Cablegate: Breton Proposes Measures to Boost Growth And

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 PARIS 004565

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PASS FEDERAL RESERVE
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STATE FOR EB and EUR/WE
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TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER
USDOC FOR 4212/MAC/EUR/OEURA

E.O. 12958: N/A
TAGS: ECON EFIN PGOV ELAB FR
SUBJECT: BRETON PROPOSES MEASURES TO BOOST GROWTH AND
EMPLOYMENT

1. SUMMARY. GOF Finance Minister Thierry Breton finally has
broken out of his shell and announced measures to boost
economic growth and reduce unemployment, admitting that GDP
growth will be lower than 2% in 2005. These measures may
help in the long term, but they are more likely to increase
budget spending than restore confidence, create jobs, boost
government's coffers, or solve structural problems. END
SUMMARY.

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Economic Growth Slows; Unemployment Remains High
--------------------------------------------- ---

2. On June 22, Finance Minister Thierry Breton admitted
that the rise in oil prices (USD 59.52 per barrel in New
York on June 20) have weighed on the current economic
recovery by crimping corporate profit margins and eroding
households' purchasing power. The French unemployment rate
remained stubbornly stuck at 10.2%. He publicly
acknowledged that GDP growth could increase less than 2% in
2005, cutting the Government GDP forecast for the second
time in three months. Breton predicted that after GDP
growth of 0.8% (annualized) in Q1 and the weak spot for
growth had passed, the GDP growth rate should return between
2.0% and 2.5% in the second half-year. He said that, over
the long term, France must find ways to boost annual GDP
growth to 3% if it wants to reduce unemployment and protect
its social benefits.

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Public debt Surges: France "living beyond its means"
--------------------------------------------- -------

3. Breton, in a catchy sound bite, declared that "France is
living beyond its means", saying his concern for the French
economy was that rising debt levels are unsustainable and
that France must reverse the relentless 25-year build-up in
its public debt. The public debt would amount to 1,100
billion euros in 2006 or to a record 66% of GDP, above the
EU limit of 60%. He warned that 2006 income tax receipts
could almost equal the interest payments of France's debt
and "the cost of the debt is taking away all our room for
maneuver in our economy." Breton added that the economy had
to be subject to "rigorous management," saying that he was
working "day and night" on this with his Budget Minister
Jean-Francois Cope.

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Government Action I: Increasing Budget Spending and
Decreasing Some Taxes to Boost Growth and Employment
--------------------------------------------- -------

4. In his first policy address on June 8, Prime Minister
Dominique de Villepin gave himself 100 days to revive
confidence in the economy. After being named to the
position on May 31, he acknowledged his own "feeling of
employment insecurity." He stressed that his mission is to
get a suffering and angry France "back to work," and
earmarked an additional 4.5 billion euros in spending to
boost employment and economic growth.

5. To this end, the government has already proposed new
labor contracts for "very small businesses - VSBs", which
will extend the probation period to two years from several
months - during which period, VSBs may lay off workers
without long notice and administrative proceedings. The
idea is to encourage companies employing fewer than 10
employees to expand and export. The government will also
remove some taxes and administrative proceedings, and will
improve unemployment benefits and vocational training,
offering a one thousand euro bonus for long-term unemployed
to accept job offers.

6. On June 21, Breton proposed additional incentives to
encourage the unemployed to find jobs in more economically
buoyant regions. If a job-seeker has to move more than 200
km from home to find a job, he/she will be entitled to a one-
year income tax exemption. Breton also announced new tax
breaks aimed at helping companies raise funds. Under the
plan, investors would be exempt from taxes on profits when
companies go public on Alternext. Individuals would also
get a tax deduction equal to 25% of their investment in
companies controlled by investment funds, extending a break
that now exists for channeling funds to closely-held
businesses.

--------------------------------------------- --------
Government Action II: Calling the French to Work More
--------------------------------------------- --------

7. Breton also called the French "to work more, throughout
their lives" in order to create growth and "finance our
social model." He hammered "France has to make an effort to
achieve growth of more than 3% at least." He warned that
financial pressures would intensify due to demographic
pressures. In 2006, the number of people aged between 15
and 60 would decrease for the first time.

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Government Action III: Selling Shares to Reduce Record Debt
--------------------------------------------- --------------

8. Villepin stated on June 8 that the Government would
stick to its commitments to contain government budget
spending at the rate of inflation. Breton said it was
essential to launch a full-blood public debate about
economic prospects, including a debt reduction strategy. He
insisted that the budget deficit would be kept to below 3%
of GDP in 2006 in spite of economic slowdown. The
government is pressing ahead to sell Government stakes in
companies to reduce public debt. The government plan is to
sell shares in gas utility Gaz de France that will start
trading by July 14. The initial public sale began on June
23.

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Bank of France's Governor: Respect EU Deficit Rules
--------------------------------------------- -------

9. Governor of Bank of France Christian Noyer at the same
time announced that he had told the French government that
it was "crucial" that it respects EU budget deficit rules,
and reduces the government budget deficit to below the
Stability and Growth Pact Limit of 3% of GDP. In 2004, the
budget deficit amounted to 3.6% of GDP (septel). Noyer
identified three risks in the French economy: a steady
deterioration in foreign trade, a sharp rise in real estate
prices, and persistent government budget deficits. He urged
the government to make structural reforms to achieve 2%
potential GDP growth.

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OECD Warns About Fiscal Sustainability
--------------------------------------

9. In its June 16 report on France, the OECD forecast
French GDP would increase 1.4% in 2005. OECD recommended
that France control budget spending, improve its labor
market and intensify competition, if France wants to spur
economic growth and employment. OECD warned about a threat
to "fiscal sustainability" in France, the second largest EU
economy. OECD argued that reducing public debt would allow
spending more on pensions and rising health insurance. OECD
said that a lack of control over government budget spending
could leave France unprepared to deal with the financial
consequences of an aging population. OECD advised cutting
the number of civil servants by attrition (which is possible
since a significant number of civil servants are retiring),
and to limit wage increases. OECD also recommended reducing
the number of offices participating in the calculation and
collection of taxes, notably by implementing withholding
income taxes. (In the French tax system, some taxes may be
withheld, but income taxes are not.) OECD advocated France
to deregulate "excessively regulated sectors" to increase
productivity and employment.

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However, Unions Still Strongly Opposed to "Liberalism"
--------------------------------------------- ---------

10. Unions representing gas and electricity sectors called
for renewed action on June 22 to protest government
employment policy, including a plan to sell shares in Gaz de
France. Labor unions had threatened strikes if De Villepin
weakened the national safety net for the unemployed and job
protection guarantees. Secretary General of Force Ouvriere
said after meeting De Villepin on June 6 "we won't accept
putting the labor code in jeopardy."

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Economists Reactions
--------------------

11. Many economists think as Chief economist of Natexis
Banques Populaires Marc Touati that the "French industry is
practically in recession, consumption remains fragile and
employment is insufficient." Morgan Stanley Chief economist
Eric Chaney thought that Breton was right in his diagnosis,
but criticized his failure to question the French model
itself and announcing only "baby steps" of reforms. Chaney
urged opting for a breakthrough strategy by a ban on
politicians taking baby steps, and openly questioning the
French social model.

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Comment
-------

12. Villepin will likely struggle to meet his goal to
revive confidence in 100 days. We do not see how his
government can succeed in significantly reducing
unemployment in such a short period of time. Convincing
consumers and companies in September that the economic
situation has improved over the summer - a vacation period
in France that is not favorable to job-creation - will be a
tough sell. Breton's options are also rather limited and
focused more on the medium-term. In identifying debt
service as a major source of spending, and by addressing the
problem by selling shares in state-owned companies, Breton
is effectively admitting that his measures will not have
immediate results on economic growth and job creation. It
appears almost certain that the government budget deficit
(septel) may again exceed EU limits for the fourth straight
year. The government has no room either to implement new
steps in the 30% income tax cuts promised by President
Chirac by 2007 or to reduce corporate tax cuts to spur
economic growth as the U.S. government has in the past.
Breton has floated the idea of "a dialogue with the French"
to persuade them of the need for serious structural reforms.
However, Breton's recent political caution and the
government's low approval ratings would not augur well for
such an approach.
WOLFF

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