How credible is France's budget?

French President Francois Hollande gives a press conference at the UN building on September 26,2012.

Story highlights

  • France has unveiled its most austere budget in 30 years
  • It aims to trim the deficit to 3% of gross domestic product
  • The economies will be achieved via cuts and tax hikes
  • Some believe the French government's plans are unrealistic

A day after Spain presented its financial prescription for next year, France unveiled what is being dubbed its "toughest budget in 30 years."

Maintaining its aim to trim the deficit to 3% of gross domestic product, the government of President Francois Hollande announced 30 billion euros in savings ($37 billion) by 2013.

As was widely expected, the economies will be achieved via a combination of cuts and tax hikes, with 10 billion euros being raised through cuts to the state and a further 20 billion euros generated through increased taxation of households and companies.

Speaking to reporters after signing off on the plan, the French Prime Minister Jean-Marc Ayrault called France's 3% objective "realistic" and "achievable."

Some economists, however, would beg to disagree. Here's why.

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France's economy has been stagnant over the last couple of quarters while some of its largest trading partners are already seeing theirs contracting.

Yet the country's new budget is based on the assumption that France's output will expand 0.8% in 2013 and 2% between 2014 and 2017.

Jurgen Michels and his team of economists at Citigroup are among those who reckon such predictions are overly optimistic.

''A review of the budgets presented since 2005 reveals that the government has had a bias of over-optimism when it comes to forecasting growth in the following year,'' the team wrote in a note sent to clients a week before the budget's release.

Citi predicts a more sluggish economy for France in 2013 will likely cause the nation to miss its 3% target by 0.7%.

In fact, to bring France's deficit back into line with the official limits, Citi's economists think France would need to save another 18 billion euros more than the 30 billion announced Friday, to compensate for weaker growth.

Yet the real problem with France's budget isn't just that it ignores the bleak outlook, it's that it relies too heavily on revenue generation via increased taxes.

And we all know the effect such levies can have on curtailing growth.

Speaking to the France 2 television station, the evening before the budget's publication, Ayrault reminded viewers the country could not afford to abandon its targets, lest its borrowing costs soar and gobble up any savings made.

He also stressed the higher taxes would only affect one in 10 households.

But plans to tax the wealthiest citizens earning over a million euros a year at 75% will no doubt cause the richest, and sometimes most entrepreneurial, French men and women to consider their options abroad.

Despite Ayrault's pledge to average families, Citi expects an increase in precautionary savings, as consumer sentiment stays at record lows and unemployment continues to tick higher.

At the same time the sharp increase in taxation for some of France's biggest firms is hardly likely to encourage job creation.

France's 2013 budget was the most important event of the year for a new administration keen to prove its credibility to the markets.

So far, its predictions look naively rosy.