France’s efforts to meet EU fiscal targets will focus on combining gradual headline deficit reduction and economic reform, Fitch Ratings says. This strategy should see debt fall slowly from 2020, even as the boost from the strong cyclical economic upturn fades.
France’s latest draft budgetary plan (DBP) forecasts the structural fiscal deficit to fall by 0.2% of GDP this year to 2.4%, versus the 0.9% reduction target recommended under the EU’s excessive deficit procedure (EDP). The gap between the headline deficit target set under the 2017 Stability Programme (2.8% of GDP) and the DBP forecast (2.9%) is much smaller.
We think that the strong political commitment by the Macron administration and a more favourable macroeconomic backdrop mean the headline deficit will be below 3% of GDP in 2017 and 2018. When France’s independent Court of Audit said in June that keeping the headline deficit within 3% of GDP would require “strong adjustment measures”, the government swiftly adopted additional fiscal measures worth EUR4.5 billion (0.2% of GDP).
If the European Commission thinks the headline deficit will fall below 3% of GDP in a timely and lasting manner, France would exit the EDP by April 2018 and become subject to the preventive arm of the Stability and Growth Pact (SGP). This would require it to reach its medium-term objective (MTO) thereafter by adjusting its structural budgetary position by 0.5% of GDP per year, and set a three-year transition period to make sufficient progress in reaching the debt reduction benchmark (the EC recently said in response to the 2018 DBP that France risked non-compliance with the benchmark).
Structural balances are harder to measure given their reliance on estimates of potential output and corresponding output gaps, which may be revised. This makes it harder to predict whether France would comply with the SGP’s preventive arm. We think that, if it meets headline deficit targets and makes tangible progress on its economic reform agenda, the EC will show some flexibility, even if structural fiscal adjustment falls short of its recommendation.
Progress on economic reform may prove swifter than we expected when President Macron took office in May. This would support the momentum in the French economy, which we forecast to grow at 1.8% this year and next year, up from 1.2% in 2016. The government has pushed ahead with labour market reform using executive decrees, and popular protests have been relatively moderate. Measures include allowing direct negotiations with employers, capping severance packages in cases of unfair dismissal, and reducing employee and employer social security contributions. We think this would help reduce France’s unemployment rate of 9.7% – more than double the ratings peer median – to below 9% by 2019.
However, France will still face a significant fiscal challenge from 2019, as GDP growth gradually slows and most tax relief measures are planned to take effect.
The government’s headline deficit target of 0.2% of GDP by 2022 implies consolidation worth 3.2pp of GDP from 2016. Achieving its ambitious expenditure-led adjustment plan alongside a 1pp reduction in the tax/GDP ratio will be challenging. Public expenditures in France are traditionally rigid, and wages and social transfers account for around 75% of expenditure.
Deficit reduction and public debt reduction are therefore likely to be gradual. We forecast public debt to remain broadly stable at around 97% of GDP until 2019, meaning France is one of the few eurozone countries in which debt/GDP is not yet on a downward trend.
We affirmed France’s ‘AA’/Stable sovereign rating in July. The rating balances a wealthy and diversified economy, a track record of macro-financial stability, and strong and effective civil and social institutions, against a high general government debt/GDP ratio and fiscal deficits spurred by high government spending.
Source: Fitch Ratings