FRENCH ECONOMY IMPROVING, BUT UNREST MAY LEAVE

UNCLAS SECTION 01 OF 03 PARIS 007771

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E.O. 12958: N/A
TAGS: EFIN ECON PGOV FR
SUBJECT: FRENCH ECONOMY IMPROVING, BUT UNREST MAY LEAVE
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1. (U) SUMMARY. While the recent unrest in France may have
dominated the headlines, the GOF has attempted to counter
the negative reports with good economic news. GDP growth
increased 2.8% (annualized) in the third quarter, much more
than expected. The unemployment rate decreased to 9.8%, and
inflation remains moderate. For 2005, GDP growth should
easily reach 1.5%, so the GOF remains confident in its
prediction of 2.0-2.5% GDP growth for 2006. The unrest will
nevertheless leave its mark on the economy: the fall of the
euro should help boost exports and necessary reconstruction
will help energize the construction sector. On the negative
side, the tourism and insurance sectors are suffering and
over the medium term foreign direct investment may decrease.
If fulfilled, new social spending promises will make
reducing the budget deficit to below 3% of GDP more
difficult. END SUMMARY.

GDP Increased More than Expected in Q-3
--------------

2. (U) Based on the National Statistical Agency (INSEE)
flash estimate, GDP (seasonally and workday adjusted)
increased 2.8% (annualized) in Q-3 compared with 1.2% in Q-1
and 0.4% in Q-2. This is the fastest growth since Q-2 2004
when GDP increased 3.2% (annualized). This is also
significantly higher than the October INSEE's forecast of
1.6%.


3. (U) While the flash estimate did not include a
breakdown, GDP growth is likely to have been driven by solid
household consumption. Consumption of manufactured products
(which accounts for about 30% of consumption) rebounded in
July and August, respectively 1.2% and 1.5% compared with
June and July, respectively. Consumer spending rose during
the summer despite less than robust increases in real
disposable income. Consumer optimism may have been boosted
by miscellaneous government measures in favor of
consumption, and improvement in the labor market.

Unemployment Decreased to 9.8% in September
--------------

4. (U) The number of unemployed has been steadily
decreasing in the last six months. More importantly, the
decrease was significant enough to result in a decrease in
the unemployment rate (based on ILO definitions) to 9.8% in
September from 9.9% in August, and from its highest level in
five years, 10.1% in January and February. The improvement
was partially due to government programs to promote job
creation in the private and public sectors, and the Social
Cohesion Plan, which raises the number of beneficiaries of
government subsidized contracts. That said, among those
under 25 the unemployment rate remains nearly 22%, about
twice the U.S. rate. Youth joblessness runs around 50% in
the suburbs where many of the more than 5 million first-and
second-generation African and Arab immigrants live.

Exports a Record in September; Industrial Production Up for
the Second Consecutive Month
-------------- --------------

5. (U) The foreign trade deficit narrowed in September to
1.7 billion euros as exports increased 4.6% to a record 31.2
billion euros. Imports increased 2.7% to 32.9 billion
euros. French industrial production increased 0.2% in
September compared with August, and 1.2% in August compared
with July.

Inflation Remains Moderate
--------------

6. (U) The consumer price index (seasonally adjusted)
subsided to 1.9% in October compared with October 2004,
despite increases in consumer oil prices. Consumer energy
prices increased 5.0% in October compared with September,
mainly due to a 7.3% increase in oil prices, although crude
oil prices fell from an August record of 70.85 U.S. Dollar.
Consumer prices excluding energy increased a moderate 1.0%
compared with October 2004.

Finance Minister Welcomes Q-3 GDP Growth . . .
-------------- -

7. (U) Finance Minister Thierry Breton went on Europe 1
radio to announce the Q-3 data 30 minutes before the
scheduled release by INSEE. He welcomed Q-3 GDP growth,
saying it was "very good news", but not a surprise because
he has been saying for months that all lights on his
indicators for the French economy had "turned to green." He
said the two weeks of unrest in French suburbs had little
impact on GDP growth, adding that the 200 to 300 million
euros increase in social programs in France's suburbs could
be easily offset by cutting spending elsewhere. The
government promised 5,000 more teachers and 100 million
euros for organizations in the troubled suburbs, 70,000
additional scholarships, vocational advancement programs,
and five new tax-free zones for investors. Breton expressed
confidence that France would enjoy much higher economic
growth in the second half than in the first half of 2005,
adding that the Q-3 GDP growth of 2.8% showed that "GDP
growth of 2.0-2.5% in 2006 is perfectly realistic and
achievable." Before the release of INSEE's Q-3 GDP data,
the IMF had forecast French GDP to increase 1.5% in 2005 and
1.8% in 2006.

. . . but Fears an Increase in European Interest Rates
-------------- --------------

8. (U) Bank of France Governor Christian Noyer said that Q-
3 GDP growth was encouraging, but he was favorable to an
increase in European Central Bank interest rates as "the
inflation risk in Europe is the factor that is threatening
economic growth the most." He said that the EU inflation
rate was close to 2.5%, and might not decrease quickly to
2.0%. Breton, along with his European counterparts, said he
was opposed to an increase in ECB interest rates that could
kill economic growth. He said, "inflation in France is
totally under control, there is no related rise in wages,
and the euro is at the right level." Ernest-Antoine
Selliere, the French head of UNICE, the European federation
of businesses, called for the ECB to not increase interest
rates as it would be a negative signal for European economic
growth.

Impact of the Unrest on:
-- Foreign Direct Investment
--------------

9. (U) From a macro-economic point of view, most analysts
see the unrest as a mixed bag. The greatest damage from the
unrest is the deterioration in France's attractiveness to
foreign direct investment. Not surprisingly, the head of
the Invest in France Agency (AFII),Clara Gaymard,
downplayed the situation, saying that foreign investors
understood that a limited group of young people were at the
origin of the unrest, not the broader French population,
which has requested a return to order. She said that
foreign investors focused on the quality of research,
training, and infrastructure to define their investment
strategies. She disagreed with head of the business
confederation MEDEF, Laurence Parisot, who called the
economic consequences of the violence "very serious."

-- on the Budget Deficit:
--------------

10. (U) The unrest is certain to affect the budget, notably
the 2006 budget deficit, which the government is trying to
keep below 3% of GDP. The impact of the unrest on the
budget may be larger than indicated by Breton. Analysts at
Credit Agricole-LCL, France's largest bank, have calculated
that to meet its new promises, the government would have to
boost budget spending by 2 billion euros. Simply fulfilling
its promise to hike spending on urban renewal by 25% would
cost 1 billion euros.

-- on the Tourism and Insurance Sectors
--------------

11. (U) The tourism sector fears a fall in business during
the Christmas period, particularly if heavy news coverage of
the unrest continues. Companies offering city tours are
especially worried about a drop-off during the holiday
season. According to French reports, up to 30% of the trips
booked to Paris by travel agencies in the U.S. have been
cancelled since the unrest began.


12. (U) The direct losses for the insurance sector due to
the unrest are considerable, but the French Federation of
Insurance Companies (FFSA) has dismissed any expressions of
concern. The FFSA estimated that 20 million euros in claims
for the 6,600 cars that were burned, and put total insurance
claims, including damage to sports facilities, schools and
businesses, at 200 million euros. This compares with 7
million euros in fire damage claims each year in France.

-- on the Building Sector
--------------

13. (U) The building sector could benefit from the
situation as soon as 2006 since all damaged buildings and
facilities will have to be rebuilt. Before the unrest, the
government had already promised to accelerate the
construction of public housing (as part of its Social
Cohesion Plan),promising to reach its objective in 18
months, before the June 2007 presidential elections.

Comment
--------------

14. (U) Some economists believe that relying on consumption
as a driver for French GDP growth is a cause for concern.
Since consumption depends heavily on consumer confidence,
which itself depends largely on employment and wages, strong
Q-4 growth cannot be taken as a foregone conclusion. An up
tick in inflation or a resurgence of civil unrest could
result in a downward correction in Q-4. On the other hand,
the fall of the euro in November against the U.S. dollar,
which was partially due to a lack of confidence related to
the unrest in France, has brightened prospects for
exporters, and the drop in energy prices has helped lift
European business confidence to a nine-month high in
October. Therefore, an increase in exports could partially
offset a downward correction in consumption. Stock exchange
markets have not reflected anticipations of lower economic
growth in the short-term. The blue-chip CAC 40 index
increased to 4,541.82 on November 11 due to the rise on Wall
Street, the decrease in oil prices, and the decrease in the
euro. The index continued increasing on November 14.
Importantly, investors have been taking their cues from U.S
economic indicators, not the French economic situation.
HOFMANN