France: France's 2015 budget tests EU fiscal rules, government announces new measures to avoid confrontation
October 28, 2014
The French government submitted its 2015 draft budget to the European Commission (EC) on 15 October, sending a message to European officials, as well as to France’s Eurozone peers, that the country will not comply with the Eurozone’s fiscal rules. When the government unveiled the draft budget on 1 October, it declared that it envisaged this year’s deficit being worse than expected and saw it rising from the initial projection of 3.6% of GDP to 4.4% of GDP. The government had expected the 2015 deficit to be reduced to 2.8% of GDP, but now projects that it will actually reach 4.3% of GDP. The government also recognized that it will be unable to meet the 3.0% of GDP deficit ceiling stipulated in the Eurozone fiscal rules until 2017, which is four years later than originally planned. In pushing this deadline further to 2017—the next presidential election year—the administration of President François Hollande recognized that this target will be left to the subsequent administration.
In order to avoid confrontation with the EC, however, the French government announced on 27 October that it would cut its budget deficit by an additional EUR 3.6 billion. The government stated that it would do so by using gains from lower interest charges on its debt and lower contributions to the EU budget. The new measure is expected to trim France’s structural deficit by 0.5% of GDP next year, which is an improvement over the 0.2% of GDP cut the government had previously promised. The additional adjustment was welcomed by the EC and also broke France’s defiant tone toward the European officials. Nonetheless, 29 October is the deadline for the EC to determine whether France committed violations to EU fiscal rules, while a full evaluation is not due until November.
French GDP growth adjusted for seasonal factors was flat for a second consecutive quarter in Q2 and more recent economic data support the view that the economy is faltering more than had been expected. These dismal results prompted the government to give up on its fiscal commitments for both this year and next. The 3.6% of GDP deficit that had been targeted for 2014 was supported by an optimistic GDP growth projection. The government initially estimated that GDP would grow 0.9% in 2014, but revised this estimate down to 0.4%, which is in line with FocusEconomics Consensus forecasters’ estimate for this year. For 2015, the government still expects GDP to grow 1.0%, which is just over the consensus of forecasters surveyed by FocusEconomics who expect the French economy to expand 0.9%.
Given that the French economy stagnated in the first half of the year and that there are prospects of weak economic growth for the second half, there are strong arguments—both within France as well as among some other European countries—in favor of propelling domestic demand through fiscal policy. This is particularly relevant now at a time when France, like the rest of the Eurozone economies, is enjoying exceptionally-low borrowing costs. On 15 October, the yield on 10-year government bonds was 1.14%, which marked a multi-year low. However, maneuvering room is limited because France’s economic model based on high public spending requires a radical reform. This is necessary, not only in order to put the public accounts in check, but also to reduce the negative impact on consumption and investment that high levels of taxation has on households and businesses.
The economic problems in France and the tense relationship the country has with some of its European peers are being exacerbated by political tensions and constraints. The fact that President Hollande’s popularity is currently at the lowest level ever for a president of the French Fifth Republic is inevitably compromising the effectiveness of his reformist agenda. Moreover, the President had to reshuffle his cabinet in August for the second time in six months in response to left-leaning ministers’ public criticism of his economic policies.
At the European level, politics has emerged as an important obstacle to coordinating economic policy across the bloc. Within this context, analysts’ and investors’ attention focused on a meeting that the French and German finance ministers held on 20 October in Berlin. In the meeting, the ministers agreed to outline a list of investment projects for the next Franco-German meeting scheduled for 1 December. However, no precise figures for the investment projects were presented. These measures came against a backdrop of a policy disagreement between the two countries: Germany is demanding that France reduces its budget, while France is calling for an investment boost in Germany.
Author: Ricardo Aceves, Senior Economist