By Daniel Flynn and Jean-Baptiste Vey
PARIS (Reuters) - French President Francois Hollande, elected in May on a promise to avoid growth-sapping austerity measures, should make tough savings and public sector job cuts to meet a European deficit target, the national audit office said in a report on Monday.
Economists have warned for months that faltering economic growth was gnawing a hole in state revenues, but Hollande kept the issue largely under wraps until he won the presidency and his Socialist party topped parliamentary elections in June.
He now risks angering the public, along with leftist allies and trade unions, to achieve what the audit office estimated would be more than 33 billion euros ($42 billion) in savings next year to reach an EU deficit goal of 3 percent of GDP.
Including an additional one-off charge of 5 billion euros to cover tax repayments to foreign investment funds mandated by a recent EU ruling, next year's adjustment could total an unprecedented 4 percent of state spending.
That comes on top of 6-10 billion euros in budget savings needed this year for France to achieve a deficit target of 4.4 percent of GDP, the auditor said in a in-depth review into the health of state finances requested by Hollande on taking office.
With its debt already due to exceed 90 percent of GDP in 2012, a level at which economists say it starts to sap economic growth, France risks being sucked deeper into Europe's debt crisis unless it stuck to its targets, the auditor warned.
"The country is in the danger zone in terms of its economy and public finances. We cannot rule out the possibility of a debt spiral," Didier Migaud, head of the Court of Auditors, told a news conference. "2013 is a crucial year. The budgetary equation is going to be very hard: much harder than expected due to the worsening of the economic picture."
Despite progress last year in cutting its deficit, France remained a laggard in terms of reforming state finances. While most euro zone peers cut spending in 2011, France mainly relied on less efficient tax increases to trim its deficit to 5.2 percent of GDP - well above the 3.8 percent euro zone average.
"Missing deficit targets would damage France's credibility and could cause an unsustainable debt increase, making it impossible to finance it at sustainable interest rates," Migaud said.
The government will again rely on some 7.5 billion euros in tax rises, mostly on the wealthy and big corporations, in a revised 2012 budget due to go before the cabinet on Wednesday.
But for 2013, unpopular welfare and civil service job cuts appear unavoidable, the court said, appearing to run counter to Hollande's insistence that his government would hold the overall number of government employees steady.
"An unprecedented brake on public spending and increases in taxation are required," Migaud said. "If the government wants any room for maneuver, it needs to cut its number of staff."
AUDITOR WARNS ON GROWTH
Public sector job cuts will be tough to explain to an electorate already fretting over a wave of private sector layoffs and alarmed at the prospect of a squeeze on their generous welfare system. State spending in France runs at 56 percent of GDP, second only to Denmark in the western world.
Persistent economic gloom was a key reason why Hollande defeated conservative Nicolas Sarkozy last month. Fears of more misery have already knocked seven points off the new president's approval rating to 51 percent, one poll showed.
Migaud is a Socialist politician appointed by Sarkozy, giving the auditor's recommendations bipartisan authority.
The auditor said it had not uncovered any skeletons left by Sarkozy's outgoing government but pointed to 1.2 to 2 billion euros of likely unfunded spending this year in areas like defense, agriculture and housing, saying this was normal.
"The state auditor has called for a continuation of the budgetary responsibility we showed in office," said Jean Francois Cope, secretary general of the conservative opposition UMP party. "The realist Left ... will turn out to follow right-wing policies."
The root of the problem is that France's budget was too optimistic on growth and the likely rise in tax revenues. The auditor said 2012 growth would likely be around 0.4 percent, less than the 0.7 percent budgeted figure, and 1 percent for 2013, shy of the previous government's 1.75 percent forecast.
Finance Minister Pierre Moscovici said in a newspaper interview published on Monday the government would revise down official growth forecasts in line with these estimates as it uses the audit to prepare the 2013 budget, due in the autumn.
"There are a few priority (government departments) like education, justice, security and the unemployment office, which will see their resources increase, but for the rest, we need to make savings," he told the newspaper.
If the 33 billion euros next year were split evenly between spending reductions and new taxes, the government could find the 16.5 billion euros of expenditure savings by slowing state spending increases to the pace of inflation, the auditors said.
Prime Minister Jean-Marc Ayrault, due to set out his legislative agenda on Tuesday, has said the central government - which accounts for four-fifths of the deficit - would hold spending flat between 2013 and 2015. Economists have questioned whether this can be done without cutting staff.
To boost tax revenues, the auditor recommended slashing widespread exemptions and increasing broad-based levies such as sales tax and the CSG welfare charge. Hollande's government has already said it will roll back Sarkozy's decision to shift some of France's onerous labor charges onto an increase in value added tax (VAT), a form of sales tax applied by all EU states.
Budget Minister Jerome Cahuzac said there would be no VAT rise in the amended 2012 budget bill and he played down expectations of a tax increase in 2013: "In principle, that was not - if I remember correctly - in Francois Hollande's election manifesto," he told reporters.
The court report did not take into account measures approved by the government since it took office in mid-May, including a 2 percent rise in the minimum wage, which would increase pressure on public spending, officials said.
($1 = 0.7880 euros)
(Editing by Paul Taylor and Will Waterman)