By Stephen Sandelius

PARIS (MNI) – The first major test of the new French government’s
fiscal resolve will be its 2013 budget, to be released in two weeks.
Many analysts believe it will not be ambitious enough.

Whether the Socialists succeed in slashing the public deficit from
4.5% of GDP this year to 3% next year will not be known until early
2014. But the preliminary parameters suggest the government is skating
on thin ice.

President Francois Hollande confirmed Sunday his strategy of taxing
mainly big business and wealthy households to boost revenues by E20
billion next year while freezing outlays in nominal terms, except for
pensions and health care, through spending cuts of E10 billion.

The budget assumption for GDP growth will most likely be cut to
0.8% from 1.2% previously, Hollande revealed.

“This growth forecast is clearly very optimistic in light of the
planned fiscal tightening,” said analyst Jean-Christophe Caffet of

Such scepticism is widespread. A survey of 18 leading banks and
think tanks published this week by the French business daily Les Echos
gave an average growth forecast of 0.3% in a range from -0.2% (Citibank)
to +1.3% (HSBC – in July). Few expect a bull’s eye for the deficit

“In our view, France will make every effort to deliver on its
target, even if that implies additional tax and spending measures next
year to plug the gap, but the 3% of GDP target will likely be missed,”
analysts at UBS said in a research note, predicting 0.4% growth and a
deficit of 3.4%.

A common concern is that France will be dragged into the vicious
circle of some of the weaker peripheral Eurozone economies, in which
rapid budget consolidation undermines growth, dampening revenues in turn
and thus requiring even deeper spending cuts or steeper tax hikes.

Some Socialists share this fear and would prefer to see the 3%
deficit target pushed back a year. But France has signed on to the EU
fiscal compact, and financial markets appear ready to punish any
backsliding. “The government has no choice,” Caffet said.

Having rescinded the VAT hike planned by the previous government,
the Socialists aim to ramp up income tax revenue by maintaining the
freeze on tax brackets in nominal terms, introduced by the previous
government, so that most households will pay more due to the inflation
impact on their earnings. A new bracket of 45% will be added for annual
earnings over E150,000 and an “exceptional” rate of 75% imposed above E1

Investment returns, which have traditionally enjoyed more favorable
rates in France, will now be treated the same as salaries via a
withholding tax. The wealth tax will be hiked, with exemptions for
primary residences and life insurance assets. Some tax shelters are
likely to be restricted and the overall ceiling on tax exemptions
lowered from E18,000 to E10,000.

Behind the Socialists’ slogan of “fiscal justice” there is also the
idea that investment earnings go primarily into savings, in contrast to
take-home pay, which is usually spent by the end the month – if not

The strategy has been carefully calibrated to have “the least
possible impact on economic activity at every level,” explained BNP
Paribas analyst Dominique Barbet.

Similarly, the extra E10 billion burden on business will fall
primarily on large corporations in order to favor small firms,
especially exporters. Dividend taxes will be hiked to encourage
companies to channel more profits toward investment, and tax shelters
will be pared, notably tax-free overtime for firms with more than 20

Barbet expressed confidence that in light of the “expertise” the
Finance Ministry has acquired in fine-tuning the tax system, the budget
to be unveiled on September 28 will be “completely consistent” with the
growth assumption and the deficit target. But he acknowledged the
inherent risks involved in projecting revenues after an overhaul of the
tax system.

Predicting GDP growth well before the budget year has started is a
also a particularly delicate excercise at a time when the economic
environment is shifting rapidly, Barbet reminded. But he conceded that
fiscal tightening “equivalent to two percentage points of GDP makes 0.8%
growth unlikely to be achieved next year.”

Caffet had penciled in 0.7% growth – before taking into account the
planned tightening, which could amputate close to 1.5 points from GDP
growth, he reckoned. On that basis, Hollande’s 0.8% would imply
“pre-tax” growth above 2%.

“Do we really believe that even without the consolidation France
would rebound with GDP growth around 2% when the world around us is
collapsing?” Caffet asked rhetorically, citing the slowdown in most
emerging economies, the “fiscal cliff” looming in the United States, the
recovery of the euro and the relentless consolidation throughout the
Eurozone, which will weigh on investment and consumption.

Analyst Manuel Maleki of ING also fears the austerity plan will not
go far enough to hit the deficit target and that “the government will
need to find at least E5 billion more.”

For Natixis chief economist Patrick Artus, a E45 billion plan would
be needed to hit a 3% deficit, given the surge in unemployment and the
risk of recession.

“With E40 billion, you’re sure of achieving 3% but perhaps with a
recession as well,” Barbet cautioned. “If you can hit the target and
avoid a recession, that would be preferable after all.” Moreover, the
government is likely to put several billions of budgeted expenditures on
ice at the start of the year to give it some leeway, he reminded.

With economic activity stagnant, some analysts argue that delaying
the deficit deadline would make economic sense. “One can ask whether a
target of 3% is really optimal for the French and Eurozone economies in
the current situation,” Barbet said.

Spain and Portugal have received a reprieve from Brussels and
Greece may as well. But France, as one of the last standing pillars of
the Eurozone, could hardly make a convincing case for special treatment
as long as its economy is still afloat, Caffet said.

Instead, “France should find a subtle way of missing its target:
announce 3%, pretend to be serious and come in at 3.5%,” Caffet quipped.
“That would already be not bad.”

And the risk of market sanctions? “If markets recognize that the
most sustainable trajectory is one that takes an extra year, I think
there will be no problem,” the analyst ventured.

This is a risk the Socialists are apparently willing to take.

UBS analysts also played down the risks of a modest deficit
overshoot: “As long as the government is committed to fiscal
consolidation and it takes the steps to show that the fiscal deficit is
on a downward path, the markets will likely continue giving France the
benefit of the doubt,” they wrote.

“This is all the more likely if the weak GDP/fiscal slippage story
is widespread across Europe and especially if, as we expect,
Keynesianism becomes fashionable again,” they added.

–Paris newsroom +331 4271 5540; email:

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