David Crossan – This is Politics and I’m delighted to say that I am joined now by the French Finance Minister, Christine Lagarde. Madame Lagarde, many thanks for becoming the first Minister to appear on the all-new version of Politics on France 24.

It’s fair to say that these are rather interesting times to be a Finance Minister: global headlines this week were dominated by American investment bank Lehman Brothers’ filing for bankruptcy – the biggest in corporate history – and we have seen the American government’s US$ 85 billion bail-out for insurance giant AIG. The stock markets have taken a hit, and central banks have been funnelling billions of dollars’ worth of liquidity into the market to try to deal with the credit crunch. The first question is whether the Federal Reserve was right to bail out AIG and why they took a different approach to Lehman Brothers.

Christine Lagarde – You’re right. These are interesting times to say the least. We are seeing a clear transformation of financial markets unfurling at the moment, right in front of us. It’s impossible to say whether it was right or wrong. I think it’s the beginning of a process. As I said, it’s very transformational. But the market certainly welcomed that measure. We saw that on Asian markets, and our markets here in Europe will be opening shortly (or have already opened) and I’m sure that their perception will be good.

David Crossan – It is often said in economic circles that, when America sneezes, the rest of the world catches a cold. There will be direct and indirect effects from all this. Only this week, you said that the effect on French banks would be limited. Do you stand by those comments and, if so, why?

Christine Lagarde – I should think so. What we did with the banking authority was check our banks’ direct exposure and found that it is very limited. Which is why I stand by what I said, i.e. that the direct effect will be limited.

David Crossan – So nothing like the €18 billion that French banks purportedly lost in the subprime crisis…

Christine Lagarde – No, those numbers have nothing to do with the current exposure.

David Crossan – What about the impact on credit over the short and long run? We have seen that banks are not that keen on lending to each other any more. Will consumers also feel the crunch?

Christine Lagarde – The cost of credit has increased significantly over the past few days. I think that will have clear consequences on lending, for businesses and for consumers. I think it is extremely appropriate that the European Investment Bank lends money to the banks, which will in turn direct it to SMEs. This is what we decided this weekend in Nice. Allocating €15 billion directly for European SMEs is the right move in the current circumstances.

David Crossan – Do you believe there is enough consultation at European level to deal with this crisis? The European Central Bank has put €100 billion worth of liquidity into the market – and it was snapped up immediately this week. Does that mean that they’re going to have to dip further into their pockets soon?

Christine Lagarde – First of all, I think that central banks have actually played a major role and have coordinated extremely well among themselves and with authorities. We have spent much of the past 48 hours on conference calls, coordinating efforts to make sure that things work out on the markets.

I believe that this crisis will transform the financial market. It is going to transform the way in which people work together. And it is certainly going to serve as a call for supervising authorities to act.

David Crossan – Meaning more regulation in the future?

Christine Lagarde – What form it will take – whether it will involve new regulation, enforcing existing regulation properly, or appropriating and owning the rules – I don’t know. But we in Europe have proposals to make. As Ecofin President, I can say that we spent Friday afternoon discussing how to improve supervision and why more coordination is indeed required.

David Crossan – In terms of how individual countries can react, the Stability and Growth Pact bans spending more than 3 percent of GDP on deficits. Is that going to be a problem for France, given that France has been flirting with that barrier for some time now?

Christine Lagarde – No, we will be below the 3-percent line (as you call it) or barrier this year. No question about that.

David Crossan – And next year, with lower growth and lower tax revenue?

Christine Lagarde – As you know, we have agreed and are determined to stay at zero-volume growth on State expenditure. We will hold to that. As you know, during the Nice Ecofin meeting, we agreed that automatic stabilisers should be allowed to play their role. That means that, if you collect lower taxes, you will not be required to reduce expenses by the same amount. That will apply to the extent that we stay beyond the limit and on target.

David Crossan – President Sarkozy has criticised the European Central Bank in the past for not having enough of a focus on growth. In the light of France’s Q2 figures, revealing a 0.3% shrink in the economy, that’s surely even more of a concern for France now…

Christine Lagarde – I think slow growth in Europe is a concern for all European countries. Growth has clearly been slow in Germany, Italy, France, and pretty much all over the place. We saw a serious cut in growth over Q2. That was what we spoke about at the Nice meeting. We have also decided – and that’s a first – to include union and manufacturer-association leaders in our next Ecofin meeting, to involve them in the process dealing with this famous second-round inflation phenomenon – which we do not want to see happening in Europe.

The goal is to show the ECB that inflation is under control, when it comes to salary costs and prices in general. Once the ECB is confident that inflation can be reined in, it should be able to look at interest rates from a different angle.

David Crossan – But wage restraint has to come first, before the ECB can consider a rate cut...

Christine Lagarde – What we want to do, all together (it’s not the ECB here, the Commission there, the Presidency over there, etc.) is rein inflation down. We realise that inflation is bad for growth, bad for people, and bad for the State. When inflation rises, our debt rises. And the interest that we pay on our debt rises. So we are very keen to reduce inflation. What we are saying is, “OK, we’ve taken the external shocks, the impact is declining (oil prices are going down, raw-material prices are going down slightly – simply because growth has settled around the world) so let’s make sure we don’t get that second-round inflation.” Otherwise, you are just fuelling inflation and it spirals to a point where everybody loses out.

David Crossan – Negative Q2 growth figures certainly create problems in terms of balancing the budget. Initial calculations, I believe, were based on an estimate of around 2 percent growth. How can France square this circle?

Christine Lagarde – Well, wait until the end of the year. Revenue is coming in and our big revenue, corporate tax, only comes in at the end of December. So we want to see what we have before drawing conclusions.

David Crossan – What is your growth forecast for 2008?

Christine Lagarde – Around 1 percent. That’s what the Prime Minister has said, and that’s what most economists are predicting. And it is very much in line with what I believe the Commission will be saying.

David Crossan – Won’t below-forecast growth compromise France’s zero-deficit target for 2012?

Christine Lagarde – Noticeably lower growth obviously means noticeably lower tax revenue. But, when you are keeping expenditure under control, and trying to significantly reduce by constantly reviewing public policy, of course you have a tough job. But this is clearly what we are targeting.

David Crossan – We have seen that the international environment was unfavourable for France but did local factors contribute to low Q2 figures? Laurence Parisot, the leader of the employers’ federation, has criticised your government for relentlessly announcing new labour charges and taxes, and denounced a “quasi-soviet” ideology among the French elite. Is that not tough to hear for a pro-business government?

Christine Lagarde – Laurence Parisot is a fabulous and fascinating communicator and she is very dedicated to her job defending companies. I really respect that. I think that enterprise should be encouraged. But let me just put things in perspective. In 2008, we have injected over €7 billion into the French economy, relieved labour and overtime charges, eliminated inheritance taxes (particularly for surviving spouses), and cut taxes by deducting mortgage interest rates. All that is money going into the economy. It is really working as a stimulus package. That was not the original purpose, but it is working as a stimulus package. We will be doing the same in 2009. The President has also pledged to eliminate what we call fixed corporate tax (which companies pay whether they make a profit or not). That, in and of itself, is a clear sign to companies that we want to relieve and reduce their tax burden. My team and I are currently working on a wholesale revamp on the professional tax (which does not exist anywhere else). That, again, will relieve company burdens.

David Crossan – Nevertheless, the French Government does not seem to have much latitude. At a press conference in January this year, President Sarkozy asked the journalists in the room and the French people, “What do you want me do to? Empty the coffers that are already empty?” And that was before things took a turn for a worse. There’s not much left for the French Government to do apart from tweaking at the edges, is there?

Christine Lagarde – If you call an in-depth reform across the French economy and employment market “tweaking at the edges”, I’m in trouble! I’m only joking. But, frankly, what we are doing at the moment is reforming the structure of the French economy and the structure of the French employment market. This is critical. Our economy and employment market were constricted, restrained, buried under layers of permits, prohibitions, requirements, red tape and so on. Competition could clearly not play its role. I am personally convinced that competition – properly reinstated and properly supervised, which is why we enhance the French competition watchdog’s authority – can affect the market in such a way that will benefit consumers.

David Crossan – But many consumers might say that more flexibility is all well and good and understand where the Government is coming from, but that they have also seen where it can lead to, in the case of the United States, for example, where unfettered markets have kick-started a crisis.

Christine Lagarde – You will have noted my comment about the authority. As much as I believe that there should be competition on the market, I believe we need an efficient competition authority. And that’s exactly what we’re doing. A sizeable portion of the problem that we are seeing on financial markets today has nothing to do with free markets: it has to do with the lack of a market (and the lack of market supervision in some instances).

David Crossan – Trust certainly needs to be restored in the financial sector given that banks don’t want to lend to each other…

Christine Lagarde – Trust is a key component in an economy that functions properly. That is one of the reasons why central banks are involved, coordinated and talking to each other at the moment. That is precisely with a view to restoring trust and confidence among the players.

David Crossan – How would you respond to charges – again, quoting Laurence Parisot – that every reform entailed an extra tax in France?

Christine Lagarde – I have presented 10 major bills in Parliament this year. We have injected money under the law on overtime, and under the law to modernise the economy, without creating any new taxes. We have eliminated taxes. If the underlying suggestion is that we are creating taxes to change people’s behaviour, and to move towards protecting our environment and the world more effectively, then I think it is warranted. Added to that, the President has asked me to think about restructuring our tax system without adding to the tax burden. He didn’t say “no added taxes” because you can reorganise the system, and redirect it based on what you want for your children and grandchildren.

David Crossan – Many thanks to Christine Lagarde, French Finance Minister, for appearing on the all-new English version of Politics. There will be another one coming your way on France 24 any time soon. Thanks for now.