Public Information Notices

Italy and the IMF

Public Information Notice (PIN) No. 00/40
June 13, 2000
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 5, 2000, the Executive Board concluded the Article IV consultation with Italy.1


Following a decade of slow growth, the Italian economy entered a phase of cyclical upswing since mid-1999, which, however, remains weaker than elsewhere in the euro area. Exports, which had been strongly affected by direct and third-market effects of the Asian crisis, rebounded markedly after mid-1999, helped by a recovery of world demand and the depreciation of the euro; investment has accelerated, including in construction; but household consumption remains relatively subdued. Employment growth held up relatively well for the second year in a row in 1999, mainly reflecting the impact of the 1997 liberalization of temporary and part-time work contracts. On the other hand, higher participation left the unemployment rate above 11 percent, the second highest in the euro area, and large regional disparities continued, with the unemployment rate in the South well above 20 percent. Inflation accelerated to 2.5 percent in the spring of 2000, as oil prices rose and the euro depreciated. The differential vis-à-vis the euro area for underlying inflation has stayed at around ¾─1 percentage point, in part due to higher aggregate unit labor cost growth and relatively slower liberalization of some product markets. This has implied a moderate loss of competitiveness relative to the euro area, but on a multilateral basis the euro's depreciation has maintained price and cost competitiveness at a very favorable level.

Substantial progress was made in consolidating the public finances in 1999. Notwithstanding lower-than-expected GDP growth, the general government deficit was limited to 1.9 percent of GDP, well below the 2.4 percent ceiling set in March 1999. This favorable trend reflected a lower interest bill, as well as improvements in tax administration and robust growth in labor income—resulting in higher tax and nontax revenues, which more than compensated for primary expenditure slippages, including on health care. Gross government debt declined to 114.9 percent of GDP from 116.3 percent in 1998, helped also by privatization proceeds. The 2000 budget targets a further reduction of the general government deficit to 1.5 percent of GDP, in line with the Stability Program's goal of achieving approximate balance by 2003. The budget includes various measures to limit expenditure, and tax cuts equivalent to the estimated 1999 structural revenue overperformance (close to ½ percent of GDP).

With monetary conditions expected to remain supportive of activity and a broadly neutral fiscal stance, the cyclical upswing is likely to continue over the next two years: strong growth in exports and investment and a gradual recovery in consumption would support GDP growth of around 2¾ percent, versus 1.4 percent in 1999. The risks to this short-term projection seem broadly balanced: upside risks relate mainly to stronger growth in partner countries and in employment; on the downside, domestic demand and exports could suffer from stronger-than-anticipated effects of the oil price increase or a disorderly adjustment in the euro exchange rate and in equity prices. The outlook for the medium term is more uncertain: the economy's growth potential will depend crucially on the direction and pace of structural reforms, discussed below.

Executive Board Assessment

Executive Directors commended the authorities for pursuing stability-oriented policies that had achieved a remarkable reduction of the fiscal deficit and a sharp decline in inflation, and for initiating far-reaching structural reforms, including privatization. At the same time, Directors indicated that there was no room for complacency. With the exigencies of short-term stabilization largely behind it, Italy could now focus on longer-term structural issues: mitigating the fiscal impact of population aging; reducing the tax burden; and improving labor and product market performance. Progress in these areas was seen as essential for achieving sustained and regionally balanced growth and, more generally, was considered beneficial for the euro region as a whole.

Directors considered the near-term economic outlook to be favorable. They viewed monetary conditions as remaining supportive, and external competitiveness as broadly satisfactory; in this context, real growth should be above potential in the near term (although it would remain weaker than elsewhere in the euro area), while inflation was expected to abate as the effects of higher oil prices diminished. However, Directors saw risks to competitiveness if the euro were to appreciate sharply. Noting that the growth rebound in the recent period owed much to a good export performance, they considered that broader-based growth would depend crucially on continued wage moderation together with a firm pursuit of structural reforms, in particular far-reaching liberalization of labor and product markets and carrying through of the planned privatization programs.

With respect to fiscal policy, Directors welcomed that, despite weaker-than-expected real growth, the 1999 budget deficit was kept well below its limit. They noted, however, that this had been partly the result of revenue overperformance. For 2000, Directors viewed the deficit target of 1.5 percent of GDP as well within reach and broadly appropriate, from both a cyclical and longer-term perspective. Several Directors stressed that, in 2000, any windfall revenues should be dedicated to deficit reduction. Beyond 2000, Directors urged the adoption of a fiscal strategy that would decisively reduce Italy's still-high debt ratio, and also avoid the need for an increase in tax rates around the demographic peak. They thought that such a strategy would call for somewhat more ambitious targets than indicated in Italy's Stability Program, notably by allocating the benefits from above-potential growth and interest savings to deficit reduction, thus maintaining the primary surplus on average over the cycle at about the level expected for 2000 (a structural primary surplus somewhat above 6 percent of GDP). This would achieve a significant overall budget surplus by the end of the decade. A few Directors, however, thought that keeping the overall budget in balance over the cycle would be sufficiently ambitious for ensuring debt sustainability, while creating room for deeper, earlier tax cuts and for additional well-targeted social expenditure.

Directors emphasized that the twin objectives of reducing both the deficit and the tax burden require firmly limiting the growth of public expenditure. In this regard, scope was seen for further cuts in public employment, taking advantage of new technologies and of the room for increased mobility within the public sector offered by recent civil service reforms, and for trimming subsidies, notably those related to the postal service and railways. On social spending, Directors noted the major progress achieved in recent years, but stressed the need for further steps to limit the budgetary impact of population aging and to rebalance spending from pensions towards programs that support labor market integration and the poor. Further pension reform could include a faster increase in the effective retirement age and an acceleration of the transition to a contribution-based system. On health care, Directors expected decentralization to improve transparency, but its success in controlling costs depended on further steps: strengthening the regions' administrative capacity and incentives to comply with the Internal Stability Pact, and introducing mechanisms to rationalize health expenditure. Noting that the main risks to the achievement of the fiscal target lie at sub-national levels, Directors welcomed the authorities' intention to prevent excessive regional budget deficits arising from decentralization. Directors welcomed the planned introduction of a comprehensive unemployment insurance system, but cautioned that attention should be paid to ensuring strong incentives to seek training and employment―a challenge that also applied to the welfare program targeted at the poor.

On tax policy, Directors urged the authorities to focus as a key priority on reducing the tax wedge on labor, thereby lowering unemployment and raising participation. They took the view that further gains from improved tax administration and a broader tax base should be allocated to reducing tax rates. Several Directors expressed reservations about the frequent recourse to ad-hoc tax incentives.

Directors noted the disappointing persistence of very large regional imbalances. In this connection, they discussed the interlinkages between labor mobility, wage differentials, and job training―elements that must be considered in the reform of labor markets. Directors welcomed the improved transparency and local accountability embedded in the authorities' new development initiatives, but stressed that success will depend on injecting broad, productivity-based wage differentiation. They urged the adoption of a comprehensive strategy, especially for the young, entailing improved job training, one-time reductions in social security contributions, and derogations from national minimum wages well beyond those under the existing apprenticeship schemes. More generally, Directors underscored the importance of improving economic performance in all regions as crucial for achieving a substantial increase in Italy's long-run growth.

Directors welcomed the progress in strengthening bank balance sheets, which had resulted in a decline in the share of nonperforming loans. They underlined the importance of reducing operating costs. In addition, as the distinction between bank and nonbank financial activities was becoming increasingly blurred, Directors stressed the continuing importance of well-coordinated supervision.

Directors welcomed Italy's role in strengthening the Initiative for Heavily Indebted Poor Countries (HIPC). They encouraged raising official development assistance toward the UN target.

Italy provides adequate data for surveillance purposes. However, fiscal data in particular compare unfavorably to most advanced economies. Directors encouraged the authorities to take the necessary corrective steps.

Italy: Selected Economic Indicators

  1997 1998 1999 2000 1/

Real economy (change in percent) GDP 1.8 1.5 1.4 2.7
Domestic demand 2.5 2.9 2.5 2.5
Harmonized CPI 1.7 1.8 1.7 2.2
Unemployment rate (in percent) 2/ 11.7 11.8 11.4 11.0
Gross national saving (in percent of GDP) 21.7 21.5 21.2 22.0
Gross domestic investment (in percent of GDP) 18.9 19.7 20.3 21.2
Public finances (general government; in percent of GDP)        
Overall balance -2.7 -2.8 -1.9 -1.5
Primary balance 6.7 5.3 4.9 5.1
Gross debt 119.8 116.3 114.9 110.7
Money and credit (end of year, percent change)        
Money (M2) 7.8 2.9 4.8 ...
Harmonized M3   1.6 2.2 ...
Total domestic credit 3.5 4.4 6.5 ...
Interest rates (year average)        
Three-month rate on treasury bills 6.6 4.8 3.0 ...
Government bond rate, ten-year 6.9 4.9 4.7 ...
Balance of payments (in percent of GDP)        
Trade balance 3.4 3.1 1.8 1.6
Current account 2.8 1.8 0.9 0.8
Fund position (as of March 2000)  
Holdings of currency (in percent of quota)
Holdings of SDRs (in percent of allocation)
Quota (in millions of SDRs)
Exchange rate        
Exchange rate regime
EMU member
Present rate (April 24, 2000)
US$0.928 per euro
Nominal effective exchange rate 3/ 0.7 -0.4 -1.8 -3.4
Real effective exchange rate based on unit labor cost 3/ 2.8 0.5 -2.0 -3.7

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.
3/ For 2000, year-on-year change for first quarter.

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


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