Sarkozy Pushes Back Deficit Reduction as Growth Slows

By Sandrine Rastello

Sept. 26 (Bloomberg) -- French President Nicolas Sarkozy, facing the slowest economic expansion in at least five years, shelved deficit-reduction plans in his second budget released today.

The budget is based on a growth forecast for this year and next of 1 percent, less than half the 2007 pace, which will leave the government with less revenue and higher welfare costs. To keep the shortfall under the European Union limit, France may cap spending, not replace half of retiring civil servants, and raise taxes to fund incentives for the unemployed to return to work.

``It's easy to explain: tax receipts are shrinking,'' Budget Minister Eric Woerth said today on RTL radio. ``Less growth means less fiscal revenue.'' He cited the higher cost of debt and high inflation as other factors pushing up the deficit.

Sarkozy's 8 billion euros ($11.7 billion) of tax cuts this year were not enough to buoy growth as surging commodities prices fanned inflation and global demand cooled amid a year-long credit crisis. The euro region's second-largest economy contracted and shed jobs in the second quarter, sending consumer confidence to a record low and curbing spending.

Deficit Widening

The new budget plan forecasts the deficit will hold at last year's level of 2.7 percent of gross domestic product this year and next, remaining below the EU threshold of 3 percent. The government initially planned to narrow the shortfall to 2.5 percent this year and 2 percent next year.

``If there's one European country in a problematic situation regarding the 3 percent, it's France,'' said Natacha Valla, an economist at Goldman Sachs Group Inc. in Paris.

The higher deficit and slower growth will force an increase in borrowing. The government plans to sell $135 billion euros of bonds and notes next year, up from $116.5 billion euros worth this year. Total debt will rise to 66 percent of GDP from 65.3 percent this year.

The budget plan is based on the assumption that the cost of oil will average $100 a barrel in 2009 and the euro will be worth on average $1.45. Crude oil reached a peak of $147.27 in July and the euro hit a record $1.6038 in the same month.

Sarkozy, who's been in office since May 2007, has faced growing popular discontent as gasoline and food prices rose. Sixty-two percent of those surveyed by BVA polling company this month found his economic policy ``bad'' or ``very bad.''

Public Support

``The reason why Sarkozy was elected president is that he'd promised to deliver on economic and social issues at a time of pessimism,'' said Gael Sliman, deputy director at BVA. Now ``the bad economic news condemn him to be unpopular during all the difficult period of 2008 and part of 2009.''

Sarkozy yesterday said he wouldn't impose austerity policies as the turmoil in financial markets hurts economic growth, job creation and household purchasing power.

``If activity were to strongly and lastingly recede, I wouldn't hesitate to take necessary steps to underpin it,'' the French president said in a speech in Toulon, France. ``Telling the truth to the French is saying that the crisis isn't over, its consequences will be lasting.''

Sarkozy's political opposition, said he was using the world economic crisis to divert attention from his policy failures.

`Using' the Crisis

``The president is using the crisis as an excuse to justify the acceleration of an austerity policy towards the middle class'' and the least well off, Michel Sapin a former Socialist Finance Minister, said in a statement.

The government has little leeway to act, especially with France holding the rotating EU presidency. Two weeks ago, Finance Minister Christine Lagarde and her European counterparts pledged to pursue financial discipline. European Central Bank President Jean-Claude Trichet called for them to deliver on their promise.

Woerth said today that government has reined in spending.

``It's going to be a status-quo budget,'' said Laurence Boone, an economist at Barclays Capital in Paris. ``They have no room for maneuver if they want to stay within the EU limits'' of a deficit of less than 3 percent of gross domestic product.

The tax cuts announced by Sarkozy last year, including a mortgage-interest deduction, the elimination of most inheritance levies and a wealth-tax rebate for people investing in small companies will extend into next year. They also include the elimination of most taxes on overtime hours, which may not be as effective because of the slowdown, Barclays' Boone said.

Legislative Victories

Sarkozy won a string of legislative victories before the summer recess. Lawmakers in recent past months passed measures proposed by the government to boost retail competition, toughen jobseekers' benefit rules and increase work hours.

``Structural reforms have been launched,'' Goldman's Valla said. ``What the economy needs are very precise and fast spending measures, but France doesn't have the means to do it.''

The president has promised to eliminate a tax on companies' sales. At the same time, he is planning new levies on private health and retirement insurers and on corporate profits distributed to employees as part of a plan to erase the health- care system deficit by 2011.

He also said last month he will impose a new capital-gains tax to fund incentives for the unemployed to go back to work, a measure backed by 65 percent of French people, the BVA poll showed.

According to Medef, France's biggest business lobby, overall levies on companies are going to rise ``slightly'' in 2008 and ``strongly'' next year.

To contact the reporter on this story: Sandrine Rastello in Paris at srastello@bloomberg.net