WASHINGTON, USA – An International Monetary Fund (IMF) mission, led by Jeffrey Franks, conducted a virtual visit during October 19 – October 30 in the context of the 2020 Article IV consultations. At the end of the visit, the mission issued the following statement: In response to an unprecedented economic shock from the COVID-19 pandemic, the French authorities have responded with large and flexible emergency support packages and will provide additional stimulus in 2021 and thereafter.
While a robust economic recovery began in the third quarter, the outlook has weakened in the face of a second wave of infections and downside risks are large. Additional fiscal stimulus, through temporary and well-targeted measures, may be needed as the situation unfolds. A credible and ambitious medium-term fiscal consolidation plan should be prepared now to be implemented only once the economic recovery is on a firm footing. The economic disruption of the pandemic represents an opportunity to reorient the French economy, making it greener, more inclusive, and more productive, including by pursuing the government’s reform agenda.
Economic Outlook
France has been among the most affected countries from the COVID-19 pandemic. The authorities appropriately took stringent lock-down measures in mid-March and new infections fell sharply by end-April. New COVID-19 cases began to creep up in July. Since mid-September, new cases have exceeded the previous peak at end-March. While hospitalizations and fatalities have remained below previous peaks, they have also been trending upwards. In response, the government introduced a new lock down from October 30 – December 1 impacting many sectors of the economy. However, schools will remain open.
The economic impact of the pandemic has been significant, but the authorities have responded with strong and flexible support measures. France suffered one of the sharpest economic contractions among EU countries, with economic activity down by nearly 19 percent (y-on-y) in 2020. The current account deteriorated significantly as exports fell faster than imports. These developments reflected the severity of the pandemic, the breadth and duration of the lock down, and the large share of sectors most sharply affected by the crisis (such as tourism, automobiles, and aerospace).
To address the crisis, the authorities put in place a large emergency support package, which focuses on supporting households and firms by preserving jobs and providing liquidity. The response was quick and flexible, with measures rapidly adjusted as the situation evolved through three amendments to the budget between March 23 and July 31. Relief reached the beneficiaries, with significant uptake of government-guaranteed bank loans and of the short-time work scheme. This helped keeping unemployment down and underpinned a sharp economic rebound—up 18 percent (q-on-q) in the third quarter.
The economic outlook remains highly uncertain. Even after the significant rebound in the third quarter, economic activity remains below pre-crisis levels and the fragile recovery faces headwinds from the pandemic’s second wave. Output is expected to decline by around 10 percent for 2020 as a whole, with the better-than-expected Q3 offset by a contraction in Q4.
For 2021 IMF staff anticipate a partial recovery of 5-6 percent, but this will depend upon the evolution of the pandemic and related containment measures. Key support to economic activity is being provided by the ECB’s continued accommodative monetary policy and the government’s Plan de Relance. The plan focuses on facilitating a green and digital transformation and will boost future productive capacity through public and private investment and provide employment support (hiring subsidies, training).
Risks to the outlook are large and to the downside. In the near-term, risks continue to be dominated by the virus dynamics. On the upside, quicker full containment of the infection, earlier-than-expected availability of an effective vaccine or treatment could bring back activity significantly faster. On the downside, a prolongation of the health crisis into 2021 could delay a return of economic activity. Broader risks, such as a more severe fall-out from Brexit, tightening of financial conditions, an increase in social tensions, and the acceleration of de-globalization developments could also weigh on economic prospects.
Maintaining adequate fiscal support
Amidst a second wave of infections and high uncertainty, continued strong and flexible fiscal support is warranted. Deficit reduction should not be a concern while the crisis is ongoing. In the near term, support to affected firms and individuals should be scaled up as needed, especially to avoid that the necessary health containment actions lead to increases in poverty and inequality. Once the recovery gains traction, we encourage the government to progressively shift from providing broad-based emergency support to targeted support for the more dynamic parts of the economy, whilst buffering those most affected by the transition.
The Plan de Relance is an appropriate effort in this direction. Given that fiscal space is limited, any additional expansionary measures should be well-targeted and temporary. Permanent tax cuts or expenditure hikes should be avoided or accompanied by specific compensatory measures so as to prevent the build-up of additional fiscal problems once the crisis eases.
Once the recovery is on firm ground, an expenditure-based consolidation effort will be needed to place debt on a downward path . While the exceptionally low-interest rate outlook has provided some fiscal space, France’s elevated debt level provides less room to maneuver over the medium-term and increases fiscal risks. The timing and pace of fiscal consolidation should depend upon the economic situation, starting only when output has broadly recovered to its pre-crisis level and downside risks to growth have abated. It would be advisable, however, to begin the planning process now in order to provide a credible medium-term fiscal path. The plan should be focused on structural fiscal reforms to streamline and boost the efficiency of recurrent expenditure.
Supporting firms and ensuring continued financial sector soundness
Strengthening corporate balance sheets and addressing risks from insolvency will be critical to the recovery. Emergency policies, such as government-guaranteed bank loans, are helping firms remain current on their obligations, build liquidity buffers, and avoid financial distress. However, liquidity support has resulted in a sharp increase in gross corporate debt in early 2020. Losses from business activity in several sectors are likely to be large and long-lasting under a moderate recovery path.
Once the acute phase of the crisis eases, the authorities should refocus measures away from government loan guarantees and towards scaled-up equity and quasi-equity financing targeted at viable enterprises to spur investment and business dynamism, while reducing risk from excessive leverage. Weakening tax incentives which favor debt over equity should be considered as a medium-term measure to help support a healthier capital structure for firms. Swift implementation of the EU Restructuring Directive (Directive 2019/1023) would help increase the effectiveness of the corporate restructuring procedures at this critical juncture.
The banking sector entered the crisis with significant buffers, but close monitoring of asset quality is warranted going forward, especially if the crisis persists. The sector incurred limited losses during the first two quarters of this year but benefited from a range of prudential and monetary measures. Together with comfortable pre-crisis capital buffers and government guarantees on new bank loans, this helped support the provision of credit to the corporate sector.
Continued vigilance is required, however, as asset quality deterioration from future non-financial sector corporate losses could represent a risk to already limited bank profitability, especially if the health crisis persists. Temporary reductions in capital and liquidity requirements and regulatory flexibility targeted at providing relief to solvent borrowers have been appropriate but should remain temporary and time-bound. Guidance by the prudential authorities to limit dividend payouts while certain support measures are in place is prudent and should continue until the shock is weathered.
Toward a greener, more productive, and more inclusive economy
The economic disruption of the COVID-19 pandemic, and the associated massive fiscal response, represent an opportunity to reorient the French economy. Policies can steer the recovery to address long-standing goals such as lifting low productivity growth, pursuing climate change mitigation targets, and better protecting the more vulnerable sectors of society (such as youth, and less trained workers).
Job-rich green investment policies, such as those in the Plan de Relance, are well placed to help limit the scarring effects from the crisis, while greening the recovery. The plan includes investment in public transport and in the building sector, where retrofitting needs are significant, but investment amortization times are long. With appropriate incentives, French firms’ strong presence in fields such as automobiles, power generation, and aeronautics could be leveraged into a leading role in the emerging fields of green energy generation and storage and zero-emission transportation.
As the recovery strengthens, France should implement further green policies consistent with Paris Climate Agreement commitments and European initiatives, including in carbon pricing. This should be accompanied by mitigating measures for low-income households to ensure their social acceptance, while also generating fiscal space to reduce distortionary taxes elsewhere in a revenue-neutral way.
The need to boost productivity—which predates the current downturn—will become increasingly important in the recovery phase, as the scarring effects of the crisis are likely to weigh on growth potential. The government’s proposals to boost the digital transformation of the economy in the Plan de Relance will be helpful in this regard, but further efforts will be needed in the coming years. Additional simplification and modernization of the tax system, including by further streamlining of distortionary business taxes, would improve efficiency. Further steps to liberalize product and service markets can also help boost productivity, such as measures fostering competition in regulated professions, retail trade and the sale of medicines. Market-based steps to boost the competitiveness of French firms in international markets are welcome.
Policies should also aim at boosting employment, particularly among vulnerable groups. Lower job creation as a result of uncertainty and continued depressed activity, especially in the labor-intensive service sector, is likely to push up the unemployment rate. The proportionally stronger effect of the crisis on lower-skilled workers, especially those not on permanent contracts, could affect negatively the integration of vulnerable groups into the labor market– a long standing challenge where recent progress is now at risk.
Once the recovery takes hold, there will be an increasing need to incentivize work by re-orienting support to facilitate new work relationships in dynamic sectors. Retraining of existing workers and integrating vulnerable groups into the labor market are important elements in this regard. Eligibility and generosity of the short-time work scheme could be gradually tightened. Continuing the reform process to reduce structural unemployment and increase labor force participation remain critical over the medium-term.
