FRANCE GDP FORECAST TO PICK UP in 2006

UNCLAS SECTION 01 OF 02 PARIS 002046 SIPDIS SIPDIS PASS FEDERAL RESERVE PASS CEA STATE FOR EB and EUR/WE TREASURY FOR DO/IM TREASURY ALSO FOR DO/IMB AND DO/E WDINKELACKER USDOC FOR 4212/MAC/EUR/OEURA E.O. 12958: N/A TAGS: EFIN ECON PGOV FR SUBJECT: FRANCE GDP FORECAST TO PICK UP in 2006 ¶1. SUMMARY. The National Statistical Agency forecast that French GDP would rebound in the first half of 2006, increasing 2.4% (annualized) in Q1 and 2.0% in Q2, mainly led by household consumption. GDP growth could run at a pace close to 2.0% (annualized) in the first half, and in full year 2006 as well, picking up from 1.4% in 2005. However, consumption and corporate investment growth forecasts are questionable. END SUMMARY GDP Growth Pick Up In the First Half . . . -------------- ¶2. In its March review of the French economy, the National Statistical Agency, INSEE, forecast GDP to rebound in the first half of 2006, increasing 2.4% (annualized) in Q1 and 2.0% in Q2. INSEE's chief economist Michel Devilliers said that "GDP growth would improve after a mixed 2005" and "the lower end of the government's forecast for 2006 of 2.0-2.5% is within reach, providing the French economy keeps increasing at the first-half pace in the second." INSEE's 2006 GDP growth estimate is line with the 2.1% OECD forecast, but exceeds the 1.8% IMF prediction. ¶3. Avian Flu: INSEE made an estimate of the impact of spread of bird flu to poultry in France, saying it would have a minimal 0.02% negative impact on Q-1 GDP. The decline is related to a decrease in poultry exports. . . . Mainly led by Household Consumption -------------- ¶4. INSEE forecast household consumption, which accounts for 56% of GDP, to be robust in the first half of 2006. Devilliers stated that household consumption would remain the main engine behind economic growth, with a 2.8% (annualized) increase in Q-1 and 2.4% in Q-2. Partial information confirmed robustness of consumption in Q-1. Household consumption of manufactured products increased 1.8% in February compared with January, after a 0.5% increase in January. According to INSEE, consumer spending will be supported by a 1.2% increase in purchasing power in the first half. With the stabilization of crude oil prices at USD 60 per barrel, INSEE forecast inflation to slow to 1.6% in June compared with June 2005. Government-subsidized Contracts Boost Job Creation... -------------- -------------- ¶5. Assuming that consumption growth is more driven by employment than by indebtedness (French indebtedness generally is incurred to smooth out decreases in purchasing power, unlike the U.S. where debt more often is used to maintain a certain lifestyle),INSEE forecast that consumers' purchasing power will be stimulated by a gradual decrease in the unemployment rate to 9.2% in June from 9.6% in January. INSEE estimates that 100,000 new jobs could be created in the first half of 2006, compared with 85,000 in the full year 2005, thanks to government-subsidized employment contracts. 85,000 government-subsidized contracts versus 35,000 in full year 2005 would be created, corresponding to a significant increase in the number of contracts in the government sector, and in the private sector as part of the Social Cohesion Plan. INSEE forecast creation of only 25,000 non-government subsidized jobs in the private sector in the first half of 2006 compared with 50,000 in 2005. Job cuts in the industrial sector would be offset by creation in the construction (15,000) and services (45,000) sectors. ¶6. Interestingly, INSEE made a first estimate of job creation through the new contract for employment ("Contrats Nouvelles Embauches" - CNE) launched in August 2005 that allows employers in small-and-medium sized companies to lay off employees with no official reason in the first two years. INSEE shares the views of two senior labor economists, Pierre Cahuc and Stephane Carcillo, that only 10,000 to 20,000 jobs will be created per quarter thanks to CNE. This is much less than government's estimate of more than 400,000 CNEs. Devilliers summarized "CNE will have little impact on the labor market." Household Investment Steady; Corporate Investment Slow -------------- -------------- ¶7. Devilliers said that construction and real estate sectors had significant contributions to GDP growth in 2005. According to INSEE, household investment will increase 3.2% (annualized) in Q-1, and 3.6% in Q-2 as effervescence in PARIS 00002046 002 OF 002 this sector should continue. ¶8. INSEE forecast corporate investment growth to slow 2.0% in Q-1 from 4% in Q-4 2005 when the manufacturing sector did not perform well. It expects a return to 4.0% growth in Q-2 due to tightening of production capacities. Low real interest rates will continue to create favorable conditions for borrowing. Imports Are Stimulated by Domestic Demand -------------- ¶9. Buoyant consumer spending will continue to boost imports. INSEE forecast imports to increase 6.6% in Q-1 and 6.1% in Q-2. The foreign trade deficit will have a zero contribution to GDP in Q-1 and a 0.1% negative contribution in Q-2. Exports Do Not Benefit from International Environment -------------- -------------- ¶10. In early 2006, INSEE described France's international environment as favorable ("porteur de croissance"),arguing that the euro zone will benefit from strong growth in the United States (4.2%),Japan (4.2%),and the U.K.(2.2%). Surveys indicate an improvement in the business climate in the euro zone. Expecting the euro to stay close to USD 1.20, INSEE forecast French exports to increase 7.4% in Q-1 and 5.3% in Q-3. INSEE economist Karine Berger stressed that "France has failed to hook up to world economic growth," and France would not recapture markets lost in ¶2005. Exports increased 2.3% in 2005 when global demand climbed 5.5%. Berger said, "that means that France lost market share overseas." ¶11. Taking into account uncertainties about France's market share abroad and the price competitiveness of French products, Devilliers warned that the foreign trade deficit could be significantly worse in 2006 after having negative contributions of 1.1% to GDP in 2004 and 1.0% in 2005. Upside and Downside Risks -------------- ¶12. INSEE sees "a more marked economic recovery in Germany," France's main economic partner, which should benefit French exports. Any increase in German domestic demand including the effect of the 2006 world soccer cup on construction, tourism and consumption of high-tech goods in Germany could benefit French trade. INSEE did not rule out the downside risk of a higher-than-expected trade deficit due to a dynamic world economy, which could push oil and raw materials prices higher, and thus increase imports. Widening trade deficits would dent economic growth and employment. Comment: -------------- ¶13. The corporate investment growth forecast remains a potential problem. Finance ministry chief economist Gerard Belet confirmed to us that corporate investment has not increased sufficiently, although companies made profits and reduced indebtedness, cash flow is healthy, and interest rates are low. He stressed that large companies mostly invested (and, by extension, created jobs) abroad. Domestic investment involved purchases of software and computers, but this had no effect on production capacities. ¶14. The preliminary results of government policies to stimulate employment are disappointing, with less enthusiasm from the private sector than the government had expected. Unrest caused by the new employment contract for the youth ("Contrat Premiere Embauche - CPE) indicates that substantial labor market reforms are unlikely in the short and medium terms. STAPELTON