France: 2013 Article IV Consultation—Concluding Statement
June 4, 2013
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.
We expect a gradual turnaround of economic conditions in the second half of this year, but risks of a more prolonged stagnation in Europe remain elevated. Restoring external competitiveness remains a critical priority and should be complemented by developing domestic sources of growth. In our view, the growth strategy should rest on the following pillars:
-Raising the economy’s capacity to create value and generate productivity gains through increased competition in product and services markets.
-Building on the momentum of the labor market reform negotiated by social partners to create better labor market outcomes and to reduce rigidities.
-Strengthening activation policies and improving the efficiency of social transfers to raise the employment rate at both ends of the age structure and to shorten the duration of unemployment spells.
The stability of public finances requires that the consolidation effort be continued over the medium term. Following three years of substantial fiscal adjustment, there is scope to moderate the pace of consolidation going forward, provided the effort is concentrated on the expenditure and backed by continued structural reforms. Balance sheet restructuring on the part of banks has greatly reduced financial stability concerns, although reaching regulatory liquidity ratios remains a challenge requiring continued improvement in funding structures..
Amid persistent uncertainty and weakness of economic indicators, we project that the economic recovery will begin to unfold only in the second half of 2013. Real GDP would contract by 0.2 percent in 2013 and grow by 0.8 percent in 2014, with downside risks weighing on the outlook. Following two quarters of negative growth (2012Q4 and 2013Q1), economic activity should begin to recover in the second half of 2013, driven by a gradual improvement in the external environment. Despite the projected turnaround, private domestic demand is expected to contract in 2013 relative to 2012. A steady decline in the household saving rate should help minimize the contraction of consumption despite a fall in disposable income. The main downside risks lie in the precarious growth prospects in Europe, which are linked to private and public balance sheet restructurings, and on the domestic front in uncertainty on tax policy which weighs on spending decisions of households and enterprises.
As discussed in last year’s report, significant rigidities hinder the economy’s capacity to grow and to create jobs. The gap relative to European trading partners in terms of cost and non-cost competitiveness remains a dampening factor and ultimately a risk for macroeconomic balances. The external environment is also changing rapidly with euro area periphery countries registering large competitiveness gains. A powering up of the reforms launched by the government in the last six months (see below) is needed to close this gap. The structural challenge faced by France is captured by three related indicators: a declining rate of productivity growth, low profit margins, and a deteriorating export performance. Developments in these three indicators are closely related: in the face of declining productivity growth, real wage growth has been sustained at the expense of profit margins, which in turn has undermined the capacity of enterprises to innovate and remain competitive in international markets. As the income base on which the social insurance and redistribution system is financed loses buoyancy, the increased tax burden has undermined incentives to create value. The fundamental constraint on the ability of enterprises to grow lies in weak profit margins, and rigidities in product and labor markets and not, based on the evidence we have seen, on a shortage of financing.
On the positive side, France benefits from a number of structural strengths which, in a more supportive environment, could provide a substantial impulse to growth. The financial situation of households and enterprises remains relatively sound (in an aggregate sense), and thus an improvement in confidence and in profit margins can more easily translate into an increase in demand. The French economy can also rely on a high household saving rate, first rate global enterprises, positive demographics, a strong scientific research capacity, and high quality public infrastructure.
The balance sheet repair of banks has continued at a sustained pace and overall risks to financial stability have abated considerably. Banks have achieved their deleveraging objectives without engendering a credit crunch and are well positioned to meet Basel III capital requirements well ahead of time (i.e., already in 2013). They remain, however, heavily exposed to wholesale funding owing to the specific nature of the French financial system (Bancassurance model) and, to a lesser extent, to the tax incentives that deflect savings away from the banks. International regulatory requirements call for a gradual transformation of the financial intermediation system (i.e., toward more deposit collection and more market-intermediated credit). Signs of stabilization in the cost of risk in the first quarter of 2013 across all segments are encouraging, but continued vigilance is necessary to ensure adequate provisioning levels given uncertain recovery prospects.
Against this background, the overarching policy challenge is to restore competitiveness and revitalize growth through mutually supportive fiscal, financial, and structural policies, with emphasis on:
• Building on the reforms undertaken (Crédit Impôt Compétitivité Emploi (CICE) and Accord National Interprofessionnel (ANI)) to facilitate a more productive use of human and capital resources, including through increased competition in product markets and continued adaptation of labor market institutions.
• Pursuing fiscal consolidation at a steady pace in structural terms (allowing automatic stabilizers to work) and anchored by an explicit expenditure containment targets backed by improved targeting of social transfers and a lower government wage bill (in percent of GDP).
• Solidifying the significant progress achieved in terms of financial stability, including by spearheading the move towards banking union, and ensuring that financing needs are met as financial institutions adjust to new prudential requirements.
A multi-pronged structural reform strategy
Since the last Article IV consultation in October 2012, the authorities have made meaningful progress on the structural reform front. This forward momentum should be sustained and broadened to address the multiple and deep challenges faced by France. In particular, we would like to underline the significance of the CICE, the ANI, and the launching of the reform process on several other equally critical fronts (pensions, training and activation policies, administrative reform, simplification of the regulatory environment, unemployment insurance, and family policies).
The CICE creates welcome breathing space for enterprises, which have been constrained by declining profit margins. It provides a sizable reduction in labor costs (estimated at around 3 percent of the total wage bill), which should enable enterprises to increase their price competitiveness on international markets and/or rebuild their competitive capacity through investment. The benefits of such a reform tend, however, to wane over time, and so it is critical that this competitive impulse be complemented by productivity and cost gains generated by broader structural reforms.
The ANI and its transposition into law constitute a second critical element of the reform strategy and should be seen, in our view, as a first step in the reform of the labor market. This agreement recognized the importance of facilitating adjustment as a way of preserving jobs. The labor flexibility provision of the ANI should also increase incentives to hire, if enterprises can more easily (and at lesser risk) adjust working conditions and restructure in the face of adverse cyclical conditions. The success of the negotiations and its broad support could also portend a less confrontational relation between social partners going forward, which, as much as institutions, is key to producing efficient labor outcomes. However, the economic impact of the ANI is uncertain because much depends on implementation and the perimeter of wage negotiations is somewhat constrained. It is important to allow the ANI to gain traction, but at the same time the process of enterprise dialogue it has initiated will likely reveal the desirability to extend the perimeter of enterprise level negotiations.
The cost of labor (and the gap relative to its productivity) remains a critical obstacle to employment at the lower skill end of the labor market. This affects a large part of the population particularly among the youth. Reductions in social security contributions on low wages have greatly reduced that gap, but the budgetary cost of this policy has reached its limit. Other instruments should be found to lower the effective cost of hiring young workers, if not through the wage through an easing of contractual work arrangements.
Acting on the productivity front is the most desirable way of closing the gap between the cost of labor and its productivity and thereby creating jobs. Removing regulatory and administrative obstacles to competition in the services sector (regulated professions, transportation, and distribution) and redistributing (through lower prices) the rents earned in protected sectors is the main lever through which productivity gains and new employment opportunities can be created in the economy. The entry of a fourth operator in the mobile telecommunication sector illustrates the benefits of competition in terms of reduced tariffs, which both increase the purchasing power of households and lower the input costs for other sectors. The employment generation benefits of this liberalization (and more generally of the low internet costs in France) will be expanded and multiplied to the extent that they are not simply captured by higher rents in protected services, but used to create new value. In this regard we view enhanced competition, combined with the French social safety net, as a positive instrument of inclusiveness. The proposed new consumer law and its class action provisions are a welcome reform, but reform in the services sector has long been thwarted by the difficulty of appreciating the potential gains against the immediate costs to the protected sectors. We believe that the process can be revived by empowering an independent advocate of reform, for instance the competition authority with accrued powers to review practices and regulations in all sectors of the economy and to guide the public debate through an enhanced consultative role.
Removing constraints on housing construction could support wage moderation and stimulate activity. Past practices show that stimulating demand through tax incentives without addressing supply constraints ultimately puts upward pressure on prices and benefits property owners at the expense of the tax payer. In this respect, the key to addressing the housing shortage and reducing prices is by acting on the administrative constraints that operate on the supply side. The government’s increased attention to this issue is very welcome.
Strengthening worker training mechanisms and activation policies are other important levers of growth. Redirecting public resources to the training of those who are most at risk of being excluded from the labor force is critical, and we welcome the government’s decision to place this issue on the table for the social dialogue of June 20—21. As noted, rates of employment in France remain well below those of partner countries at both ends of the age distribution. Reforms undertaken in recent years (pensions and phasing out of early retirement schemes) have already yielded measurable results in terms of the employment rate of seniors. As demand recovers and structural reforms on the product market take hold, it will become increasingly important to increase incentives for a larger share of the working age population to actively seek employment. Parametric choices in the reform of pensions (discussed below) should therefore put a premium on encouraging longer working lives. Similarly, the reform of unemployment insurance should be the occasion to introduce stronger incentives to exit unemployment, for instance by capping unemployment benefits and increasing their degressivity (possibly combined with an offsetting increase of the initial level of benefits). The duration of unemployment spells can also be lowered by reducing mobility costs both geographically (cost of services and housing) and across professions (consolidation of multiple pension and benefit systems).
Maintaining the fiscal consolidation momentum through higher quality adjustment
The fiscal consolidation needed to restore the health of public finances remains substantial over the medium term, but measures should be concentrated henceforth on the expenditure side. The heavily front loaded adjustment expected in 2011-13 covers 2/3 of the cumulative effort needed over the medium term, even if it has been at the cost of a procylical fiscal stance. The transition to a structural deficit target under the Loi de Programmation des Finances Publiques (LPFP) and the Stability Program is a welcome change in the fiscal policy framework. By filtering out the cyclical component of the deficit, a structural target will eliminate the need for inefficient stop-gap measures to meet nominal deficit targets in the face of changing macroeconomic conditions. In our view, the move to structural deficit targets should also be the occasion of anchoring the adjustment strategy to an explicit expenditure containment objective. Going forward, the medium-term balanced budget target should be achieved by acting solely on this policy lever while maintaining the overall level of taxation (in relation to GDP) unchanged from its current level. The recurrent use of revenue measures to fill budgetary gaps has not only raised the overall tax burden to excessive levels, but has also undermined business and household confidence. Greater predictability in tax policy would remove uncertainty that weighs adversely on business and household spending decisions. This said, within an unchanged overall tax burden, there is considerable scope to reduce distortions by closing tax expenditures while lowering rates.
We consider that the pace of public expenditure growth targeted under the Stability Program for 2014-15 (0.4 percent in real terms in 2014 and 0.3 percent in 2015) is appropriate. Combined with a stabilization of the revenue-to-GDP ratio at its 2013 level, this expenditure path would result in a deficit of around 3½ percent of GDP in 2014 and of under 3 percent in 2015, consistent with the recent proposed recommendations of the European Commission. We consider that expenditure growth should be kept at around 0.3 percent in real terms after 2015 until the structural budget balance objective is reached. The Stability Program envisages that this objective can be reached in 2016, but based on real GDP growth assumptions which are rather optimistic. As long as adjustment continues to be driven by expenditure containment, a one year delay relative to the Stability Program target owing to less favorable growth outcomes would not undermine debt sustainability.
This degree of expenditure containment is admittedly very ambitious relative to past trends, and its credibility depends on the identification of structural spending measures that can be deployed over time. The inter-ministerial committee charged with identifying ways to rationalize public policies (Modernisation de l’ Action Publique, i.e., MAP) has already played a useful role in this regard. The MAP and the government more generally can also rely on the extensive work carried out by the Audit Court (Cour des Comptes) that has identified and documented potential efficiency gains in the public sector. The containment of government spending growth over the medium term ultimately has to be distributed between reducing the public sector wage bill (in relation to GDP) and reducing social transfers by pursuing social objectives more efficiently. Pushed by the growth of the wage bill of local governments and state agencies (ODAC), the general government wage bill has grown to over 13 percent of GDP (2 points higher than the EU average). Reversing this trend would be helped by a simplification of the layers of subnational governments, going beyond the objectives envisioned under the third phase of decentralization. Although social spending in France is the highest among the OECD countries (in terms of GDP), social outcomes are not uniformly better, suggesting that the social protection objectives of public policy could be achieved more efficiently. The planned reforms of pensions and of unemployment insurance will play an important role in this regard. While closing the deficits of the social security accounts is crucial for fiscal consolidation and sustainability of the social protection system, reforms of these schemes also constitute an opportunity to improve labor market outcomes.
The first two opinions issued by the newly created fiscal council (Haut Conseil des Finances Publiques) attest to its independence and professionalism. The mission considers that the council’s recommendation to base budget projections on less optimistic macroeconomic assumptions would help protect against negative surprises and increase the predictability of policies. The council will play a critical role in assessing the realism of the macroeconomic and fiscal assumptions underlying the 2014 budget.
Enhancing the Role of the Financial Sector in Promoting Growth
The growth strategy outlined above also relies on the efficient intermediation of financial resources from savers (households) to borrowers (enterprises and the various levels of government). Under the pressure of new international regulatory standards, French banks still have some way to go to increase their liquidity buffers and improve net stable funding ratios. This requires a move toward more market-intermediated credit and higher deposit collection. Given uncertainty on the pace at which banks can move to an originate-to-distribute model, policies should focus on removing constraints on the deposit base. In this regard, the diversion of an important part of household savings toward regulated savings accounts (due to the past and planned increase in the ceiling of the livret A and the livret de développement durable) goes against the regulatory objectives set out by the authorities. The parameters that define the distribution of the funds collected through these instruments between the Caisse des Dépôts et Consignations and the banks could be set in a more flexible manner so as to support the adaptation of financial institutions to the new regulatory requirements. Eventually, a more thorough reform of the taxation of financial income would be desirable toward a maturity-based rather than product-based approach.
Signs of stabilization in the cost of risk in the first quarter of 2013 are encouraging, but continued vigilance is necessary to ensure adequate provisioning levels given uncertain recovery prospects. The ACP’s (Autorité de Contrôle Prudentiel) extensive knowledge and intrusive monitoring of bank balance sheet risks reduces potential concerns about adequacy of capital buffers that could emerge in the run-up to the European Banking Authority-led Asset Quality Review (AQR) in late 2013. Regular assessments by ACP of the quality of balance sheets (e.g., reviews of banks’ internal risk models and origination standards as well as semi-annual stress-test exercise) suggest that the French banking system is comparatively well positioned ahead of the AQR. Nonetheless, given current uncertainty about the factors behind the low risk ratios of French banks relative to European peers and limited public disclosure of financial sector data, the ACP should consider publishing detailed updates on the various supervisory reviews it has already concluded on the reliability of banks’ risk weights, as well as a summary of the main findings of its semi-annual stress-test exercise to provide guidance to market participants on the quality of balance sheets and their resilience to deteriorated economic conditions.
Finally, the mission welcomes the efforts deployed by the French authorities to keep the process of European convergence toward the Single Supervisory Mechanism and Single Resolution Mechanism in the European Union on track, including through progress made on the domestic reform front. The draft law on banking reform currently before Parliament anticipates the European-level structural bank reforms and aligns the resolution regime to the draft EU Recovery and Resolution Directive, in line with FSAP Update recommendations. It gives the banking supervisor new responsibilities for banking crisis preparedness and resolution under the new name of Autorité de Contrôle Prudentiel et de Résolution (ACPR). The draft law also allows the deposit guarantee fund (FGD) to be involved in bank resolution, following a decision by the ACPR. It gives the authorities powers to separate failing entities into good and bad banks and to establish bridge banks, and will gradually increase the pre-funding of the FGD from the current €2 billion to €10 billion. The draft law also strengthens the institutional set-up for macroprudential surveillance and supervisory powers of the ACPR over governance of financial institutions.
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.