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Italy and the IMF
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On November 5, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Italy.1
Final domestic demand in Italy began to decelerate in the second half of 2000, and economic weakness became more widespread by early 2001. The initial deceleration in domestic demand reflected in part an unwinding of the stimulus from earlier declines in interest rates (related to adoption of the euro), as well as negative effects on households' disposable income of higher energy prices and terms of trade losses. Moreover, weaker external demand led to a sharp deceleration of exports and industrial activity by early 2001, and GDP growth stagnated in the second quarter. With relatively slow growth over much of the past decade, Italy's output gap is estimated by staff at around 2 percent, the highest in the euro area. Earlier pressures on headline inflation are abating: as energy prices reversed part of their earlier rise, harmonized consumer price inflation has begun to decline—to 2.6 percent (year-on-year) in September after a peak of 3.0 percent in April—and the positive differential relative to the euro-area average has been closed. Wage increases have remained moderate and eschewed spillovers from higher import prices, especially in the private sector. Wage restraint has supported employment growth, and the unemployment rate fell to 9.2 percent in July from 10.1 percent a year earlier. Still, demographic and regional imbalances in the labor market remain pervasive, with unemployment much higher in the South and among women and the young.
In 2000, further progress was made on fiscal consolidation—the general government deficit met the targeted 1.5 percent of GDP, and public debt declined in relation to GDP to 110 percent. For 2001, however, achieving the deficit target of 0.8 percent will be difficult in light of sizable expenditure overruns, especially on health care expenditures and wages. At the same time, nominal revenues are expected to meet budget targets, reflecting improved tax administration and buoyant direct tax revenues.
In light of the worldwide economic slowdown and potential repercussions from the September 11 terrorist attacks, prospects for a recovery in the near term have dimmed. Staff expects GDP growth to be limited to 1.8 percent in 2001 and to 1.4 percent in 2002. These projections are, however, subject to considerable uncertainty, not least related to the unfolding of the fallout from the September attacks. On the downside, confidence could deteriorate sharply, lowering domestic demand, especially for investment and consumer durables; and external demand could also weaken more than currently anticipated. On the upside, monetary easing and lower oil prices could trigger a more robust recovery. As discussed in the Executive Board assessment below, the outlook for growth over the medium term will depend crucially on the pace of structural reform in general, and on further increases in labor-force participation in particular.
Executive Board Assessment
Executive Directors commended the authorities for achieving macroeconomic stability, containing inflation, reducing unemployment, lowering public debt, and moving structural reforms forward in a number of areas. However, Directors noted that Italy's recent growth performance was among the weakest for industrial countries and that major fiscal and structural challenges remain. Against this background, they welcomed the authorities' intention to undertake reforms aimed at reinvigorating growth and strengthening the public finances. In particular, Directors highlighted the need to reduce the tax burden, especially the tax wedge on labor; to mitigate the fiscal impact of population aging; and to further improve labor and product market performance. They encouraged the authorities to implement this reform agenda quickly and decisively, although several Directors also underlined the desirability of building a broad consensus, especially in the current unsettled environment.
Directors considered the near-term economic outlook to be fraught with uncertainty, given the present global slowdown. Notwithstanding recent monetary easing by the European Central Bank, which would be supportive of a recovery in activity, they viewed monetary conditions as remaining somewhat tight from a purely domestic perspective, noting Italy's large output gap and abating inflationary pressures. They considered external competitiveness as broadly satisfactory at present.
Directors viewed favorably the reduction in the budget deficit in 2001, despite weaker than expected real growth, although they regretted that primary expenditure had again exceeded the budget targets. They welcomed Italy's intention to live up to its Stability Program commitments in 2002 and 2003. Many Directors expressed concern, however, that underlying adjustment in 2002 was being postponed, with deficit targets to be met through asset sales implying that the fiscal support to economic activity would go beyond the operation of automatic stabilizers. Directors discussed the authorities' plans to handle these asset sales through a new financial vehicle, and recommended caution in the use of this instrument. They recognized that such sales might qualify under the Stability and Growth Pact as deficit-reducing, but urged the authorities to focus on a durable reduction in public expenditure. They also considered that asset sales should be recorded rigorously.
While letting the automatic stabilizers operate on the revenue side was viewed as appropriate, most Directors saw little scope for discretionary fiscal policy to support aggregate demand, given the high public debt. A few Directors, however, considered this fiscal stimulus appropriate, in view of the weaknesses in economic activity. Directors endorsed the objective of a balanced budget by 2003.
Beyond 2003, Directors recommended adoption of a fiscal strategy that would decisively reduce Italy's still high public debt ratio, thereby avoiding the need for an increase in tax rates around the demographic peak. Directors considered that such a strategy would call for achieving and maintaining a structural primary surplus somewhat above 6 percent of GDP for the rest of the decade, a more ambitious target than implied by the broadly balanced overall budget indicated in Italy's Stability Program and in the authorities' medium-term plans.
Directors emphasized that the twin objectives of reducing both the deficit and the tax burden will require tight limits on the growth of public expenditure. In this regard, they welcomed the government's plans to reduce public employment, taking advantage of attrition and redeployment, and saw scope for winding down subsidies and tax expenditures. On social spending, Directors welcomed the progress achieved with earlier pension reforms, but stressed the need for further steps to limit the budgetary impact of population aging, and to rebalance spending from pensions toward programs that support labor market integration and the poor. Further pension reform could include a faster increase in the effective retirement age, an acceleration of the transition to a contribution-based system, and allowing a large role for private pension funds. Directors welcomed the recent agreement with the regions aimed at containing health expenditure, and stressed the need to make the delivery of health services more efficient and to contain expenditures on pharmaceuticals. They recommended the adoption of multi-year nominal expenditure ceilings, which could enhance the near-term credibility of fiscal policy, while allowing automatic stabilizers on the revenue side to operate unfettered.
On tax policy, Directors saw the need to establish an effective medium-term strategy, addressing the most severe distortions in the economy first, in particular the high tax wedge on labor income, which discourages labor participation and employment. However, the scope for tax reform will depend critically on implementation of durable expenditure reforms. Several Directors cautioned against using overly optimistic growth assumptions in medium-term budget projections. A few Directors also expressed reservations about the recourse to temporary tax incentives.
Directors welcomed the signs of improved economic performance in the South, as evidenced by faster output and employment growth, but regretted the persistence of very large regional imbalances. They emphasized that reduction of these imbalances will depend on improving labor market performance along several dimensions: the most important and urgent is to foster broad and productivity-based wage differentiation, but Directors also recommended the authorities to adopt additional measures to facilitate job-market entry, specifically for the young (including tax cuts and improvements in training); and to streamline and better target active labor market policies. They viewed the government's plan to facilitate enterprise migration from the informal to the formal economy as a useful step, provided it is accompanied by a credible strategy to reduce taxes and regulation over the medium term. Directors also stressed that further product market liberalization and privatization, along with efforts to strengthen local administrative capacity and law enforcement and to simplify administrative and procedural requirements for the setting up of businesses, will help spur investment in disadvantaged areas.
Directors welcomed the improvements in bank profitability and efficiency, and supported the authorities' call for banks to raise their risk-weighted capital ratios. They underlined the importance of reducing operating costs, and pointed to the potential benefits—for banks and borrowers alike—of a more efficient judicial process and a new bankruptcy law for nonfinancial corporations.
Directors welcomed Italy's aim to raise official development assistance toward the UN target and the authorities' policy objective of abolishing all EU barriers for exports from the poorest countries.
Italy provides adequate data for surveillance purposes. In view of the need to further improve some of the data, Directors welcomed the authorities' request to prepare a ROSC module on fiscal transparency, and, more generally, welcomed the intention to undertake several other ROSC modules.
|Italy: Selected Economic Indicators|
|Real economy (change in percent)|
|Unemployment rate (in percent)||11.8||11.4||10.6||9.5|
|Public finances (general government; in percent of GDP)|
|Overall balance 2/||-2.8||-1.8||-0.3||-1.2|
|Primary balance 2/||5.2||5.0||6.1||5.1|
|Money and credit (end of year, percent change)|
|Contribution to euro-area M3 3/||1.6||3.4||4.2||4.7|
|Total domestic credit||3.7||6.3||6.1||...|
|Interest rates (year average)|
|Six-month rate on treasury bills||4.6||3.0||4.5||4.1|
|Government bond rate, ten-year||4.9||4.7||5.6||5.0|
|Balance of payments (in percent of GDP)|
|Fund position (as of August 2001)|
|Holdings of currency (in percent of quota)||68.4|
|Holdings of SDRs (in percent of allocation)||36.0|
|Quota (in millions of SDRs)|
|Exchange rate regime||EMU member|
|Present rate (October 15, 2001)||US$0.910 per euro|
|Nominal effective exchange rate 4/||-0.4||-1.7||-3.2||0.3|
|Real effective exchange rate based on unit labor cost 4/||-1.9||-0.3||-3.2||-0.7|
|Sources: Data provided by the Italian authorities; International Financial Statistics; and IMF staff estimates and projections.
|1/ IMF staff estimates and projections.|
|2/ For 2000, including UMTS receipts of 1.2 percent of GDP. For 2001, including estimated receipts from asset sales of 0.2 percent of GDP.|
|3/ For 2001, year-on-year change for July.|
|4/ For 2001, based on monthly average to August.|
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. This PIN summarizes the views of the Executive Board as expressed during the November 5, 2001 Executive Board discussion based on the staff report.
IMF EXTERNAL RELATIONS DEPARTMENT