France may have escaped having its draft 2015 budget rejected, but a new debate has opened on whether or not to come down hard on Europe's second largest economy or provide it with another extension to meet its deficit targets under Europe's fiscal rules.

In a worst case scenario, France could encounter fines for having not made sufficient efforts this year to meet Stability and Growth Pact rules to bring its budget deficit down to 3% of GDP by 2015.

On face value, the French government would seem to be way off the mark, the European Commission suggested on Tuesday.

In its Autumn economic forecasts, the Commission said it did not agree with the French government's assertion that its deficit would peak this year at 4.4% of GDP and then decline. Instead, it forecast that the deficit would continue to rise, reaching 4.5% in 2015 and 4.7% in 2016.

"Despite significant expenditure cuts, France's general government deficit and its debt-to-GDP ratio are expected to continue rising," the Commission said. It also said that among E21 billion in pledged 2015 spending cuts, E2 billion remained "insufficiently specified to be incorporated into the forecast."

An additional E3.6 billion pledged by the government for deficit reduction after the 2015 draft budget was submitted "was also not included in the forecast due to a lack of details on the measures at the cut-off date," the Commission said.

France's ability to specify how these savings will be achieved as well as to make a convincing argument on the efforts it has undertaken to reduce its structural deficit will be significant.

It all boils down to whether "we find that effective action has been taken," said one senior Commission official, who spoke on the condition of anonymity. "Then on that basis they can extend the deadline."

"The Commission also can find that we think there is not effective action even after the revised forecasts and step up the procedure, which would lead to the Commission to recommend fines," the official added.

Any decision on fines would have to approved by European finance ministers. Early discussions on the matter will move ahead on Thursday at the Eurogroup meeting in Brussels and the Commission will make its final opinion on the euro area's budgets before the end of the month.

The principle calculation for the Commission will be to decide if its figures for the French structural adjustment are accurate when considering changes in the economic forecast. The structural deficit figure strips out the effects of the economic cycle from spending and revenue levels.

The Commission will look at what measures have actually been taken to reduce the structural deficit and how much those efforts have yielded. "All this is put together and brings us to a view of yes effective action has been taken or no," the official said.

Three European officials said they thought that the most likely scenario would now be for France to be given two further years to bring its deficit below 3% of GDP in exchange for some concrete commitments to structural reform.

"There's a sense of resignation about France and Italy's plans," said one official. "They're not willing to take bigger steps and the Commission is not willing to reject their plans."

He said that there will, in the coming months, be a debate about the EU's fiscal rules known as the two-pack and the six pack, which outline rules for how countries should be made to comply with targets of a budget deficit of 3% of GDP and a debt-to-GDP ratio of less than 60%.

What has happened with France and Italy will influence that. "The rules clearly don't work as they are laid out," the official said.

In 2004, France and Germany's inability to stick to the Stability and Growth pact led to a loosening of the rules. It is not yet clear whether a similar reform will follow the current exercise.

The official said France's efforts at reform so far were "hardly worth the paper they're written on" and that Italy's debt ratio "will continue to rise under the current scenario." (The Commission forecast the Italian economy to contract by 0.4% this year.)

France could however still be subject further steps under the excessive deficit procedure from the Commission even if it is given more time.

Another official agreed there would likely be an extension for Paris although the Commission might yet ask for France to do more in its budget and that it was still an "open question" as to whether the budget would be sent back to lawmakers.

A third official said that sending back the budget to French lawmakers would "be a serious constitutional step" and that the Commission would do everything it could to avoid that, although the French measures "will need to be robust."

How France's structural deficit is calculated depends greatly on the updated economic situation in the country. The structural budget effort in 2014 is now predicted to be only 0.1% of GDP compared to an effort of 0.7% calculated in the Spring.

However, the Commission Tuesday that the French economy is predicted to grow by just 0.3% this year compared to 1.0% predicted in May.

"Economic growth has been stagnating since mid-2011 and the latest short-term indicators do not suggest that a firm recovery is imminent. Investment is not expected to gain momentum before 2016, while international trade looks unlikely to provide a boost to activity over the forecast horizon," the Commission said.

It added that the tax credit for competitiveness and employment as well as additional cuts in social security contributions planned under the Responsibility and Solidarity Pact will improve company profit margins, but the positive effect on investment will only materialize with a lag, from 2016 onwards.

Indeed, the biggest hurdle on what to do with France may have already been surmounted when the Commission decided not to reject its budget at the end of October. Officials over the past months have told Euro Insight that there seems to be little political will to punish France for its weak performance.

Jyrki Katainen, EU vice president for growth and jobs, hinted that the Commission under Jean-Claude Juncker would be doing everything possible to avoid pressing France any harder than it needs to.

"I cannot comment on any countries in specific, but because of different economic situations within the member states, the adjustment of the rules are relatively flexible and the core of flexibility is that the adjustment is structural, not nominal. There is flexibility, which is very important to take into account in this particular situation," Katainen said.

MNI