The International Monetary Fund urged France on Wednesday to take additional deficit-cutting measures to safeguard its AAA credit rating and to undertake structural reforms to improve flagging competitiveness.
In its annual review of France's economy, the Fund warned that President Nicolas Sarkozy's government would miss its key target of cutting the deficit to the euro zone ceiling of 3 per cent of GDP by 2013 without further austerity measures.
The Fund said the government's deficit forecasts from 2012 onwards were based on overly-optimistic tax and revenue estimates.
It forecast France's deficit would decline to 5.7 per cent of GDP in 2011 from 7.1 per cent of GDP last year, but only fall to 3.8 per cent by the end of 2013.
"France cannot risk missing its medium-term fiscal targets given the need to strengthen implementation of the Stability and Growth Pact and keep borrowing costs low by securing France's AAA rating," the IMF staff report said.
"Achieving the deficit target of 3 per cent of GDP by 2013 requires additional measures."
With tax rates already amongst the highest in Europe, France's best option was for the government to reduce its spending to meet its midterm targets, the IMF said, particularly in areas such as pensions and healthcare.
With France gearing up for presidential elections in April, the Fund also backed Mr. Sarkozy's proposal to write balancing the budget into the constitution. The reform requires the support of the Socialist opposition, which has so far refused to back it.
Responding to the IMF report, Budget Minister Valerie Pecresse said that the government stood ready to make further reductions in tax exemptions to meet its fiscal commitments.
"The deficit reduction target is sacrosanct. France has to have a deficit of 3 per cent in 2013," she said.
With concern over contagion sending shock-waves through the euro zone, Mr. Sarkozy played a decisive role in securing a deal last week on a second Greek bailout.
But economists say France's top-notch credit rating remains under scrutiny. France has the highest deficit, debt and primary deficit - which excludes interest payments - among the AAA-rated euro zone countries.
Under its baseline scenario, the IMF said France's debt would peak at 88 per cent of GDP in 2013, but it warned that it could climb as high as 95 per cent if interest rates were higher than expected and economic growth slower. The government forecasts that debt will peak at 86.9 per cent of GDP in 2012.
The IMF called for France to instigate a multi-year budget plan based on independent economic forecasts.
The Fund estimated France's economy, the second largest in the euro zone, was on track to grow 2.1 per cent in 2011, roughly in line with a government forecast of 2.0 per cent, before slowing slightly to 1.9 per cent in 2012.
The government, by contrast, forecasts growth will accelerate to 2.25 per cent next year.
The Fund urged the government to reduce hefty taxes on labour to improve France's declining competitiveness and to take steps to reduce high structural unemployment especially among the young.
It noted that French banks' profitability was now back above pre-crisis levels and the sector was gaining strength. While risks from a boom in house prices and the euro zone debt crisis were contained, the Fund urged French banks to press ahead with meeting Basel III capital criteria by 2013-2014.
"We are confident that the sovereign risks are manageable because the exposure of the French financial system are quite diversified," said Anne-Marie Gulde-Wolf, IMF Mission Chief to France.
With file from Leigh Thomas and John Irish