Public Information Notice: IMF Concludes 2004 Article IV Consultation with Italy

February 9, 2005

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On February 7, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Italy.1


A cyclical recovery is underway, with real GDP having risen by 1.2 percent in the first three quarters of 2004 relative to the same period of the previous year, thanks to the favorable external environment and a recovery of investment. Staff forecasts growth of 1.5 percent in 2004 and 1.7 percent in 2005, the latter broadly in line with consensus forecasts but below the official projection of 2.1 percent. Despite the increase in international oil prices in 2004, price pressures are expected to remain moderate, with inflation averaging only about 2¼ percent this year.

A package of corrective measures adopted in mid-2004 is likely to have proven sufficient to keep the fiscal deficit just below 3 percent of GDP last year. Nevertheless, significant reliance on one-off measures and the large gap between the Stability and Growth Pact deficit and the public sector borrowing requirement (net of privatization receipts) remain sources of concern. The 2005 budget targets a small reduction in the headline deficit, to 2.7 percent of GDP, based in part on new measures to control expenditure growth. The budget includes a personal income tax cut of about ½ percent of GDP.

Labor market reforms and wage moderation have led to a substantial increase in hours worked in recent years, although the employment ratio remains the lowest in the euro area. Stagnant productivity, however, has offset much of the growth impact of improved labor market performance. In this respect, a lack of competition in key sectors and problems with the business environment are widely recognized as impediments to investment, innovation, and growth. Progress has been made in increasing competition in the energy sector, but advances in other areas, and in improving the business environment more generally, have been more limited.

Banking system developments in 2004 were generally positive, with profitability and vulnerability indicators improving. Following the high-profile bankruptcy of Parmalat in December 2003, the authorities introduced a draft law to strengthen securities regulation, but passage of the law has been delayed. In response, the authorities have incorporated some key elements of the reform strengthening the powers and resources of Consob (the securities regulator) in the area of investor protection into a draft law implementing the EU's market abuse directive, which is also under consideration by Parliament.

Executive Board Assessment

Italy's short-term economic prospects are improving, based on a rebound in investment and exports, while inflation remains moderate. However, the economic recovery is likely to be modest, and there are downside risks stemming from high oil prices and the appreciation of the euro. More broadly, Italy's growth potential remains constrained by long-standing supply-side weaknesses and continuing uncertainty over fiscal prospects. Against this background, Directors considered that a key challenge facing Italy is to enhance its growth potential by securing durable fiscal consolidation and pressing ahead with further structural reforms to enhance competition and strengthen the business environment. Progress in these areas will require determined efforts to shape a supportive national consensus.

Directors underlined the importance of a strong and credible medium-term fiscal strategy based on durable adjustment measures to ensure the long-term sustainability of the fiscal accounts. In view of the high public debt burden, they felt that the objective of achieving a small structural fiscal surplus before the end of the decade still remains appropriate, and regretted that the authorities' economic plans had dropped a previous explicit commitment to this effect. They commended the implementation of the pension reform, and called on the authorities to move quickly to finalize supporting legislation and adjust pension replacement rates in line with increases in life expectancy.

While acknowledging that Italy has been able to keep its fiscal deficit below the Stability and Growth Pact's ceiling, Directors noted that this was in large part due to significant reliance on one-off measures. Looking forward, they noted that the fiscal adjustment envisioned in the 2005 budget—with a small decline in the overall deficit and a limited decline in one-off measures—again falls short of what is needed. Moreover, there are risks that the deficit target might be missed in the absence of further action. Directors called on the authorities to be prepared to adopt structural measures over the course of 2005 to ensure that the target is met. While recognizing the need for reductions in the tax burden over the medium term, Directors believed that the tax cut implemented this year should have been tied to additional structural expenditure cuts or delayed. They also cautioned that fiscal decentralization will need to be accompanied by strengthened coordination among government units, the adoption of transparent and stable rules, and strict monitoring of compliance with these rules in order to avoid a loosening of the fiscal stance.

Directors underscored the need to continue improving the structure of the public finances, and welcomed the government's commitment to eliminate one-off measures by 2006. Given Italy's high tax ratio, Directors emphasized that any additional adjustment should focus on current spending, and welcomed the newly-introduced uniform cap on spending growth as consistent with this objective. They noted that incorporating these spending limits into a system of multi-year spending reviews could help develop and protect budget priorities. Directors supported the authorities' plans to step up privatization efforts. At the same time, they stressed that transactions such as securitization of future income flows, sales and lease-backs of assets, and the sale of parts of the road network might well have negative implications for future budgets and would therefore need to be assessed carefully.

Directors observed that fiscal transparency needs to be improved. The decline in the public debt ratio in recent years has been muted by the large gap between the fiscal deficit and the public sector borrowing requirement net of privatization receipts. They welcomed recent initiatives to clarify the sources of this discrepancy, but underscored the urgency of strengthening these efforts with a view to focusing on the economic causes of the persistently larger borrowing requirement.

Directors were encouraged by the positive results from labor market reforms, including increases in the employment rate and in hours worked. However, the employment ratio is still low, while regional and demographic disparities in unemployment rates remain large. Directors therefore recommended approval of the second stage of the "Biagi" labor market reform bill, which would further reduce rigidities. They also encouraged the social partners to agree to greater decentralization of the wage bargaining process and increased wage flexibility, with some Directors observing that the authorities could contribute to this goal by accelerating the construction of regional cost-of-living indexes and anchoring public sector wage increases to them. Some Directors noted that the implications of wage decentralization for fiscal federalism would need to be taken into consideration. Also, labor market reforms should be accompanied by increased efforts to enhance the quality of the labor force through training and education.

Directors stressed the need to raise Italy's low productivity growth, including through greater competition in product markets and enhancement of the business environment, noting that deep-seated rigidities are hampering competition and impeding innovation, investment, and efficiency. While commending some progress made in the energy sector, Directors called on the authorities to promote competition more forcefully through regulatory reforms, and to address shortcomings in the business environment, including through measures to accelerate legal procedures and to eliminate red tape. In particular, they emphasized the importance of enacting the long-delayed reform of the bankruptcy law.

Directors welcomed the continuing positive trends in Italy's financial sector, as indicated by the first round of the Financial Sector Assessment Program. They noted the increase in bank profitability, which has contributed to improvements in financial vulnerability indicators. A few Directors cautioned, however, that despite substantial progress, non-performing loans remain relatively high, partly reflecting the length of recovery procedures. While observing that financial sector supervision is generally strong, Directors recommended prompt passage of reforms designed to enhance the powers of the securities market regulator. They noted the importance of strengthening corporate governance standards, and welcomed the forthcoming introduction of a legislative package that will address this issue. Directors looked forward to the results of the next round of the Financial Sector Assessment Program.

Directors welcomed the authorities' commitment to increase overseas development assistance to 0.33 percent of GDP by 2006, and encouraged faster progress toward meeting the United Nations' target of 0.7 percent of GNP. Directors encouraged the authorities to continue to resist pressures for increased trade protection, and to monitor the domestic impact of the expiration of textile export quotas.

Directors noted that Italy's statistics are adequate for surveillance. They nevertheless underscored the need to address remaining weaknesses, some of which were identified in the 2002 Report on the Observance of Standards and Codes, and to clarify the reasons for the persistent discrepancy between the fiscal deficit and the borrowing requirement net of privatization revenues.

Italy: Selected Economic Indicators






2004 1/

2005 1/

Real economy (change in percent)









Domestic demand














Unemployment rate (in percent)








Public finances (general government; in percent of GDP)


Overall balance







Structural balance 2/







Gross debt








Money and credit (end of year, percent change)


Private sector credit 3/ 4/







Contribution to euro-area M3 5/ 6/








Interest rates (year average) 7/


Six-month rate on treasury bills







Government bond rate, ten-year








Balance of payments (in percent of GDP)


Trade balance







Current account








Fund position (as of November 30, 2004)


Holdings of currency (in percent of quota)


Holdings of SDRs (in percent of allocation)


Quota (in millions of SDRs)



Exchange rate


Exchange rate regime

Euro-area member

Present rate (February 7, 2005)

US$1.2857 per euro

Exchange rate (change in percent)


Nominal effective 8/







Real effective (based on unit labor cost) 9/







Sources: Italian authorities; IMF: International Financial Statistics; World Bank: World Development Indicators; Bloomberg; Eurostat; and IMF Staff estimates and projections.

1/ Staff estimates and projections, unless otherwise noted.

2/ Structural balances are calculated using the staff's estimates of potential output and exclude one-off measures.

3/ Data for 2004 refer to end-June.

4/ Twelve-month credit growth, adjusted for securitizations.

5/ Data for 2004 refer to end-October.

6/ Excludes the currency in circulation held by non-bank private sector.

7/ Data for 2004 refer to end-November.

8/ Data for 2004 refer to end-September.

9/ Based on CPI.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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