19 February 2013

WSJ: Weak growth strikes a blow to French deficit goals

The French government has said it will not be able to lower its budget deficit to 3 per cent of annual output this year because of weak growth, dropping a key economic pledge by President Hollande and raising the pressure on the eurozone's second-largest economy to show it can restore its public finances.

Mr Hollande's government had staked its credibility on the commitment to lower the deficit to 3 per cent of gross domestic product in 2013, and introduced tax increases to bolster public coffers when economic growth was insufficient to ensure the target was met. "With even weaker growth, it's true that we won't meet the 3 per cent deficit in 2013", Prime Minister Jean-Marc Ayrault said.

By relinquishing its policy goal, the French government is gambling that the credibility it has built in financial markets won't be tarnished. Its pledge to stick to the 3 per cent commitment is among the factors that have encouraged investors to buy French debt, helping to drive the country's borrowing costs to record lows in recent months and in turn making it easier to keep finances under control. Bank of France Governor Christian Noyer said that such credibility can be sustained if the government is clear about where it will cut spending in the longer term and sticks to its current plans for reining in finances this year.

The commission has already indicated it is focusing less on nominal and more on structural targets, which strip out the effects of one-off measures and the business cycle. "A country may receive extra time to correct its deficit" if it is carrying out the "necessary structural reforms", said Olli Rehn.

France must focus on spending cuts in areas like pensions, instead of tax increases as Mr Hollande's administration has done so far, Mr Noyer said. Even if the impact of such cuts isn't immediate, it is important to lay out a path for several years to come. "We can't increase charges on business any more as it harms the target of being more competitive, so it has to be on public spending."

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