US embassy cable - 05PARIS2298

UNCLAS SECTION 01 OF 02 PARIS 002298 
 
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:  FRENCH GDP GROWTH TO SLOW IN THE FIRST HALF 
 
1.  SUMMARY.  GDP growth is likely to slow in the first half 
of  2005, mainly due to lower consumer spending.  Rising oil 
prices   and  the  appreciation  of  the  euro  are  curbing 
investment and exports.  Measures recently announced by  the 
government   to  boost  consumption  are  unlikely   to   be 
sufficient to help boost economic growth.  END SUMMARY. 
 
------------------------------------------- 
GDP Growth Likely to Slow in the First Half 
------------------------------------------- 
 
2.   The  National  Institute for Statistical  and  Economic 
Studies  (INSEE) revised upward its Q-1 GDP growth  forecast 
to  2.4%  (annualized) from 2.0%, but revised  significantly 
downward  Q-2  GDP growth to 1.2% from 1.6%.  INSEE's  Chief 
forecaster  Michel  Devilliers said on  March  24  "after  a 
strong  rebound  from  mid-2003 to  mid-2004,  the  economic 
recovery has become less robust under the shocks of oil  and 
the  U.S.  Dollar  drop."   The  economy  is  cooling  after 
expanding 2.3% in 2004, hindered by the highest jobless rate 
in five years (10.1% in January and February). 
 
3.  INSEE forecast consumer growth, which accounts for 54% 
of GDP, to slow to 3.2% (annualized) in Q-1 and to 1.2% in Q- 
2 from 3.6% in Q-4 2004, which had driven 2004 French GDP 
growth above average euro zone economic growth rates, 
notably the German.  INSEE explained the slower consumer 
spending in Q-2 is caused by a decrease in consumer 
purchasing power due to low job creation, and by higher 
social contributions to reduce the health insurance deficit. 
 
4.  According to INSEE, corporate investment will increase 
4.9% (annualized) in Q-1, but slow to 3.2% in Q-2 despite 
low interest rates.  Rising oil and raw material prices are 
curbing global economic growth and corporate profits. 
Devilliers said that companies are not motivated to increase 
significantly their investment in France, instead, they are 
investing abroad to grow. 
 
5.  Based on European surveys, industrialists are not 
optimistic about export outlook, notably due to the strength 
of the euro.  INSEE forecast export growth to slow to 4% 
(annualized) in Q-1 and Q-2 from 5.3% in Q-4 2004. 
 
--------------------------------- 
The Economy Creates Very Few Jobs 
--------------------------------- 
 
6. Private and public sector economists agreed that economic 
growth  is creating very few jobs, and consumers' purchasing 
power will remain moderate.  INSEE forecast low job creation 
of  41,000 jobs in the first half (including 27,000  in  the 
private sector), barely enough to absorb the increase in the 
labor  force.   INSEE  also  forecast  a  decrease  in   the 
unemployment rate to 9.9% by June, not sufficient to achieve 
the  Prime Minister's objective to trim unemployment by 10%, 
or  reduce  the rate to less than 9% this year from  10%  in 
2004.  Devilliers said that making 9% by the end of 2005  is 
impossible, since employment increases about 1.6%  per  year 
when GDP increases 2.0%. 
 
------------------------------------- 
Inflation Remains Remarkably Moderate 
------------------------------------- 
 
7.  Although oil prices are reaching records (56.15 USD on 
March 17), INSEE is confident that inflation will recede to 
1.5% in June from 1.6% in February, assuming the cost of the 
Brent crude oil averages 40 USD a barrel in Q-2. 
Nevertheless, rising oil prices have a visible impact on 
prices of manufactured products.  Underlying inflation 
(inflation excluding food, alcohol, tobacco and energy) is 
increasing, to slightly above 1.5%. 
 
--------------------------------------- 
Risks of the INSEE's Scenario are Mixed 
--------------------------------------- 
 
8.  INSEE did not rule out the upside risk of a rebound in 
the U.S. economy that would be favorable to the euro zone 
economy, and thus to the French.  INSEE economists also keep 
in mind that oil prices could stay at 50 USD a barrel in the 
first half-year.  At this level, oil prices would boost 
inflation and cut GDP growth by 0.1% during the first half- 
year. 
 
--------------------------------------------- -------- 
GOF Measures in Favor of Consumption will Not Do Much 
--------------------------------------------- -------- 
 
9.  INSEE did not include in its forecasts measures just 
announced (on March 23) by Prime Minister Jean-Pierre 
Raffarin, notably new tax breaks for companies paying profit- 
sharing bonuses to employees, relaxing access to funds 
locked in employees savings plans, and the GOF's promise to 
raise civil servants' wages.  Devilliers commented that tax 
breaks and easier access to savings plans would have a 
moderate effect on consumption. Only employees working in 
large companies benefit from profit sharing and savings 
plans, but not all potential beneficiaries take advantage of 
the new measures, and in 2004, profit-sharing bonuses became 
subject to income taxes.  Devilliers made a comparison with 
last year's measures in favor of consumption, saying that 
only 20% of the tax-exempted gifts to family members 
directly benefited consumption.  The remainder benefited 
real estate investment or was saved by recipients, 
resulting, in this case, in a transfer of savings between 
generations. 
 
--------------------------------------------- ----------- 
GOF Lowers GDP Forecast, but Still Hopes to Achieve 2.5% 
--------------------------------------------- ----------- 
 
10.   On March 16, Finance Minister Breton cut the GOF  2005 
GDP  growth  forecast to a 2.0-2.5% range from 2.5%,  citing 
the  61%  increase in Brent crude oil, and the  euro's  5.3% 
gain   against  the  US  Dollar  in  the  past  12   months. 
Nonetheless, he said that the GOF still hoped for  2.5%  GDP 
growth in 2005. 
 
11.  Currently, the average 2005 GDP forecast of the 
Consensus group of 17 banks and institutions, including BNP 
Paribas and Morgan Stanley, is much lower at 1.9%. 
Devilliers warned "meeting the lower end of Breton's GDP 
growth forecast for this year, requires GDP to expand 2.1% 
(annualized) in Q-3 and Q-4.  Meeting the upper range 
requires GDP growth of 4.8% in Q-3 and Q-4."  He advised 
"France needs to lift structural barriers to create jobs, 
and boost innovation, and focus on the most promising export 
markets to grow faster." 
 
------- 
Comment 
------- 
 
12.  2.0% GDP growth in 2005 is more likely than 2.5%, as 
4.8% GDP growth in Q-3 and Q-4 looks unrealistic.  In the 
reform field, the law modifying and making the 35-hour 
workweek more flexible has just been passed.  However, the 
law does not automatically increase the workweek.  Companies 
still have to negotiate longer hours with their employees on 
a case-by-case basis, which is a practical obstacle to hoped- 
for productivity gains. 
 
LEACH