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France: Staff Report for the 2003 Article IV Consultation

Author(s):
International Monetary Fund
Published Date:
October 2003
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I. Overview

1. The French economy has been no exception to the prolonged global slowdown and, despite tentative signs of a prospective upturn, the near and medium-term outlooks remain uncertain. The economy’s initial resilience to the downturn based on the strength of private consumption—supported by employment growth and fiscal easing—has been eroded as growth slowed progressively during 2002 and the economy flirted with recession through mid-2003. Investment underperformed and consumer confidence weakened when layoffs materialized and geopolitical uncertainties rose. With the latter uncertainties receding and the global outlook improving, an economic recovery is now expected in late 2003 but it is likely to be gradual and remains subject to downside risk. Over the medium term, population aging will reduce potential growth and associated expenditure increases will challenge fiscal sustainability. Low activity rates and an onerous tax and administrative burden remain fundamental structural weaknesses.

2. On the policy front, the resumption of fiscal consolidation was put on hold in 2003 owing to the weak state of the economy, but key structural issues began to be addressed. Expenditure slippages and the operation of automatic stabilizers have boosted the deficit to a level that has triggered a rise in the public debt-to-GDP ratio. On the other hand, the recent pension reform represents a milestone toward longer-term fiscal sustainability, and reform of the health care system—an important source of spending pressure—has been placed high on the agenda. In other structural areas, gradual progress is being made, in the labor market mostly by reversing some earlier detrimental measures, while divestiture and liberalization of network industries have advanced somewhat haltingly.

3. Over the past several years, implementation of Fund recommendations has been lacking not so much in intention as in pace and timing owing to political economy considerations and a strong social preference for publicly-provided services. The Fund has long stressed the need to strengthen public finances through pension, civil service, and health care reform, while reducing the heavy tax burden and raising low activity rates. Following considerable progress in the run-up to EMU, fiscal consolidation was reversed in 2000-03 owing to tax cuts—induced by a misjudgment on the strength of structural revenues during the cyclical upswing and electoral considerations—and, lately, to widespread expenditure overruns. Meanwhile, the advocated structural reforms remained largely on the drawing board, with the government favoring gradualism. More recently, however, the success of the pension reform, despite extensive social protest, is a decisive move in the opposite direction, buttressing the political will to reform but—the discussions suggested—not necessarily providing an impetus to accelerate its pace.

II. Policy Discussions

4. The discussions focused on how to foster a durable economic recovery while tackling long-standing threats to fiscal sustainability. To promote the recovery, the authorities favored a fiscal strategy consisting of tax cuts and a neutral underlying fiscal stance in 2003, shifting in 2004 to moderate underlying adjustment through expenditure restraint. Meanwhile, they were embarking on long-term oriented reforms to deal with the consequences of population aging. The staff pressed the need to resume fiscal consolidation as a necessary complement to such reforms; tackle health expenditure overruns; lift administrative interventions in financial markets; and provide impetus to product market and trade reforms.

A. Economic Performance and Near-Term Outlook

5. Economic recovery has remained elusive and the economy’s initial resilience has recently given way to a brush with recession (Figure 1 and Table 1). There was agreement that the downswing mostly reflected global developments, including the bursting of the equity bubble, that had led to a sharp decline in exports and a morose outlook for investment, reflecting also overinvestment by some large French firms during the boom. Consumer demand had held up well, bolstered by supportive policy conditions, including tax cuts and the operation of fiscal stabilizers, as well as initial labor boarding by enterprises. However, with geopolitical uncertainties rising at the beginning of 2003 and pressures mounting on firms to reduce employment, household savings—already on a secular rise owing to demographics—had increased further (Figure 2). As in the past, household consumption has continued to be well explained by developments in disposable income and the employment outlook (Figure 3), with only a marginal role for wealth effects, as equities represent only a small part of household financial wealth and mortgage refinancing to take advantage of higher house prices is limited.

Figure 1.GDP and Demand Components

Sources: 1NSEE, Quarterly National Accounts; and IMF, WEO.

1/ Contribution to GDP growth.

Figure 2.Household Savings and Unemployment Expectations

Source: INSEE.

Figure 3.Household Consumption and Disposable Income

Source: 1NSEE, National Accounts.

Table 1.France: Main Economic Indicators(Annual percentage change, unless otherwise indicated)
1999200020012002200320042005200620072008
Prej.Proj.Proj.Proj.Proj.Proj.Proj.
Demand and supply in constant prices1
Gross domestic product3.24.22.11.20.52.02.72.62.52.5
Private consumption3.52.92.81.51.21.82.62.42.32.3
Public consumption1.53.02.94.11.61.62.02.22.22.2
Gross fixed investment8.38.42.1-1.4-1.02.44.24.03.83.8
Business investment9.19.73.1-2.3-2.03.26.05.65.35.3
Residential investment7.23.40.80.81.01.11.21.21.21.2
Public investment7.010.7-0.2-1.0-0.11.11.31.31.21.2
Stockbuilding2-0.20.5-0.7-0.40.20.0-0.10.00.00.0
Total domestic demand3.74.52.01.11.11.82.72.72.62.6
Foreign balance2-0.4-0.20.10.1-0.60.10.1-0.10.00.0
Exports of goods and NFS4.213.41.81.3-1.65.27.56.26.46.4
Imports of goods and NFS6.215.31.40.80.45.07.66.76.76.8
Prices
GDP deflator0.40.71.71.91.61.61.61.61.61.6
Consumer prices (average)30.61.81.81.91.91.71.61.61.61.6
Consumer prices (end of period)41.41.71.42.22.0
Employment and wages
Employment2.02.6l.S0.70.00.41.10.90.70.7
Unemployment510.79.38.58.89.59.79.28.98.37.5
Productivity61.21.60.30.60.51.51.71.71.81.8
Unit labor costs (whole economy)1.20.82.82.32.11.51.61.51.31.3
Output in manufacturing4.36.73.1-0.10.34.04.54.04.04.0
Hourly labor compensation in manufacturing1.14.72.53.22.63.74.04.04.04.0
Unit labor costs in manufacturing-1.8-2.80.30.70.6-0.1-0.10.00.00.0
Personal sector
Real disposable income73.13.43.42.00.92.12.82.42.32.3
Savings ratio815.315.716.216.716.216.416.616.516.516.5
Output gap9-1.00.70.4-0.6-2.1-2.4-1.9-1.2-0.60.0
Rate of growth of potential output2.42.42.42.32.02.32.31.91.91.9
Balance of payments
Trade balance (billions of euros)16.5-3.63.910.15.56.78.58.58.67.7
(in percent of GDP)1.2-0.30.30.70.40.40.50.50.50.4
Current account (billions of euros)39.419.525.727.519.125.228.930.331.632.1
(in percent of GDP)2.91.41.71.81.21.61.71.71.71.7
Terms of trade0.1-2.71.01.5-0.10.40.40.30.20.1
Nominal effective exchange rate1095.892.793.093.896.6
Real effective exchange rate1092.389.088.289.091.4
Public sector accounts11
Revenue51.851.251.050.449.950.049.949.849.849.8
Expenditure53.652.652.653.554.053.652.651.750.950.1
General Government balance-1.8-1.4-1.6-3.2-4.0-3.5-2.7-1.9-1.0-0.2
Structural balance-1.1-1.8-1.8-2.8-2.7-2.1-1.5-1.1-0.6-0.2
Primary balance1.61.81.60.0-0.9-0.50.41.22.02.8
Gross debt58.557.156.858.961.362.963.062.561.159.0
Sources: Bank of France; data provided by the authorities; and Fund staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year's GDP.

Harmonized CPI.

For 2003, year on year in July.

In percent of labor force; harmonized index.

GDP over total employment.

Personal disposable income deflated by the implicit deflator for private consumption.

In percent of household disposable income.

In percent of potential GDP.

Indox; Base 1995=100. For 2003, data as of June.

In percent of GDP; Data for 2001-02 excludes the proceeds from the sale of UMTS licenses, which amounts to about 0.1 percent of GDP.

Sources: Bank of France; data provided by the authorities; and Fund staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year's GDP.

Harmonized CPI.

For 2003, year on year in July.

In percent of labor force; harmonized index.

GDP over total employment.

Personal disposable income deflated by the implicit deflator for private consumption.

In percent of household disposable income.

In percent of potential GDP.

Indox; Base 1995=100. For 2003, data as of June.

In percent of GDP; Data for 2001-02 excludes the proceeds from the sale of UMTS licenses, which amounts to about 0.1 percent of GDP.

6. Fixed investment has been weaker than could be expected from the state of its traditional driving forces. Indeed, the authorities noted, the decline in 2002—the first since 1996—was stronger than could be explained by changes in demand, profitability, and Tobin’s Q (Figure 4). It is likely that the fall in equity valuations exerted an exceptional drag on investment and worsened financing conditions, as evidenced by the initial sharp rise in risk premia for borrowing by large enterprises. There was consensus that, with the exception of some large corporate groups that had participated in debt-financed acquisitions abroad in the late 1990s, corporate accounts had held up quite well to the slowdown both compared to the previous downturn and internationally. Companies not belonging to large groups had lower indebtedness than in the early 1990s, lower interest rates made for easier debt service and, unlike in previous downturns, there had thus far not been any marked increase in bankruptcies or nonperforming loans. Nevertheless, the situation of some troubled large companies had heightened—in the authorities’ view excessively so—the focus on debt reduction and deleveraging, adversely affecting investment decisions of other companies through direct linkages and indirect confidence effects. This could explain why positive investment intentions had not translated into an equivalent rise in investment in early 2003. The information technology and communications cycle also contributed. The associated weakness in bank credit to enterprises was seen as mostly demand-driven.

Figure 4.Investment, Enterprise Margins and Tobin's Q

Source: Data provided by the authorities.

7. Employment expanded for longer than expected and unemployment rose by less than in the previous comparable downturn and in some other major industrial countries (Figure 5). The wage moderation of the 1990s has led to a higher labor content of each unit of output produced, a development that was accentuated by the ongoing structural shift in production from industry to services—with the latter typically exhibiting a lower capital-labor ratio (Figure 6). In these circumstances, output has to grow by less to keep unemployment from rising. Nonetheless, once output falls—as in the last quarter of 2002 and again more recently—employment losses would be larger, likely exacerbated by the currently higher share of temporary work. The step increase in the unemployment rate in late 2002 is consistent with this interpretation.

Figure 5.Unemployment Rates Normalized by Their Recent Trough

Source: Cronos Database.

Figure 6.Sectoral Employment

(1990=100)

Source: INSEE, Quarterly National Accounts.

8. At the time of the mission, the shared view was that a gradual recovery was likely to take hold in the second half of the year, though there was as yet little hard evidence of an upturn. It was noted that the repeated failure of projected recoveries to materialize—while weakening the credibility of forecasts—should not swing the pendulum toward excess pessimism. The impact of adverse shocks was waning, policies had been generally supportive, and a large correction in the investment rate had taken place. With external demand improving, investment would be rekindled, supporting employment and, in turn, private consumption. On the other hand, following euro appreciation, the foreign contribution would turn negative. There was, however, little actual sign of recovery as short-term indicators had failed to rebound following the end of the Iraqi war (Figures 7 and 8), and strikes against pension reform weighed on second quarter activity. While new official forecasts would not be released until the fall, the authorities accepted that GDP growth in 2003 could be in line with staffs projection of 0.8 percent at the time of the mission, but were somewhat more optimistic than the staffs projection of about 2 percent for 2004.

Figure 7.Business Indicators

(Dispersion Index)

Source: WEFA Database.

Figure 8.Consumer Indicators

(Dispersion Index)

Source: WEFA Database.

9. Developments since the mission point to weaker average growth for the year, but otherwise support the scenario of a gradual, mostly externally driven recovery, with downside risks. Strikes and a mild spring led to a decline in activity and energy production in the second quarter, while the expected associated technical rebound in the third quarter is likely to be mitigated by a drought which is adversely impacting agriculture and by labor action affecting tourism. Consequently, staff now projects real GDP to grow by only 0.5 percent in 2003. On the other hand, the recovery in the U.S. and Asia, the improvement in equity markets, relatively strong household balance-sheets, and the stabilization of the euro are reassuring factors. The euro’s appreciation was seen as a move toward equilibrium (Figure 9), which had not compromised competitiveness unduly, though it would dampen tourism revenues somewhat and add to the risk of weaker-than-expected intra euro-area demand. The loss of competitiveness visà-vis Germany was seen to be in line with the relative performance of the two economies and would contribute to a decline in the foreign balance. In this context, the authorities expressed concern that further weakness in Germany could jeopardize the expected recovery. Domestically, the household savings rate could increase further if the employment outlook remained gloomy, or in reaction to pension reform that could be perceived as wealth-reducing by the current generation, while investment could remain weak if corporate balance sheet adjustment continued to be judged incomplete.

Figure 9.Real Effective Exchange Rate

(RNULC Based)

Source: IMF, IFS.

10. The persistent rise in core inflation ended in 2002 and the price outlook was judged to be benign. Energy and food prices, along with increases in tobacco excises, had buffeted headline inflation, while underlying inflation had been boosted by increases in health care fees and other service prices (Figure 10). The latter stemmed partly from small service-sector enterprises passing on higher hourly labor costs as a result of the workweek reduction. However, with slack in the economy increasing, wage growth slowed down, contributing, together with euro appreciation, to a decline in underlying inflation. These factors are expected to continue to exert downward pressure on inflation, but the sizeable hike in the minimum wage (SMIC) in July 2003—the first of three annual installments in the process of aligning multiple minimum wages1—and possible further health care fee increases will have the opposite effect. All in all, the staff projects annual inflation to average 1.8 percent in 2003-04. There was agreement that there were no indications that deflation is a risk in France at this point.

Figure 10.Inflation Components

(Annual Growth Rates)

Source: Cronos Database.

11. Against this background, monetary policy would need to take the lead role in supporting the recovery, in part by making it more effective through the removal of administrative controls. With the appreciation of the euro and the ECB's interest rate cuts broadly offsetting each other, monetary conditions were seen to remain supportive (Figure 11). There was agreement that monetary policy remained the prime tool to address area-wide conditions. The authorities were sympathetic to the staffs euro-area advice favoring an accommodative bent for monetary policy. Staff noted, however, that various national controls (most particularly the prominent role of administered interest rates—unchanged since mid-2000) were acting to dampen the effects of ECB monetary easing in France. Staff pressed that, as a first step, administered interest rates be urgently brought down and kept in line with market rates and that other impediments to the efficient functioning of credit markets be removed (¶ 29). The authorities concurred on the first point and, effective August 1, lowered administered savings rates and announced a new formula for future adjustments.

Figure 11.Monetary Conditions

Source: Dalastream-Thomson Financial; and IMF, IFS

12. The authorities were attentive to the possible adverse short-run effects of underlying fiscal adjustment on growth. They accordingly intended to keep the fiscal stance broadly neutral in the near term and resume consolidation as the recovery got under way in 2004, while allowing automatic fiscal stabilizers to provide support. Already planned cuts in social security contributions (designed to offset some of the labor cost increase due to the SMIC realignment) would provide further stimulus. With long-term fiscal sustainability in question from population aging and doubts about expenditure control, the staff felt that an immediate resumption of fiscal consolidation could have positive short-run effects through its confidence-enhancing aspects. In particular, it would establish the credibility of recent tax cuts, thus inducing households to spend rather than save more of the associated increase in disposable income. The demand effects of fiscal consolidation would also depend on its composition. Staff welcomed the recent pension reform as an important step in strengthening the long-term fiscal outlook but noted that it would not in itself suffice to secure fiscal sustainability.

B. Fiscal Consolidation Strategy

13. Expenditure pressures, modest tax cuts, and cyclical weakness are set to push the deficit further above the SGP ceiling in 2003, well in excess of initial plans (Table 2 and Figure 12). Owing to overruns on health care, increases in unemployment compensation, and the catch-up of previously underfunded spending programs, overall real expenditure rose by 3 ¼ percent in 2002, contributing to a doubling of the general government deficit (to 3.2 percent of GDP, excluding the proceeds from sales of UMTS licenses). In 2003, overruns in social security spending are continuing and revenue performance is expected to flag further in relation to GDP. To contain slippage, the authorities implemented some expenditure freezes that were intended to limit the deficit officially to 3.4 percent of GDP, but they recently announced that cyclical weakness would push the deficit to 4 percent of GDP and the public-debt-to-GDP ratio above 60 percent, in line with staff projections (Figure 13).

Table 2.France: General Government Accounts, 1995–20021(In billions of euro)
19951996199719981999200020012002
General Government
Revenue587.4623.1649.7668.4701.9728.0753.3766.9
Tax revenue515.9542.5562.8584.9616.1638.4658.9667.6
of which:
VAT85.792.496.399.2102.6104.5106.2108.0
Income tax42.643.340.241.846.349.848.745.6
Corporate tax19.221.826.328.734.437.744.339.5
TIPP21.822.622.823.524.724.323.624.3
Non-tax revenue71.480.686.983.585.889.694.499.3
Expenditures652.4672.5687.7703.2725.8748.0775.8814.4
of which:
Salaries161.9168.5172.7178.9185.6191.7199.2
Pensions117.0121.2125.1129.3134.2137.8144.6
Health expenditure62.665.566.369.270.576.781.2
Other social transfers218.6225.5235.2240.3248.0252.8264.1
Balance-65.1-49.4-38.0-34.9-23.9-20.0-23.8-48.2
Primary balance-20.7-1.78.311.921.125.723.70.2
Structural balance-45.1-24.0-13.0-21.8-15.6-24.9-26.1-42.5
Central government balance-48.8-45.1-44.7-39.0-35.3-34.8-34.4-57.5
Social security balance-8.0-5.3-5.4-1.43.77.24.0-4.4
Local government balance-2.10.72.94.04.32.82.13.3
ODAC balance-6.20.39.21.53.44.85.711.0
Gross debt645.3691.8741.6777.3792.1812.1838.7896.6
Interest payments44.347.746.346.845.045.747.548.4
Memorandum items
Nominal GDP21181.81212.21251.21305.91355.11420.11475.61520.8
Structural nominal GDP1216.41253.71290.61329.31367.61411.31469.61531.3
Source: INSEE and IMF staff calculations.

Excludes UMTS receipts.

Annual national accounts; Maastricht definition.

Source: INSEE and IMF staff calculations.

Excludes UMTS receipts.

Annual national accounts; Maastricht definition.

Figure 12.General Government Balance

(Percent of GDP)

Sources: Authorities and Fund staff estimates.

Figure 13.General Government Debt

(Percent of GDP)

Source: INSEE.

14. The level of the underlying deficit and the extent of its deterioration were subject to debate, but there was full agreement that the pension reform represented a notable improvement in the long-term structural fiscal position. The authorities felt that the staff underestimated potential output and growth somewhat, leading to an exaggeration of the structural deficit. They noted that specific features of the French tax system, in particular the absence of withholding for personal income taxes and lags in corporate taxation, induced an overestimation of the structural deterioration during downturns—while the opposite held during upswings. Also, as acknowledged by staff, pension reform had improved long-term fiscal sustainability considerably, but this was not reflected in current measures of the structural deficit. Nonetheless, even though potential growth had risen in the second half of the 1990s to about 2¼ percent per year, owing to increases in employment rates and capital accumulation that more than compensated for a decline in total factor productivity growth (see Selected Issues Paper), there was agreement that the impending demographic shock would reduce potential growth appreciably.2 While there was ample scope for policies to raise employment rates to offset some of this decline, it was also important to resume fiscal consolidation.

15. The authorities felt that a moderate pace of consolidation, starting in 2004, would strike the right balance between the short-term concern of unduly weighing on the recovery and the long-run need of securing fiscal sustainability. Although final plans were still being elaborated, the authorities stated that these would aim for an underlying adjustment in the order of ½ of one percentage point of GDP per year as from 2004, as per the Stability Program presented at end-2002. For 2004, central government spending would be kept constant in real terms (versus real growth of 0.3 percent in the Stability Program), and social spending growth would be curbed significantly from current rates, for which specific measures would be needed in the 2004 budget, especially for health care. There was agreement that already planned modest tax cuts should go forward but, in the absence of credible and tangible expenditure reduction measures, staff saw no room for additional tax relief. The authorities concurred that any such room was limited, although the political intent to grant some further tax relief has gained momentum. At the time of the mission, the authorities had not translated the implications of this approach into a nominal deficit target, while officially posting the intention of reducing the deficit to below the 3 percent SGP ceiling in 2004.3 Staff saw this as a remote prospect, and projects a deficit of 3½ percent of GDP.

16. Staff stressed the importance of ongoing and durable adjustment. Indeed, while the current pension reform addresses a significant fraction of the adverse fiscal consequences of the demographic shock, further consolidation is equally necessary to secure fiscal sustainability (¶ 18 and Box 1). Achieving a small structural surplus within the next five years and maintaining it for a substantial period would be a prudent strategy to deal with the remaining cost of aging and the uncertainty surrounding long-term growth projections. This was all the more relevant as, in the context of the liberalization of the main network industries, the state could incur additional pension liabilities worth several percentage points of GDP. The authorities responded that they intended to pursue gradual fiscal consolidation beyond 2004 toward a medium-term objective of achieving structural balance. In recognizing the need for rules-based fiscal discipline in EMU, they felt that their intended approach was consistent with the move to greater emphasis on structural balances in the application of the SGP, and noted the importance of giving adequate weight to both the growth and stability aspects of the Pact.

Box 1.France: Fiscal Sustainability and Pension Reform

The current structural fiscal deficit and the prospective higher budgetary outlays stemming from population aging threaten fiscal sustainability. Prior to the recent pension reform and taking into account the recent ongoing increase in health care spending, budgetary outlays on pensions and health care due to aging were set to rise by about 6.2 percentage points of GDP between 2002 and 2040 (of which somewhat more than 4 percentage points due to pensions) and remain stable at this higher level thereafter. In the absence of any improvement in the underlying fiscal balance from its 2003 level, the general government public debt-to-GDP ratio was on an explosive trajectory, under any set of realistic macroeconomic assumptions (figure-No Policy Reform).1

The recently enacted pension reform, together with the achievement of a small structural surplus after 2008, and a reduction in the NAIRU to 4.5 by 2010 would address the fiscal shock of aging. Reaching structural balance by 2008, consistent with the SGP, and subsequently maintaining it except for the impact of the spending increases due to aging requires an adjustment of somewhat more than 2½ percentage points of GDP. This would still leave the debt-to-GDP ratio on an explosive trajectory (Structural Balance 2008). The recently enacted pension reform (without feedback effects and assuming a NAIRU of 7) dramatically improves debt dynamics, but is unable to stabilize it (+Reform). Thus it is crucial that labor market policies deliver a rapid decline in the NAIRU, allowing resources devoted to unemployment compensation to be reallocated to pension spending (+NAIRU4.5). Nonetheless, even when feedback effects on participation—projected to raise the activity rate of the cohort of 55-64 years by 7 percentage points by 2020—are taken into account (+NAIRU4.5 feedback) the debt-to-GDP ratio is not fully stabilized. To attain this objective, further changes to the pension or health care regime or a further structural adjustment (of ¼ of one percentage points of GDP in 2009) would be needed.

Public Debt (In Percent of GDP)

Key uncertainties involve the long-term GDP growth rate, the pace of fiscal consolidation and reduction of the NAIRU, and the possible realization of contingent liabilities from public enterprises. Lower long-term GDP growth by Vi of one percentage point would require an additional permanent structural adjustment of 1 percentage point of GDP from 2009 onward. Postponing fiscal consolidation or increasing the public debt-to-GDP ratio due to the realization of contingent liabilities would require more adjustment to cover the related additional interest expenditure. A 10-year delay in reducing the NAIRU to 4.5 would require additional fiscal adjustment of ¼ of one percentage point of GDP.

1 This scenario is based on: (1) the Summer 2003 WEO projections through 2008, followed by average annual GDP growth of 1.9 percent over 2009-2050; and (2) a gradual decline in the real interest rate from the current implicit rate of 3.8 percent to 3 percent.

17. With the adjustment strategy crucially relying on keeping real spending growth below potential output growth, a robust expenditure control framework was recognized to be essential. The authorities acknowledged that instruments employed to date to control spending—such as the multiyear norms set out in Stability Programs (Table 3) and the health care spending limit (ONDAM)—had been ineffective, primarily because of the absence of a mechanism to correct overruns and the lack of accountability, particularly for the ONDAM. In response, new initiatives had been undertaken, notably in-depth reviews of ministerial spending priorities and the ongoing application of the new law on budgetary procedures. They conceded that these initiatives were focused on the central government and that establishing expenditure control in other areas would be essential and would require agreement among social partners. Furthermore, the preparatory document for the 2004 budget contained a comprehensive review of possible medium-term fiscal rules, drawing also on other countries' experiences, e.g., Netherlands, Canada, and United Kingdom. They noted with interest staff suggestions to (a) set multi-year limits on the nominal or real level of expenditure; (b) base budgets on conservative economic projections (though they saw difficulties in the staff proposal of using growth projections somewhat below potential growth); and (c) establish clear rules devoting positive budget windfalls to debt reduction. The absence of such rules accounted for the lack of adjustment during the latest upswing, and staff advised strongly against the stated, procyclical intention of stepping up tax cuts in the event of higher-than-expected growth.

Table 3.France: General Government Real Expenditure Growth(Percent per year)
2000200120022003200420052006Cumulative

difference

Actual-SP
Actual/Staff Estimate 20031.42.03.21.5
SP 19981.21.21.33.1
SP 19991.31.31.32.8
SP 20001.51.51.5
SP 20011.31.31.3
SP 20021.21.41.4
Source: Authorities and Fund staff calculations.
Source: Authorities and Fund staff calculations.

18. The recently enacted pension reform will make a key contribution toward fiscal sustainability as it lowers the expected increase in budgetary outlays appreciably. The reform is expected to remove two-fifths of the increase in pension costs of aging directly (generating savings of slightly less than 2 percentage points of GDP per year in steady state), mainly through the alignment of the contribution period for civil servants with that of the private sector and a further lengthening of the contribution period in line with life expectancy for all.4 Another one-fifth of the cost increases is projected to be absorbed by a shift from unemployment to pension contributions as the unemployment rate is projected to fall to 4½ percent by 2010—a prospect which the authorities acknowledged to be uncertain and whose realization would require a strengthened focus of labor market policies on raising employment rates. In addition, since the choice between working and retiring was being made actuarially fairer, early retirement was no longer being encouraged, and the effective retirement age was likely to increase, although this effect would likely be small. Nonetheless, staff simulations suggested that these reforms—even if be accompanied by the achievement of structural balance by 2008—are unlikely to stabilize the debt-to-GDP ratio in the very long run, though such calculations are sensitive to small changes in underlying assumptions (Box 1).5 Further changes to the parameters of the system would thus be necessary and the authorities underscored that the anticipated five-yearly reviews would serve to correct the pension regime as needed to secure its fiscal sustainability.

19. The authorities acknowledged that containing health care spending growth would be a key challenge. Sharply rising health expenditures were responsible for an appreciable part of budget overruns, despite measures to rein in overconsumption of drugs (Figure 14). With pension reform in full debate in mid-2003, the authorities had been loath to use the new tool of a corrective social security budget, also because it would likely have entailed recourse to the facile “solution” of an increase in the general social contribution (CSG). The authorities intended resisting such an increase, while working toward broader health care reform over the coming year. Staff supported these intentions but noted the need for early and continuous steps to curb spending growth (e.g., effective increases in co-payments, the establishment of a referral system, and a clamp-down on abuses of long-term sick leave), especially since population aging was already expected to add about 2 percentage points of GDP to health care outlays by 2040. The authorities agreed that the 2004 consolidation objective would require concrete savings measures already in this fall's social security budget, though specific proposals remained to be defined.

Figure 14.Public Health Care Spending

Source: INSEE.

20. Civil service reform was also seen as key to medium-term fiscal consolidation and efficiency. France's broad public sector employs nearly one-quarter of the labor force6 and the wage bill of the general government amounted to 13.7 percent of GDP in 2002, well above the euro-area average. With a large fraction of civil servants scheduled to retire within the next decade, natural attrition is seen as an opportunity to achieve efficiency gains. Several ministries are adopting plans to only partially replace departing staff by making judicious use of information technology, focusing on core tasks, and outsourcing non-essential services. Specific figures on the associated budgetary savings were not available, however, and retrenchment was likely to run into union opposition. Staff pressed for meaningful progress in this area, well beyond the modest steps initiated in 2003.

21. The authorities viewed decentralization as crucial to increase government efficiency and generate additional savings. They noted that decentralization would allow public services to be better tailored to local preferences, reduce the cost of their delivery, and increase their quality. In March 2003, a constitutional amendment defined the framework for devolution of responsibilities and resources to subnational governments, and specific further steps would be forthcoming (e.g., in education and transportation). To finance devolution, the proceeds of the excise tax on petroleum products (TIPP) would be shared with subnational governments, who would be allowed to set their own tax rate within a band of a few percentage points. The authorities acknowledged that providing the right incentives for efficiency gains and maintaining fiscal discipline would be a challenge. They did not share the staffs concern that the TIPP arrangement might not suffice to establish effective local fiscal autonomy as it would de facto permit only small variations in tax rates across regions.

22. While it was agreed that a reduction in the tax burden—if earned through expenditure restraint—was essential and would benefit growth, staff saw merit in a revenue-neutral modification of the tax system in the interim to alleviate distortions. A reduction in taxes that fall solely on labor financed by increased revenue from broader-based taxes such as the VAT and the general social contribution (CSG), and environmental taxes, would help reduce labor costs and strengthen work incentives (Box 2). Noting that reduced VAT rates are not a cost-effective way to achieve social objectives, as in absolute terms they benefit the wealthy more than the poor, the staff advised against intended steps in this area (e.g., for restaurant services) and recommended raising existing reduced rates toward the normal rate to improve the buoyancy and neutrality of the VAT. It also argued in favor of eliminating some unusual local taxes that were costly to collect and applying instead local surcharges to national taxes. The authorities felt that the net economic gains of such a strategy would be limited and that any such reforms would best take place in the context of a reduction in the tax burden. Still, they felt that there was scope to remove some anomalies and continue to reduce collection costs through administrative reform.

C. Labor and Product Markets

23. With social objectives traditionally pervading labor market policies, incentives for labor market participation and job search had been distorted, but ongoing initiatives attempted to sustain the recent increase in employment rates. Unemployment insurance, non-work related income support, high marginal tax rates, and the workweek reduction have depressed labor supply, while high minimum wages have lowered demand. In response, the unemployment regime had been modified in 2002 to promote active job search, supported by higher resources for the public employment agency. Although strengthened controls had increased administrative removals from benefit rolls and raised the exit rate from the unemployment insurance system, in a weak economy these represented mainly exits from the labor force rather than new-found employment. The staff, while supporting the emphasis on job search, suggested that consideration also be given to reinstating the phasing-out of unemployment benefits and establishing experience-rating for employers.7 While the former remained in the domain of the social partners and had been ruled out at this stage, the latter was considered with some interest, though the authorities noted significant employer resistance. With respect to income support programs, the authorities agreed that the basic income support scheme (the revenu minimum d ‘insertion, RMI) had largely failed in its stated aim of returning destitute individuals to the labor force, despite a reduction in replacement rates. They now aimed to promote the return to activity by supporting the demand side: employers who hire people that have been on protracted income support would receive the basic income support as a subsidy for a given period of time. Finally, high marginal tax rates were being reduced, including through the increase in the earned income tax credit (PPE) and, in order to promote participation of older workers, early retirement was being discouraged and a continuing education initiative was being developed.

Box 2.France: Tax Policy and Economic Efficiency 1

France's tax system is characterized by high effective tax burdens, dominant social security contributions, a complex income tax system, atypical local taxes, and a high administrative burden. In 2001, tax revenues were the fifth highest in the OECD. Effective taxes on labor and corporate income are comparatively high. Social security contributions generate about half of revenues and income taxes are fairly progressive. Local authorities levy two antiquated taxes with low yields. Several administrations manage the tax system, burdening taxpayers and the budget.

Effective Tax Rates (2000)
LaborCapitalConsumptionTax Wedge on LaborCorporate Rate (1999)*
France41.821.823.955.733.2
Euro Area38.520.021.251.5n.a.
EU36.223.020.949.520.2
United States23.922.99.130.8n.a.
Sources: Martinez-Mongay, European Commission.

Marginal.

Sources: Martinez-Mongay, European Commission.

Marginal.

High labor taxation and high marginal effective tax rates increase labor costs and create disincentives that may reduce output. Consequently, policies to reduce labor taxes and improve the neutrality of taxation, even without reducing the average tax burden, could yield growth dividends. The QUEST model of the EU, for example, shows that a shift of 1 percentage point of revenue from labor taxes to consumption taxes could increase the level of GDP by 0.4-0.7 percentage points after 10 years.

Thus a possible avenue for reform in France would consist of altering the overall tax structure to remove distortions. Specifically, this would entail reducing social security contributions while increasing revenues from broader-based taxes such as the VAT or the CSG. Other beneficial reforms would include: (i) selectively reducing taxation on low and high-income earners; (ii) improving VAT efficiency by increasing reduced rates; (iii) lowering corporate taxes; (iv) eliminating low yielding and costly taxes; and (v) increasing administrative efficiency. Against this background, the increase in the earned income tax credit, the phasing out of a surcharge on corporate income taxes, the removal of the payroll element from the local business tax base, and ongoing targeted reductions in social security contributions are likely to be beneficial. In contrast, possible additional across-the-board reductions in personal income taxes, and the proposed lowering of the VAT rate on restaurants, are unlikely to be helpful.

1See Selected Issues Paper for details.

24. The staff observed that labor market policies implemented to offset other policy-induced increases in labor costs appeared effective in raising employment but were costly to the budget (Box 3). For example, alleviating the impact of the SMIC realignment that resulted from the introduction of the 35-hour workweek is likely to absorb most of the available room for tax cuts for some years. The PPE—which the staff sees as a useful tool—avoids labor cost increases while redistributing income and enhancing work incentives, though not without budgetary implications. The various targeted cuts in social security contributions needed to price labor back into the market given the high minimum wage and income support also weigh on the public purse.

25. In response, the authorities observed that the tenet of labor market policies had now decisively shifted toward tempering the rise in labor costs and promoting private sector employment. To stem increases in labor costs without adverse budgetary consequences, workweek reduction requirements for smaller enterprises had been eased and some employment protection provisions introduced by the previous government suspended. In the past, policies had included substantial job creation in the public and non-profit sectors, but the phasing out of these schemes was now being accelerated. The uptake of the new youth employment program (jeunes en entreprise), in which young newcomers to the job market with little education get unlimited duration contracts in exchange for temporary cuts in employers' social security contributions, was stronger than expected. Though some additional resources had been devoted to rekindling non-private sector-oriented programs, the authorities stressed that this effort was limited in size and would not overturn the declining trend, which would be pursued.

Box 3.France: Do Active Labor Market Policies Increase Employment?

Active labor market policies (ALMPs)—training, subsidies to job creation, public employment services and other expenditures to promote employment—affect employment in many ways. They may enhance vacancies/job matching, increase productivity, keep idled workers attached to the labor force and reduce labor costs. However, they may dampen productivity growth, create windfall benefits for non-target groups, and boost wage demands as they lower the opportunity cost of being unemployed. France spent more on ALMPs than virtually any other industrial country since the early 1990s and, in a relative sense, raised resources devoted to direct job subsidies dramatically, mainly in the form of reduced social security contributions (figure).

Using panel data techniques applied to a large sample of OECD countries during 1985-2000, the staff finds a strong and robust positive impact of spending on ALMPs (ALMP/GDP) on business employment rates in the 1990s but not in the 1980s (see Selected Issues Paper). Specifically, a one percentage point increase in ALMP/GDP would boost employment rates by about 1.9 percentage points. The wage moderation associated with ALMPs in the 1990s is a likely explanatory factor, while the absence of any effect in the 1980s is most likely due to the low spending on ALMPs. These results hold when controlling for other policy, institutional and economic variables. The overall positive effect in the 1990s masks the fact that direct subsidies to private sector jobs had a large positive effect on business employment rates while spending on training and public employment services were either ineffective or had negative effects. The increase in spending on ALMPs is estimated to have raised the net business employment rate in France by close to one percentage point between 1990 and 2000, though it should be noted that it remains 7 percentage points below the average of the other 14 countries in the sample (55 percent).

Ratio of expenditures on ALMP to GDP in France relative to other 14 industrial countries

Source: OECD and staff calculations.

These results should, however, not be interpreted as implying that ALMPs are an effective treatment for low employment rates in a general equilibrium sense. Increases in ALMP spending in some European countries could be seen as a response to counteract the deleterious effects of rigid labor market institutions or, in France, of high minimum wages. Thus, similar or even stronger employment effects could be attained by changing labor market institutions to improve work incentives and lower labor costs. Finally, while the fiscal costs of increased recourse to ALMPs would be mitigated by larger tax revenues and lower inactivity-related expenditures, it is by no means established that ALMPs pay for themselves.

26. Product market functioning was being improved gradually through a variety of initiatives. The regulatory and administrative burden was being eased in several areas and, following some recent high-profile cases, the need to modernize bankruptcy legislation has moved up on the agenda. Divestiture was being promoted (e.g., sale of Renault, plans for Air France) though its pace would depend on equity market developments, while obstacles to such progress in network industries (namely, unviable company pension regimes) were being addressed. A new agency had been set up to strengthen governance of state participations. The staff pressed for full divestiture of commercial involvement; conversely, episodes in the opposite direction (e.g., interventions in France Telecom and Alstom), as well as the use of divestiture proceeds to recapitalize other state-owned enterprises, needed to be strictly circumscribed.

D. Financial Sector

27. Financial sector performance has been favorable compared to previous economic downturns and relative to a number of other countries. As the financial health of the household and corporate sectors—with the exception of some large groups—generally remains good, nonperforming loans have not increased significantly, helping to maintain profitability and solvency in the banking sector (Table 4). The insurance sector has suffered from the decline in equity prices, although limited guaranteed returns in life insurance and conservative asset-liability management have mitigated the impact. Profitability has been negatively affected by higher reinsurance costs and low interest rates, but an ongoing repricing of premiums is improving results and reducing dependence on investment returns. There was agreement that, in a scenario of gradual economic recovery, the risks to the financial sector would remain manageable. Finally, although the merger of Credit Agricole and Credit Lyonnais has entailed a significant step-increase in concentration, available indicators suggest that banking market conditions remain highly competitive.

Table 4.France: Vulnerability Indicators(In percent of GDP)
19992000200120022003
Prel.Latest estimateDate
External Indicators
Exports (annual percentage change, in U.S. dollars)-1.4-1.4-1.55.5
Imports (annual percentage change, in U.S. dollars)0.23.0-1.72.8
Terms of trade (annual percentage change)0.1-2.71.01.5
Current account balance2.91.41.71.8
Capital and financial account balance-2.4-2.2-2.4-3.4
Of which: Inward portfolio investment (debt securities etc.)8.110.27.74.2
Inward foreign direct investment3.23.34.03.5
Other investment liabilities (net)5.24.22.71.9
Total reserves minus gold (in billions of U.S. dollars, end-of-period)39.737.031.728.429.5June
Euros per U.S. dollar (period average)0.9391.0851.1181.0630.903July
Market Indicators
Financial Markets
Public sector debt (Maastricht definition)58.557.256.859.0
3-month T-bill yield3.04.93.32.92.2June
3-month T-bill yield (real)1.73.11.90.80.2June
Spread of 3-month T-bill with the U.S. (percentage points, end-of-period)-2.2-0.91.61.71.2June
5- to 8-year government bond5.35.15.14.43.8June
Spread of 10-year bond with the U.S. (percentage points, end-of-period)-0.9-0.10.00.40.4June
Yield curve (10 year - 3 month)2.30.31.71.51.6June
Stock market index (end-of-period)321.1319.4249.2165.1178.4August
Real estate prices (index, 1997= 100, period average)113.2124.6132.6144.8158.0June
Credit markets (end-of-period growth rates)
Credit to the private sector6.49.66.03.93.6July
Bank credit to households7.86.85.86.97.0July
Mortgages8.27.16.36.98.8July
Bank credit to nonfinancial enterprises6.411.93.63.10.0July
Sectoral risk indicators
Household sector
Household savings ratio15.315.716.216.7
Household financial savings ratio6.77.37.27.9
Real estate household solvency ratio (index, 1992=100)1162.6153.7150.4152.7146.5June
Corporate sector
Profitability of business sector40.039.939.939.5
Investment ratio17.518.418.317.4
Savings ratio17.816.516.416.0
Self-financing ratio93.982.082.083.9
Banking sector
Share of mortgage credit in bank credit to the private sector30.329.229.430.831.1July
Share of non-performing loans in total loans5.75.05.05.0
Ratio of provisions to non-performing loans260.760.859.958.3
Ratio of non-performing loans net of provisions to capital14.112.812.512.6
Liquid assets to total short-term liabilities147.9138.5152.5157.0
Return on assets0.60.70.70.6
Return on equity12.813.313.211.7
Regulatory capital to risk-weighted assets12.712.212.312.3
Sources: Banque de France; IMF, International Financial Statistics; Bloomberg; FNAIM; Commission Bancaire.

This index combines the effect of real disposable income, repayment conditions for loans, real estate prices, and public incentives for the purchase of houses.

Refers to metropolitan France.

Sources: Banque de France; IMF, International Financial Statistics; Bloomberg; FNAIM; Commission Bancaire.

This index combines the effect of real disposable income, repayment conditions for loans, real estate prices, and public incentives for the purchase of houses.

Refers to metropolitan France.

28. In response to increased risks stemming from protracted economic weakness, financial sector supervision is being strengthened. First, supervisory authorities have stepped up their vigilance: banking supervisors are closely monitoring the quality of loan portfolios and banks’ risk management policies, while the insurance supervision agency has worked to improve provisioning requirements. Second, a new law on financial security, approved in August, simplifies the supervisory landscape and increases consumer protection. The law creates a Financial Markets Authority by merging three agencies previously responsible for securities market supervision and regulation. It establishes an autonomous insurance supervisor that integrates the agencies in charge of commercial and mutual insurers. Finally, the law specifies the responsibility for banking system competition policy, assigning it to the Ministry of Finance. The authorities have requested participation in the Financial Sector Assessment Program (FSAP) which is envisaged to take place in 2004.

29. The need to reduce administrative intervention in the financial sector was broadly acknowledged. Administrative controls on savings, deposit and payment instruments, and on lending rates, have become more distortive and burdensome as market interest rates have fallen (Box 4). Staff maintained that the misalignment of interest rates was adversely affecting the profitability of the banking system and the transmission of monetary policy. It needed to be corrected, and a transparent and simple mechanism put in place to prevent future misalignments, as an interim step toward abolishing controls. The authorities concurred on the need for a realignment, reducing the rate on the benchmark savings account (livret A) from 3 percent to 2¼ percent, effective August 1, and setting a new adjustment formula.8 However, the new rate is still appreciably above comparable rates in other euro area countries and will furthermore remain frozen until August 2004, when the new rate-setting system will enter into force. In advocating the lifting of all controls, the staff also noted that the provision of social housing finance—the main institutional purpose of the administered savings system—could be achieved more efficiently with other mechanisms (e.g., through the budget). In other areas, the legal requirement to provide checks free of charge had led to overuse of this cumbersome payment instrument, imposing a collective cost. Staff also saw merit in relaxing or abolishing the usury rate for lending to individuals and company overdrafts, thereby opening access to credit to a significant fraction of admittedly higher-risk economic agents. Having recently removed the usury rate for most business lending from the penal code, the authorities doubted the feasibility of further steps in this area. Finally, they noted with interest staff suggestions to review government-imposed fees that hindered mortgage refinancing.

E. Other Issues

30. The framework for corporate governance, auditing, and accounting standards was being strengthened. In these areas, France had initiated and actively supported domestic, European, and international initiatives. A supervisory body for auditors had been created, the independence of auditors reinforced, and transparency in the relations between enterprises and shareholders enhanced. Internationally, the authorities would like to see the EU adopt a stronger regulatory framework and favor greater harmonization of regulations.

31. France has a comprehensive anti-money laundering framework and continues to strengthen efforts to combat money laundering and terrorist financing, remaining proactively involved in these efforts at the European and international levels. The OECD has judged France's legal framework as conforming to the anti-bribery convention's requirements.

Box 4.France: Administrative Intervention in Financial Markets

Administrative interventions in the French financial system broadly cover three areas: administered savings, the “ni-ni” requirement, and the usury law. Administered savings comprise a range of bank savings products designed by the government and offering government-imposed interest rates and/or other conditions. A significant share of the deposits collected with these products is centralized in a government-controlled fund that is used in part to finance social housing projects. The “ni-ni” requirement prohibits the remuneration of demand deposits and requires banks to provide checking services free of charge to their clients. Finally, the usury law—despite its recent relaxation—still prohibits lending to individuals at rates above four-thirds of the average rate observed in a given loan category.

These interventions have a substantial impact on the functioning of the financial system and fail to achieve their policy objectives efficiently. Administered savings amount to half of France's resident bank deposits, and the “ni-ni” requirement affects a further 35 percent. One-fifth of bank deposits is centralized in a publicly managed fund, overuse of “free” checks is a costly phenomenon, and the usury law inhibits sub-prime lending. Administered interest rates that deviate from market rates introduce unnecessary volatility in banks’ profitability (with a bias on the downside) and resources, and hamper the transmission of monetary policy. The centralization of deposits to finance social housing entails liquidity and interest rate risks that can only partially be addressed by investing most of the centralized funds in financial markets.

Savings Deposit Interest Rates

Source: IMF, IFS.

32. The authorities expressed support for multilateral trade liberalization, with adequate safeguards, and considered the recent EU agreement on reform of the Common Agricultural Policy a breakthrough. In response to staff questions, they argued that France's position on preferential trade arrangements for African countries was consistent with its support for overall liberalization, mainly because unconditional trade liberalization would worsen the terms of trade of a number of developing countries that lacked the means to compete. In this respect, they regretted that President Chirac's initiative for African agriculture had not received wider support. With respect to the CAP, the authorities agreed that France was a net beneficiary whose position would erode with EU enlargement. They stressed that the recent agreement on CAP reform improved the chances of progress at the Canciin meeting. Staff concurred, but, noting that many distortions remained, urged more ambitious steps and expressed the hope that these developments would lead to less use of agricultural subsidies and trade measures to achieve social and environmental objectives.

33. The authorities noted that the gradual increase in official development assistance (ODA) would continue, with the aim of reaching 0.5 percent of GNP in 2007 and the U.N. target of 0.7 percent of GNP in 2012. In 2002, ODA had amounted to 0.36 percent of GNP—the highest among G-7 countries—and was concentrated on the poorest countries in Africa.

III. Staff Appraisal

34. Amidst weakening performance, the authorities have succeeded in appreciably strengthening the long-run fiscal outlook, but expenditure control remains elusive and further reforms are needed to secure sustained robust growth. The recent pension reform has made major inroads in tackling long-run fiscal sustainability, but fiscal adjustment was further postponed in 2003. A welcome shift toward a resumption of fiscal consolidation has been announced and it will be critical to deliver on this front through durable expenditure restraint. Civil service and health care reforms provide substantive scope for the latter, but a strengthening of the expenditure control framework is needed to secure lasting success, while broad structural reforms are required to raise potential growth.

35. There are tentative signs of a prospective economic recovery, but it is likely to be gradual and subject to downside risks. With external demand recovering, policy conditions supportive, the impact of adverse shocks waning, and balance sheets of households, corporations, and financial institutions holding up relatively well, the stage appears set for a resumption of growth—a scenario that is now being validated by some improvement in forward-looking indicators. Nonetheless, growth is likely to remain below potential for some time, and several downside risks persist. Core inflation is projected to decline, without indications that deflation is currently a risk.

36. Against this background, macroeconomic policies will need to continue to do their part to support the economy. Monetary policy remains the primary tool to address euro-area wide developments, but administrative controls that dampen the effects of ECB monetary action in France and other interventions in credit markets should be lifted. The recent reduction in administered interest rates is welcome and should be pursued until rates are fully in line with market rates. As to fiscal policy, the full play being given to automatic stabilizers together with the cuts in social security contributions related to the SMIC realignment should suffice. Non-cyclical expenditures should be held to budgeted amounts in 2003 and the planned, moderate fiscal consolidation for 2004 adhered to. Any further tax reductions should be backed by additional concrete expenditure reduction measures, and geared toward lowering high marginal rates on labor.

37. With pension reform in hand, a major step has been taken toward fiscal sustainability but a resumption of fiscal consolidation is needed. To achieve long-term sustainability, pension reforms will need to be complemented by further fiscal adjustment. The aim should be to improve the structural balance by about Vi of one percentage point of GDP per year until a small surplus is achieved to deal with any remaining costs of aging. Such an approach could well have positive confidence effects on economic performance in the near term, as it would establish the credibility of past and ongoing tax cuts, while the related strengthening of the public finances would buttress the common fiscal framework within EMU. Some rephasing of this pace of adjustment could be considered if credible, high quality expenditure measures were put in place that would yield the required cumulative fiscal adjustment over the next three years. Absent such a more forward-looking approach, however, consolidation should resume as from 2004 and proceed at a steady pace thereafter.

38. The 2004 budget plans need to be backed by concrete measures to slow the growth in non-cyclical social security spending. In 2004, the adjustment of the underlying deficit is set to be achieved by keeping central government spending constant in real terms and curbing health care expenditure growth. To deliver the latter, specific measures will need to be identified and implemented without delay.

39. The credibility of the government's fiscal strategy hinges crucially on its ability to reduce the share of public spending in GDP. New initiatives to control spending are highly welcome and should be supplemented by the adoption of multiyear expenditure norms expressed in terms of the level of non-cyclical spending in the context of budgets based on prudent growth assumptions (for example, somewhat less than potential). Importantly, this framework should clarify that windfalls from growth exceeding potential would be saved, reducing the public debt. Such an approach would limit contentious debates on growth projections, provide clarity on the level of resources available to spending agents, introduce a reference point to correct overruns, and secure consistency across successive budgets.

40. Reforms of pensions, health care, and the civil service, and well-designed decentralization, provide scope for substantial spending restraint. The recent pension reform is an important milestone in this respect but, as envisaged, the system's parameters will need to be reviewed periodically to secure long-run viability. In the health system, in the absence of a blueprint for successful reform, it will be necessary to take continuous steps to curb spending growth. Civil service reform offers ample potential to improve the efficiency of the public sector, and the reduction in public employment through attrition should be pursued vigorously. Decentralization should provide an opportunity to streamline and eliminate overlaps between the many levels of government and to tailor services better to local preferences. Nonetheless, safeguards will need to be built in to maintain fiscal discipline.

41. While ultimately France’s tax burden should be lowered—once room has been created on the expenditure side—consideration should in the interim be given to a revenue-neutral reform of the tax system to remove distortions. To reduce labor costs and strengthen work incentives, the tax structure could be rebalanced by decreasing social security contributions, high marginal income taxes, and corporate taxes, and raising revenue from broader-based taxes such as the VAT. Low yielding and costly-to-collect taxes could be abolished and the various collection administrations streamlined. New reduced VAT rates on specific products or services should not be introduced, while existing reduced VAT rates could usefully be raised to narrow the difference with the normal rate.

42. Steps to enhance labor and product market efficiency need to continue. In the labor market, attention should be paid to the cost effectiveness of policies: the easing of workweek reduction requirements for small enterprises and the suspension of some employment protection measures are welcome in this regard. Consideration should be given to restoring the phasing-out of unemployment benefits and introducing experience-rating for employers’ unemployment contributions. Product market functioning stands to be improved by the initiatives to reduce the administrative and regulatory burden and the strengthening of governance of state participations. Nonetheless, network industry liberalization should be accelerated for the benefit of consumers, divestiture should be pursued resolutely, and the practice of using privatization proceeds to recapitalize other enterprises phased out.

43. The functioning of credit markets should be improved and the ongoing strengthening of supervision and governance pursued. Administered interest rates need to be reduced further to market levels without delay, and, more fundamentally, the system of administered savings would best be phased out. The mechanism to finance social housing should be made more efficient and transparent. The interdictions on remunerating sight deposits and charging for checks also need to be lifted. Supervisory authorities have rightly stepped up their vigilance, and the financial situation of some large corporate groups will continue to warrant attention. The new law on financial security will further strengthen and simplify supervision, and improve corporate governance and consumer protection. Given further consolidation in the banking sector, competitive conditions should be monitored closely.

44. The shift in France’s position that contributed to the medium-term reform of the Common Agricultural Policy is welcome, though the authorities are encouraged to actively pursue the removal of agricultural subsidies and other barriers to trade, working toward a successful conclusion of ongoing multilateral trade negotiations. France's contribution to development through its relatively high level of ODA and its intention to reach the UN target by 2012 is commendable.

45. It is proposed that the next Article IV consultation take place on the standard 12-month cycle.

APPENDIX I France: Fund Relations

As of July 31, 2003

I. Membership Status: Joined December 27, 1945; Article VIII.

II. General Resources Account:

SDR MillionPercent of Quota
Quota10,738.50100.00
Fund holdings of currency6,158.3357.35
Reserve position in Fund4,580.1342.65

III.SDR Department:

SDR Millionpercent of Allocation
Net cumulative allocation1,079.87100.00
Holdings485.8844.99
Designation plan0.00

IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs): None

VII. Implementation of HIPC Initiative: Not applicable

VIII. Safeguards Assessments: Not applicable

IX. Exchange Rate Arrangements:

  • Since January 1, 1999 France has participated in Stage III of the European Economic and Monetary Union (EMU).
  • France continues to apply exchange restrictions vis-a-vis Iraq, the Federal Republic of Yugoslavia (Serbia and Montenegro) and the Socialist People’s Libyan Arab Jamahiriya. These restrictions have been notified to the Fund under Decision No. 144-(52/51), as follows: in respect of Iraq, see EBD/90/234 (8/8/90) and EBD/93/92, Supplement 1 (1/6/94); and in respect of the Federal Republic of Yugoslavia (Serbia and Montenegro) and the Socialist People's Libyan Arab Jamahiriya, see EBD/93/92 (12/27/93) and Supplement 1 (1/6/94).

X. Article IV Consultation:

The last article IV consultation was concluded at EBM/02/110 (10/28/02). France is on the standard 12-month consultation cycle.

XI. FSAP Participation and ROSC:

Date IssuedDocument No.
Transparency in Monetary and Financial Policies10/17/00SM/00/236
Fiscal Transparency Module10/18/00SM/00/238
Fiscal Transparency, Transparency in Monetary and Financial Policies—Update10/18/01SM/01/316
Fiscal Transparency Module—Update10/07/02SM/02/312
Transparency in Monetary and Financial Policies—Update10/07/02SM/02/313
APPENDIX II France: Statistical Information

France's economic database is comprehensive and of high quality. The authorities regularly publish a full range of economic and financial data and calendar dates of main statistical releases are also provided. The transmission of data in electronic form from INSEE and the profusion of data from various institutions (Banque de France, INSEE, Ministry of Finance, Ministry of Labor and Solidarity) have helped to build an infrastructure in which all data can be easily accessed through the Economic Data Sharing system. As a subscriber to the Special Data Dissemination Standard (SDDS), France posts its metadata on the Fund's Dissemination Standards Bulletin Board (DSBB) on the Internet.

Since the beginning of 1999, France’s monetary and banking statistics methodology has changed to reflect the standards of the European Monetary Union. Statistics for International Financial Statistics on banking institutions and monetary aggregates are prepared on a monthly basis and are timely.

France adopted the European System of Integrated Economic Accounts 1995 (ESA95) in 1999. Although data for GDP and its components are available since 1978, data for the household, corporate, and public administration accounts are only available since 1992. France produces annual national accounts aggregates based on two methodologically different systems of accounting: the quarterly and the annual accounts. Both systems provide valid information although estimates from the two accounts differ slightly.

Recent data issues include the need to provide monthly or quarterly developments not only in the finances of the central government, but also in the social security and local governments. These data should be presented in a comprehensive fashion and on a national accounts basis, to facilitate monitoring of public finances.

France: Core Statistical Indicators

As of September 10, 2003

Exchange RatesInt’l Reserves1Central Bank Balance SheetReserve/Base MoneyBroad MoneyInterest RatesConsumer Price IndexExports/ImportsCurrent Account BalanceCentral Government BalanceGDP/GNPExternal Debt/Debt Service
Date of Latest ObservationSep 9Jun 03Sep 5Sep 5Jun 03Sep 9Jul 03Jun 03Jun 03Jul 032003 Q1Jun 03
Date ReceivedSep 9Jul 03Sep 10Sep 10Jul 03Sep 9Aug 03Aug 03Aug 03Sep 03Aug 20Jul 03
Frequency of DataDailyMonthlyWeeklyWeeklyMonthlyDailyMonthlyMonthlyMonthlyMonthlyQuarterlyMonthly
Frequency of ReportingDailyMonthlyWeeklyWeeklyMonthlyDailyMonthlyMonthlyMonthlyMonthlyQuarterlyMonthly
Source of UpdateReutersBanque de FranceBanque de FranceBanque de FranceBanque de FranceReutersINSEEReuters/INSEEBanque de FranceMoFINSEEBanque de France
Mode of ReportingElectronicElectronic/FaxElectronic/FaxElectronic/FaxElectronic/FaxElectronicElectronic/FaxElectronic/FaxElectronicElectronicElectronicElectronic/Paper
ConfidentialityPublishedPublishedPublishedPublishedPublishedPublishedPublishedPublishedPublishedPublishedPublishedPublished
Frequency of PublicationDailyMonthlyWeeklyWeeklyMonthlyDailyMonthlyMonthlyMonthlyMonthlyQuarterlyMonthly

Includes all gross international reserves of the state; reserves at the Banque de France are reported weekly, and within a week.

Includes all gross international reserves of the state; reserves at the Banque de France are reported weekly, and within a week.

1Multiple monthly minimum wages emerged from the phased adoption of the 35-hour workweek. The authorities elected to harmonize these minimum wages under the constraint of maintaining purchasing power for all workers. As a result, the average minimum wage will rise by 6.3 percent in real terms by mid-2005.
2The temporary reduction in potential growth in 2003 shown in Table 1 reflects the cumulative effect of the decline in the investment rate following the equity bubble.
3In its recommendation to France of June 2003, the Ecofin Council established a deadline of October 3, 2003 for France to take “appropriate measures… to put an end to the present excessive deficit situation as rapidly as possible and by 2004 at the latest.” A supplement to the staff report will report on the 2004 draft budget.
4Current provisions lengthen the contribution period for all workers to 41 years by 2012; further modifications will be decided in the context of five-yearly reviews.
5Potential debt sustainability problems are not well-captured by the standard template in cases—such as France—where such problems stem from slow-moving demographics (see “Sustainability Assessments—Review of Application and Methodological Refinements,” SM/03/206, 6/11/03). Box 1 accordingly modifies the assessment to capture such effects.
6Compared to an EU-11 average of less than 16 percent.
7In an experience-rated unemployment insurance system (such as that of the U.S.), firms that have higher recourse to the system pay higher contributions to cover the additional burden imposed thereon and to counterbalance the system's implicit layoff subsidy.
8The formula sets the remuneration equal to the average of inflation and short-term interest rates, plus 0.25 percentage points; adjustments will be six-monthly.

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