hit countries may be rebounding, at least on the external side, and that it may put pressure on France.
MS. GAVIRIA: Thank you all for participating. Good bye.
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