Public Information Notices

Italy and the IMF

Public Information Notice (PIN) No. 99/52
June 23, 1999
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes Article IV Consultation with Italy

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 June 3, 1999, the Executive Board concluded the Article IV consultation with Italy.1


Economic activity remained weak in 1998, and real GDP increased by only 1.4 percent. In part, this reflected a marked deterioration in the external environment—in the aftermath of the Asian crisis, Italy’s trade balance with the region deteriorated more than that of its European partners, reflecting to some extent differences in the commodity structure. Domestic demand weakened toward the end of the year, as investment declined and household consumption stagnated. Unemployment remained unchanged from the previous year’s peak of 12.3 percent and large regional disparities continued, with the unemployment rate in the South well above 20 percent. The inflation differential between Italy and the euro area widened during 1998, and consumer price inflation, at 2.0 percent (harmonized basis), was 1 percentage point above the euro area average. The differential narrowed significantly in early 1999, as wage growth rates converged to euro-area levels.

The Bank of Italy maintained a relatively tight monetary stance during most of 1998, with a view to minimizing the risks of financial turbulence in the run up to EMU. However, monetary conditions eased considerably toward the end of 1998 and in early 1999, associated with entry into monetary union and the European Central Bank’s (ECB’s) decision to reduce interest rates in April.

Notwithstanding lower-than-anticipated real GDP growth, fiscal policy remained broadly on target in 1998, with the deficit of the general government stable at 2.7 percent of GDP. Lower-than-budgeted interest payments compensated for the deterioration in the primary balance, which reflected on the revenue side the underperformance of the newly introduced regional tax on firms’ value added (IRAP), and on the expenditure side overruns on health and capital spending. Gross government debt declined from 122.3 percent of GDP to 118.7 percent in 1998.

In 1999, real GDP is expected to grow by 1 percent. This assumes that activity will strengthen considerably in the latter part of the year, reflecting the expected pickup in external demand and the lagged impact of the earlier easing in monetary conditions. There are, however, considerable downside risks to this growth forecast: external demand may not accelerate as envisaged; consumer demand could decelerate, especially if unemployment were to rise. The outlook for the medium term indicates annual real GDP growth of around 2 percent during 2000–04; but growth prospects hinge crucially on progress in addressing persistent structural rigidities, notably the high tax burden and labor market rigidities, and the need for further product market deregulation and public sector reform. Some reforms have already been initiated, including several steps to increase flexibility in the labor market, which are beginning to bear fruit and contributed to an increase in employment in 1998. And schemes to stimulate investment and employment in depressed areas, notably in the South, have been strengthened.

The 1999 budget targeted a deficit for the general government of 2.0 percent of GDP, predicated on real GDP growth of 2.5 percent. More recently, the authorities have revised their estimate to 2.4 percent of GDP.

Executive Board Assessment

Executive Directors commended the authorities for their persistent pursuit of macroeconomic policies, which had sharply reduced the fiscal deficit, resulted in low inflation and interest rates, and enabled Italy to be an initial euro participant. However, EMU participation made it necessary to urgently address a number of remaining issues. These included achieving a sustainable fiscal position that would allow a rapid decline in the public debt ratio from a level that was still very high, reforming the pension and welfare systems that were both costly and inefficient, and removing structural rigidities in labor and product markets. Progress in these areas was seen as an integral part of a policy strategy to reignite more dynamic output and employment growth, particularly in the South.

Directors noted that, despite considerably weaker economic growth than assumed in the budget, the 1998 fiscal deficit had remained broadly on target. At the same time, they noted that this had been achieved to a large extent by lower than envisaged interest payments, with slippages having emerged in some revenue and expenditure categories.

Regarding 1999, Directors viewed monetary conditions as supportive of real growth, and external competitiveness as broadly satisfactory. As real GDP growth was now likely to turn out considerably weaker than previously anticipated, Directors agreed that there would be room, and indeed a useful role, for a substantial operation of automatic fiscal stabilizers. However, a few Directors considered that the cyclical weakening in revenues was broadly matched by further savings in interest payments. Some also noted that the projected failure to meet the overall fiscal balance target was due largely to budgetary developments unrelated to the cycle. Most Directorsurged the authorities to make every effort to keep the overall deficit in 1999 as close as possible to the original target of 2 percent of GDP, and, in any case, below 2.4 percent of GDP, which they considered to be a ceiling, and not a target. A few of these Directors called for early adoption of additional measures to this effect. Others, however, considered the more supportive fiscal stance appropriate and not a cause for concern.

Directors emphasized that the projected deviation from the original target should not be allowed to compromise the authorities’ medium-term objectives. They observed that, as in most countries of the European Union, further steps would be necessary to place the public finances firmly on a sound medium-term footing. In particular, Directors noted that the long-term needs to reduce the debt ratio rapidly, and prepare for the aging of the population, argued for targeting a primary budget surplus of about 5.5 percent of GDP, and an overall budget surplus over the medium term. Several Directors welcomed the authorities’ readiness to take additional measures, if needed.

Directors also stressed that the composition of the medium-term fiscal adjustment was important in fostering more dynamic growth. In particular, sufficient room would need to be created to allow a lowering of the direct tax and social security contribution burdens. They welcomed some of the recent initiatives envisaged in this area and encouraged the authorities to redouble their efforts so as to reach, as soon as possible, the reduction in the tax burden envisaged in the Stability Program. To be sustainable, however, this reduction would also need to be accompanied by substantial cuts in primary current expenditures. They noted that such savings would necessitate significant further retrenchment in public employment, improved efficiency in social spending, and reduced subsidies, notably to the public transportation sector. They stressed the importance of using the proceeds of privatization to reduce the debt-to-GDP ratio.

While welcoming the various steps taken since 1992, Directors argued that further reform of the social security system would be needed to make the system sustainable in the face of likely demographic and economic trends. On pensions, in particular, they stressed that recent reforms needed to be strengthened to contain projected future increases in expenditure and in the pension funds’ imbalances. Important measures in this direction included accelerating the increase in the effective retirement age, and extending the previous reforms to cover all employee categories.

On the structural front, despite appreciable progress in a number of areas in recent years, Directors noted the persistence of rigidities that would need to be addressed to improve economic performance and ensure sustainable growth over the medium term. On product markets, Directors welcomed recent initiatives in the areas of privatization and deregulation. They were of the view that further privatization of the energy sector and rapid deregulation of the gas market would be particularly helpful in fostering competition. On the banking system, Directors called for rapid completion of the state’s divestiture, and a further tightening of restrictions on controlling interests of foundations,2 while also allowing a market-based consolidation of the sector, with public intervention limited to enforcing prudential regulations and transparency.

Directors expressed concern about the slow progress in overcoming the protracted problems that hamper economic performance in the South, most visible in the persistence of very high regional unemployment levels. They emphasized that an integrated strategy was needed to secure an economic takeoff in the South, including further steps to promote wage flexibility, improve governance, strengthen regional accountability through fiscal reform, and ensure adequate infrastructure investment. In addition, Directors stressed the need for greater wage differentiation, particularly at the entry level into the labor market.

In other areas of labor market reform, Directors welcomed signs that earlier initiatives to enhance flexibility, including through part-time and fixed-term employment, were beginning to bear fruit. They called for broader reform, especially as regards high dismissal costs, and stressed the need to increase the scope, and quality, of job training and apprenticeship programs. Reflecting concern about the potential adverse impact of a mandated 35-hour week, especially on small- and medium-sized firms, Directors welcomed assurances not to press ahead with planned legislation.

Directors welcomed Italy’s support for the Heavily Indebted Poor Countries (HIPC) Initiative, but regretted the adverse impact of recent budgetary restraint on official development assistance. They urged the authorities to complement their commendable support for the international community by increasing official development assistance from 0.1 percent of GNP in 1997 toward the UN-recommended level of 0.7 percent of GNP.

Italy: Selected Economic Indicators

1996 1997 1998 1999 1/

Real economy (change in percent)
GDP 0.9 1.5 1.4 1.5
Domestic demand 0.2 2.4 2.6 1.7
Harmonized CPI ... 1.9 2.0 1.3
Unemployment rate (in percent) 2/ 12.1 12.3 12.3 12.2
Gross national saving (in percent of GDP) 21.4 21.2 21.2 21.5
Gross domestic investment (in percent of GDP) 18.0 18.3 18.8 19.2
Public finances (general government; in percent of GDP)
Overall balance -6.6 -2.7 -2.7 -2.6
Primary balance 4.0 6.6 4.9 4.3
Gross debt 124.6 122.3 118.7 117.4
Money and credit (end of year, percent change)
Money (M2) 3.5 7.8 4.8 ...
Harmonized M3 ... -0.1 0.2 ...
Total domestic credit 5.1 3.1 3.8 ...
Interest rates (year average)
Three-month rate on treasury bills 8.6 6.6 4.8 ...
Government bond rate, ten-year 9.4 6.9 4.9 ...
Balance of payments (in percent of GDP)
Trade balance 5.0 4.1 3.6 3.5
Current account 3.4 3.0 2.3 2.3
Fund position (as of March 1999)
Holdings of currency (in percent of quota) 59.2
Holdings of SDRs (in percent of allocation) 12.2
Quota (in millions of SDRs) 7,056
Exchange rate
Exchange rate regime EMU Member
Present rate (May 14, 1999) US$1.07 per euro
Nominal effective exchange rate 9.2 0.8 -0.4 ...
Real effective exchange rate based on unit labor cost 11.2 2.9 0.6 ...

Sources: Data provided by the Italian authorities; International Financial Statistics; and IMF staff estimates and projections.

1/ IMF staff estimates and projections.
2/ Excluding workers in the Wage Supplementation Fund.

1Under 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 directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.

2Nonprofit organizations whose boards are appointed by local governments or by the Treasury, although they remain formally independent in carrying out their activities.


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