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12 Aug 2013

Fiscal challenges for France

Mathilde Lemoine

by Mathilde Lemoine

Economist, HSBC

Fiscal challenges for France (Getty Images/Maciej Noskowski)

The French government may refuse to accept a sharper slowdown in public spending growth

President François Hollande’s administration could be the latest French government to be overoptimistic on GDP growth while underestimating the structural deficit. We think France will fail to meet its target of reducing the public deficit to 3.9 per cent of GDP for 2013 and could miss its 3.6 per cent target for 2014 by an even wider margin – contrary to its undertakings to the European Commission in May 2013.

But a higher-than-planned public deficit could create tension in Europe. Indeed, the new European fiscal rules will be applied to the draft 2014 finance bill published in September 2013. If the European Commission finds the proposed budget does not conform to European commitments and the fiscal compact, it is likely to demand further austerity measures.

If the French government refuses to accept a sharper slowdown in public spending growth it could trigger a clash with other eurozone governments that feel France should implement greater austerity.

We expect growth of just 0.1 per cent in the second half of 2013 after an estimated 0.3 per cent contraction in the first half. China and Asia’s slowing economies will weigh on export growth while the low production-capacity utilisation rate is delaying the upturn in corporate investment. Household consumption is limited by rising unemployment and tax increases.

A higher-than-planned public deficit could create tension in Europe

The French government had originally planned to reduce the public deficit from 4.8 per cent of GDP in 2012 (revised up from 4.5 per cent) to 3 per cent in 2013. However, the European Commission allowed it to delay this target until 2015. But since the new deficit target of 3.9 per cent of GDP for 2013 was set, the deteriorating world growth outlook means that even this revised target will probably not be achieved.

Growth is likely to be below government forecasts, VAT revenues are running well below expectations while the central government deficit has risen. And the current austerity measures are not enough to slow real public spending growth as expected, according to our calculations.

We estimate that if GDP falls by 0.3 per cent in 2013, the public deficit could hit 4.2 per cent of GDP. But even with 0.5 per cent growth in 2014, the deficit would not shrink.

Since May 2013 the European Commission can review a country’s proposed budget and ask a government to amend it if the public deficit reduction is not credible – even before the national parliament votes on it.

If economic data is better than we expect, the European Commission could simply take note of France’s budget but make no comment. But if the public deficit exceeds 3.9 per cent of GDP in 2013 and the draft finance bill measures are not enough to reduce real public spending growth to 0.4 per cent in 2014, the European Commission could demand changes. If Paris amends the budget and announces further structural reforms, the Commission could take note but make no comment.

The European Commission has no powers to force the French government to act if it refuses to amend its proposed budget. However, investors might see that as an indication of the inability of eurozone countries to coordinate their fiscal policies in spite of the fiscal compact, provoking concern over the eurozone’s future.

And the European Commission could, after March 2014, tell France to lodge a non-interest bearing deposit of 0.2 per cent of GDP with the European Union under the excessive deficit procedure.

It therefore makes sense for Paris to amend its 2014 draft finance bill and slow public spending growth. That would avoid a clash with the European Commission and Germany but would weigh on social security benefits – the main reason for the sharp growth in public spending.

With the eurozone representing 48 per cent of French imports in the first quarter of 2013, it would also probably lead to further downgrades of forecasts for 2014 GDP growth within the region.

This research was first published on 2 August 2013.