05 August 2013

IMF Executive Board concludes 2013 Article IV consultation with France

In a context of weakening economic conditions in Europe, sizeable fiscal consolidation and domestic policy uncertainty, the French economy flatlined in 2012, but recent improvements in economic indicators support the expectation of a gradual recovery in the second half of 2013.

The economy's growth potential, beyond its cyclical recovery, is hindered by structural rigidities in labour and product markets, which have, over time, contributed to a gradual loss of cost competitiveness and export performance. These have been accompanied by sizeable declines in the share of manufacturing production and employment and a narrowing of profit shares in national income. Structural reforms to address these constraints have been given an important forward momentum by the recent reduction in labour taxes and correction of the labour market toward greater "flexicurity".

The pace of fiscal consolidation was accelerated further in 2013, with a structural adjustment equivalent to 1.8 per cent of GDP, which comes on top of an adjustment of 2.2 per cent of GDP sustained over the previous two years. IMF staff projects that the fiscal deficit will decline to 3.9 per cent of GDP in 2013, from 4.8 per cent in 2012. The bulk of the adjustment to date (about 90 per cent) has been realised through revenue measures, whereas IMF staff had suggested a more balanced distribution of the effort. Under the new fiscal government framework, the authorities have announced that they would henceforth be setting and monitoring fiscal objectives in terms of the structural deficit, thus increasing the stability and reducing the procyclicality of fiscal policy. The Stability Programme of April 2013 targets an easing of the pace of adjustment starting in 2014 and a rebalancing of the adjustment efforts toward expenditure measures.

Financial stability risks have abated considerably, as banks have completed their deleveraging objectives and strengthened capital and liquidity buffers. However, bank profitability remains low. The French financial system still needs to adapt fully to new international regulations on bank liquidity.

Executive Directors were encouraged by recent improvements in economic indicators, supporting the expectation of a gradual recovery during the second half of the year. Given remaining risks, including from uncertain euro area prospects, Directors underscored the importance of pursuing structural reforms to support the recovery of private demand and strengthen competitiveness, while continuing efforts to ensure fiscal sustainability and safeguard financial stability.

Directors welcomed the significant progress already achieved towards consolidating public finances. Going forward, many Directors saw merit in allowing for a smoother pace of adjustment than envisaged in the Stability Programme to support the hesitant recovery. Many other Directors advised the authorities to persevere with the consolidation plans under the programme, noting that it already allows automatic stabilisers to operate. While Directors welcomed the shift to structural deficit targeting, a number of them noted that nominal targets should not be neglected. With tax rates already at a very high level, Directors stressed that rebalancing fiscal adjustment toward expenditure containment is critical, including in the areas of social security and local spending where there is room for improved efficiency.

Directors welcomed the progress made on structural reforms. They noted that the reduction in the labour tax wedge would boost enterprise competitiveness until the impact of deeper structural reforms gains ground. They commended the broad labour market reform of 2013 and its contribution to greater labour market flexibility while still protecting worker security, and encouraged the authorities to follow up on its implementation.

Directors underscored the importance of pursuing reforms on a broader front to improve competitiveness and growth prospects. They welcomed on-going efforts to simplify the regulatory framework and improve labour training mechanisms, and urged the authorities to reform pensions in a way that increases labour market participation rather than contribution rates. Directors called for deeper labour market reforms to increase employment of the young and low-skilled, and underscored the potential growth and employment gains from opening product and services markets to greater competition.

Directors welcomed the significant progress achieved in reducing financial vulnerabilities while preserving the capacity of banks to provide credit. Nonetheless, the combination of low bank profitability and weak growth prospects calls for continued vigilance. Directors also noted that the French financial system would need to adapt further to prudential requirements, notably in regard to bank funding structures, which continue to rely heavily on wholesale funding. To that end, Directors recommended that tax incentives on financial products be better aligned with regulatory objectives, including by removing tax disincentives against deposits and phasing out regulated interest rates.

Directors welcomed the efforts deployed by the authorities to keep the process of convergence toward the Single Supervisory Mechanism and Single Resolution Mechanism in the European Union (EU) on track. They commended the banking reform for aligning the resolution regime to the EU directive, in line with Financial Sector Assessment Programme recommendations, ring-fencing trading activities, and strengthening the macro-prudential framework.

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