29 October 2012

IMF: France - 2012 Article IV Consultation Concluding Statement

The IMF says that as financial stability risks abate, and with the prospects of a gradual resolution of the euro area crisis, France's competitiveness gap emerges as the main challenge for macro-economic stability, growth and job creation.

The government has rightfully launched a broad debate on the subject and has engaged social partners in a dialogue on critical reforms. This creates a unique opportunity to achieve meaningful reforms. The government has also demonstrated strong fiscal resolve, which has helped anchor market confidence. Going forward, policy priorities should be: (i) quality fiscal adjustment, based on a stronger containment and rationalisation of public spending to improve its efficiency and to create room for a reduction of the tax burden over the medium term; (ii) reforms of the labour market and services to reduce costs, increase the capacity of enterprises to invest and adapt, and create more efficient and inclusive outcomes in terms of growth and employment; and (iii) a rationalisation of the taxation of financial income to ensure an adequate flow of long-term (including equity) financing to enterprises.

The economic policy challenges are on three main fronts:

• Sustaining fiscal consolidation over the medium term to decrease the burden of debt; but at the same time focusing on quality fiscal adjustment in order to strengthen incentives to work and invest.
• Correcting labour market impediments to investment, employment, and ultimately growth, and extracting more value out of the services sector through greater competition.
• Consolidating the significant progress already achieved in terms of financial stability, while ensuring that savings are effectively intermediated to the economy, as banks and insurance companies adapt to new prudential requirements.

The government’s demonstrated commitment to ambitious fiscal deficit targets for 2013 and the medium term strengthens policy credibility, which over time had suffered from the persistence of large structural deficits. The gain in credibility is confirmed by the marked decline in interest rate spreads vis-à-vis Germany, which also reflects a broader easing of euro area tensions. While front-loaded fiscal adjustment provides a strong signal of the government’s resolve, it may, however, dampen an already uncertain short-term growth outlook. A pick-up of growth in 2013 along the lines expected by the government should permit the measures deployed in the draft 2013 budget to achieve the government’s fiscal target. By contrast, persistent weakness of economic activity in the euro area (and in France) should be the occasion for France, its European partners and European institutions to review jointly the speed of fiscal consolidation at the European level, with a view to providing more support to the recovery.

The quality of fiscal adjustment would be enhanced by a rebalancing of the fiscal effort toward expenditure containment beyond what is currently envisaged. With rates of taxation (and government spending) already among the highest in Europe, the ratcheting up of the tax burden in 2012-13 further undermines incentives to work and invest, and places France at an additional competitive disadvantage relative to its peers. A more ambitious objective of expenditure containment over the medium term, relative to the current multi-year plan, appears warranted to enable a gradual reduction of the tax burden, to levels closer to those of European partners. Given the relatively optimistic growth assumptions on which the medium-term framework is built, tighter expenditure targets are also desirable to protect the deficit objective against the risks of less favourable growth outcomes.

Expenditure containment should involve all levels of government, based on a rationalisation of spending. In this regard, the initiatives taken by the government to improve the efficiency of public spending are particularly welcome, notably with the Modernisation de l’Action Publique (Initiative to Modernise the Role of Government) and stricter ex-ante evaluation of public investment projects. These actions will need to be accompanied by: a better match between resources and mandates across the various levels of government as part of the Acte III de la Décentralisation (third phase of decentralization); strict containment of health spending (ONDAM); and tighter controls over the wage bill of all government institutions. The government’s decision to review periodically the efficiency and the rationale of tax expenditures and social security contributions exemptions is also welcome, especially if it is used to achieve a more efficient tax system based on a broader base and lower rates. France has undertaken an important reform of pensions to place the system on a more secure financial footing. This reform also appears to have increased the participation of seniors in the labour market, with a positive impact on potential growth. Consistent with these achievements, any revisions to the pension system needed to maintain its financial balance should continue to rest on an increase in the retirement age rather than an increase in contributions.

The organic law transposing into French law the Fiscal Compact also contributes to the enhanced credibility of French fiscal policy. Through its built-in fiscal rule and corrective mechanism, the organic law will anchor annual budgetary policies more firmly into a medium-term objective of budgetary balance. Under the new architecture, the Haut Conseil des Finances Publiques (HCFP, High Council of Public Finances) will play an important role by providing an independent view on the appropriateness of the macro-economic projections that underpin the budget and by monitoring the implementation of corrective actions in the event of deviations from the established fiscal trajectory. As established, the HCFP offers strong assurances of independence. It will be important to avoid possible conflicts of interests between the monitoring and ex-ante evaluation roles of the HCFP and the ex-post audit and advisory role of the Cour des Comptes (Audit Court) to which the HCFP is associated, notably in terms of corrective budgetary actions to be taken in the event of deviations from targets.

Financial stability concerns, which arose in connection with euro area tensions and dollar liquidity problems in 2011, have abated considerably. French banks have moved aggressively to improve their solvency ratios and funding structures through retained earnings and disposal of international non-core businesses. Banks are well positioned to comply ahead of schedule with internationally-set capital requirements. Banks are also better placed to handle the impact of low economic growth on asset quality, as well as market and liquidity tensions, although their high exposure to wholesale funding could be a source of vulnerability in the event of another severe liquidity or euro area confidence shock. Even so, French banks still appear to have the capacity to dispose of non-core assets in the event of pressures, without compromising their core lending activities.

The resilience of French banks contributed to sustaining positive domestic credit growth through the crisis, but on-going international regulatory changes call for an overhaul of the tax treatment of financial income to enable the continued effective intermediation of savings to the economy. In stark contrast to banking sectors elsewhere, French banks were able to effect considerable deleveraging without curtailing domestic credit growth. The main constraint on the banks’ capacity to provide long-term financing could come from more stringent regulatory liquidity requirements. At the same time, insurance companies may also reduce investments in equity in response to new regulations and accounting standards. The conjunction of these two factors raises the question of how the financial sector (dominated in France by these two types of institutions) will channel savings to meet the long-term financing (including equity) needs of enterprises. The overhaul of the financial taxation of savings envisaged by the government should be an important instrument to address this challenge by creating a more level playing field among financial instruments and increasing incentives for long-term saving.

Press release

© International Monetary Fund