Global Insight Perspective

Significance

Despite stalling growth in the third quarter of 2006, Economy and Finance Minister Thierry Breton is still forecasting overall GDP growth of between 2.0% and 2.5% this year. In light of this, next year’s budget forecasts foresee a reduced national debt, as well as a reduced public deficit.

Implications

The government has tried to strike a balance with the 2007 budget, which includes voter-pleasing measures such as income tax cuts and increases in social benefits, along with higher public spending and initiatives to trim the excessive debt.

Outlook

With 2007 an election year, it is unsurprising that the centre-right government is aiming to attract undecided voters by offering attractive financial incentives. The fact that the budget was rejected by the left-leaning and centrist parties will inevitably put some of the measures into doubt should a change in government occur. Global Insight is cautious about the over-optimistic forecasts of the French finance minister, and we foresee a moderation in GDP growth to 1.7% in 2007.

An Optimistic, Yet Unambitious Budget

Deputies in the National Assembly (lower chamber of parliament), and senators in the upper chamber yesterday approved the state budget for 2007. All of the ruling Union for the People’s Movement (UMP) members of parliament voted in favour of the financial plan, which was easily passed because of the absolute majority the party holds in the National Assembly. Crucially, however, opposition deputies on the left and at the centre of the political spectrum either abstained or voted against the budget, claiming that the measures fall short of tackling the intrinsic problems of France’s public finances. Although some UMP deputies had been equally critical of the budget for not going far enough, the need to preserve a sense of unity within the party just four months ahead of presidential elections, followed by legislative ballots, ensured that they voted in favour in the national assembly.

Finance Minister Thierry Breton has indeed drawn up an optimistic pre-election financial programme. Despite stagnant GDP growth in the third quarter of 2006, Breton is confident that the economy is still on course for GDP growth of between 2.0% and 2.5% this year, a rate he expects to continue into 2007. The budget foresees gradual cuts in personal income taxes, to be financed in part by the centre-right government’s privatisation plans, which have already seen several key state-owned companies fully or partially sold off this year. Last month, Breton announced that revenues from privatisations could total up to 10 billion euro (US$12.9 billion) in 2007. Over the course of the year, the government is expected to propose tax cuts and rebates totaling over 6.5 billion euro.

Significantly, privatisation revenues are also expected to finance the lowering of France’s excessive public debt, which it was revealed earlier this year was in excess of 66% of GDP in 2005. In the 2007 budget, the Finance Ministry has made a reduction in the public debt a key priority, forecasting it to fall to 63.6% next year, providing that the target for this year (64.6%) is met. The public-sector deficit forecast for 2007 has been quite optimistically cut to 2.5% of GDP, down from an earlier prediction of 2.8%, and well below the Eurozone ceiling of 3.0%. In light of the promising fiscal revenues in 2006, a budgetary deficit of 41.9 billion euro is now forecast for next year, down from the initial prediction of 48 billion euro. Clearly, Breton is keen to present as rosy an outlook as possible.

Other measures enshrined in the budget include more “socially” amenable provisions, foremost among which is an increase in the one-off tax break afforded to new employees. This will be increased from the current 714 euro to 948 euro, and will apply to those in first-time employment as well as those who have rejoined the workforce, acting as an added incentive for the long-term unemployed to re-enter active working life. The pension provisions to French war veterans who fought in any of the country’s former colonies are also set to increase.

Outlook and Implications

The 2007 budget is the final one of the current legislature, and all things considered, the centre-right government decided to play it safe, just months before elections which could well lead to a change in government. The proposed tax cuts on personal income were muted in the budget debate because an overhaul of France’s fiscal policy and system is only envisaged by 2009, when the current UMP government may not be in power. Furthermore, this budget was clearly one of small provisions, rather than large-scale, medium-term measures, understandable considering the circumstances. Minor tax concessions were awarded to game-playing in cafés, as a concession to an industry worried about the impact of the public smoking ban that enters into force in February 2007. Far-reaching carbon taxes on industry have not been included in this budget, despite having been recently suggested by Prime Minister Dominique de Villepin.

The finance minister has inevitably provided optimistic forecasts concerning public debt and the public deficit, in an effort to sway a disgruntled public ahead of the elections. Nonetheless, the rosy picture Breton has tried to paint is premature, in light of the disappointing third-quarter data, the overall impact of which the minister has tried to play down. Indeed, the sharp slowdown of the French economy in the third quarter was driven by a setback in all the GDP components, particularly exports, rather than by technical factors, as many had previously anticipated. Moreover, the fact that no major structural reform of the labour market has been factored in, and no significant legislative proposals are in the pipeline, is a further disappointment, all the more so because unemployment consistently tops the list of electoral priority issues for the French public. Although the government has reason to celebrate the fall in the country’s persistently stubborn unemployment rate, this did not come about due to significant job-creation policies, or flexibility in the labour market.

Just months before crucial elections, the state budget has not offered much in the way of tangible measures. However, it may have succeeded in instilling a sense of optimism in the general public going into 2007; no major economic reform is expected now until after the formation of a new government and legislature. Despite the optimistic forecasts of the Finance Ministry, however, Global Insight forecasts GDP growth to moderate to 1.7% in 2007, on the basis of a stronger euro, higher interest rates, still-high oil prices, slower global demand, and some fiscal tightening in Germany and Italy, both important markets for the French economy. It remains to be seen whether Thierry Breton and the centre-right will remain in power to present a more far-reaching budget next year.