France’s Fine Line: Those Expecting A “Fiscal Revolution” Will Be Disappointed

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France faces a narrow path to reconcile supply-side structural reforms and fiscal measures with demand management. The budget bill for 2019 targets a deficit at 2.8%, pretty close to the EU limit. But analysts at BoAML do not share the criticisms over lack of ambition on public spending.

France’s macroeconomic equation revolves around three constraints: 1) structural reforms must boost potential growth; 2) Supply-side fiscal measures magnify the impact of structural reforms, but the recent weakening demand is calling for some attention; 3) any combination of supply and demand support must result in an overall fiscal position compliant with the European rules, while still making sure it is not contributing to the government’s loss in popularity and thus impairing its capacity to deliver said structural reforms.

There is thus a very narrow path for the government to tread on, and those expecting a “fiscal revolution ” in France will be disappointed in BoAML’s view.

The budget bill for 2019 unveiled on last month is being criticized for not being bold enough on reducing expenditure while targeting a deficit for 2019 at 2.8% uncomfortably close to the limit set by the Stability and Growth Pact. In our view, a steeper effort on spending in 2019 would risk smothering a recovery which is already looking fragile.

We would even argue that should growth disappoint and the deficit break the 3% limit next year, the French government should not opt for drastic corrective measures. Indeed, a third of next year ’ s deficit will be attributable to a one-off – turning a powerful tax credit for corporations into a permanent cut in payroll tax – which is actually supportive of potential growth. This will automatically correct in 2020. The European Commission in the past has b een open-minded when the deviation was small, and its source well-identified and temporary.

But optics matter and it took only an hour after Paris unveiled it s budget bill for Italy ’ s Deputy Prime Minister Di Maio to call on Rome to follow “ France’s path ” and opt for a “ bold budget ” for 2019. There may be a conflict between the strong pro-European message the French government will want to send ahead of the European elections in May – which would call for strict compliance with the letter of the Stability and Growth Pact – and macroeconomic management, which would call for a more flexible approach.

Domestically, in 2019 the analysts at the form will focus on the outcome of the unemployment benefits and pensions reforms. The government has managed to reform the labour market and the national railways without widespread opposition. This may prove more difficult with a less stellar growth rate and relapsing popularity .

Actually, in our opinion, accelerating tax cuts for households in 2019, funded by a phasing-in of the permanent cut in payroll tax, could have helped easing in th ose reforms. It is a delicate balance of course, but given the risks of further headwinds next year – in particular even higher oil prices impairing real income growth and an escalation in trade war hurting export expectations – supporting household consumption could come handy.