## 1itaea2020001

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### Executive Board assessment and context
- Staff report based on discussions with Italian authorities in January 2020 and information as of January 28, 2020; prepared prior to the outbreak of COVID-19 in Italy and does not cover the outbreak or related policy response.
- Executive Directors:
  - expressed deep sympathy and solidarity with Italy for the high human and economic costs of the COVID-19 pandemic;
  - commended authorities for resolute, decisive actions.
- Directors’ near-term recognition: priority shift to combating the pandemic and supporting health care, workers, firms and households.
- Directors’ medium-term recommendation (post-health crisis): implement a comprehensive package to boost potential growth and enhance resilience comprising:
  - structural reforms to raise productivity and investment;
  - a credible medium-term fiscal consolidation to put public debt on a firm downward path;
  - measures to support financial sector health.

### COVID-19 developments and policy response (Supplement: as of March 11, 2020)
- Epidemic developments:
  - As of March 9, Italy ranked second behind China in the number of COVID-19 cases worldwide.
  - Over 9,000 people contracted the virus, up from three in mid-February.
  - The daily net inflow exceeded 1,000 net new cases in recent days.
  - About 80 percent of cases are concentrated in Lombardy, Veneto, and Emilia Romagna (constituting close to 40 percent of national GDP).
- Containment measures:
  - Local quarantines and public health safety measures implemented early.
  - March 7: several provinces put in lockdown; schools, universities, and public offices to be closed until early April.
  - March 9: nation-wide lockdown announced.
  - Companies in services asked employees to work from home; ban on exports of personal protective equipment imposed.
- Fiscal package:
  - March 5: government planned one-off measures increasing the overall deficit by €6.3 billion in 2020, including additional funds for healthcare and civil protection, income support for laid-off workers, suspension of tax payments for small- and medium-size enterprises, and state guarantees for banks to support credit.
  - European Commission acknowledged the need for flexibility in the fiscal framework.
- Financial market impact (as of March 9):
  - 10-year sovereign spread vis-à-vis German bunds rose to 228 basis points, over 90 basis points above pre-outbreak levels (February 21).
  - 10-year sovereign yield increased to around 1.4 percent.
  - Stock market index fell 25 percent; bank stocks fell around 30 percent.

### Data revisions for 2019
- 2019 fiscal deficit: 1.6 percent of GDP (better than authorities’ November estimate of 2.2 percent of GDP).
- Real GDP growth in 2019: 0.3 percent (marginally higher than preliminary estimates).
- Public debt/GDP ratio: remained constant (despite higher tax burden).
- Higher social benefit and public capital spending than previously estimated.
- National accounts revisions confirmed contraction at end-2019.

### Staff updated projections and risks
- Growth projections:
  - Staff revised 2020 growth forecast from about ½ percent to about ‒½ percent.
  - Growth over the medium term projected at around 0.7 percent (subject to uncertainty).
  - Staff note a high risk of a notably weaker outturn given escalated lockdown measures and the wider outbreak across Europe.
- Fiscal projections:
  - Staff projects an overall deficit of 2.6 percent of GDP in 2020.
  - The deficit could be higher if the virus impact is prolonged and growth substantially weaker.
  - The deficit improves slightly over the medium term consistent with government’s previously announced plans.
- Risks:
  - Uncertainty is very high and risks are sharply to the downside.
  - Continued infections and prolonged disruptions could cause a further sharp contraction in activity and potentially reignite the sovereign-bank nexus.
  - Prolonged weakness in key trading partners would further impact Italy; the public debt/GDP ratio would also worsen.
- Staff support:
  - Staff strongly supports authorities’ prompt near-term response focused on limiting human and economic effects of COVID-19.

### Key issues identified (pre-outbreak medium-term focus)
- Developments:
  - Fiscal policy implementation in 2019 was better than expected; engagement with the European Commission helped avoid launch of EU Excessive Deficit Procedure.
  - Following formation of a pro-EU government in September 2019, borrowing costs fell sharply.
  - Despite improvements, domestic policy uncertainty and a weakening external environment have taken a toll; low potential growth and a marked economic slowdown persist.
  - Average real income per capita remains 7 percent below pre-crisis (2007) levels.
  - Unemployment is close to 10 percent (historical average) with higher rates in some regions and among youth.
- Overarching challenges:
  - Raise growth and enhance resilience.
  - Staff projects growth in Italy to be the lowest in the EU over the next five years.
  - High public debt remains a key vulnerability.
  - Important financial sector weaknesses remain despite progress in strengthening bank balance sheets.

### Policy recommendations (medium-term priorities)
- Structural reforms:
  - Further liberalize product and service markets.
  - Decentralize wage bargaining to realign wages with labor productivity at the firm level.
  - Enhance public sector efficiency.
  - Deploy the new insolvency code.
- Fiscal policy:
  - Implement a credible medium-term consolidation that targets a small overall surplus and puts debt on a firmly declining path.
  - Establish credibility by legislating upfront pro-growth and inclusive measures such as:
    - reforming the tax system to broaden the base, lower statutory rates and help fight evasion;
    - cutting current primary spending; and
    - improving the design of the social safety net.
- Financial sector:
  - Improve bank profitability by rationalizing costs and encouraging further consolidation.
  - Bolster capital in weak banks.
  - Continue reducing nonperforming loans.
  - Strengthen the crisis management framework.
  - Use prudential policies to attenuate still strong sovereign-bank links.

### Selected economic indicators (excerpt)
- Real Economy (change in percent)
  - Real GDP: 2017: 1.7; 2018: 0.8; 2019: 0.3; 2020: -0.6; 2021: 0.8; 2022: 0.8
  - Final domestic demand: 2017: 1.5; 2018: 1.2; 2019: 0.4; 2020: -0.1; 2021: 0.7; 2022: 0.7
  - Exports of goods and services: 2017: 5.4; 2018: 2.3; 2019: 1.2; 2020: -1.9; 2021: 5.3; 2022: 3.2
  - Imports of goods and services: 2017: 6.1; 2018: 3.4; 2019: -0.4; 2020: -2.0; 2021: 4.9; 2022: 3.1
  - Consumer prices: 2017: 1.3; 2018: 1.2; 2019: 0.6; 2020: 0.7; 2021: 1.0; 2022: 1.2
  - Unemployment rate (percent): 2017: 11.3; 2018: 10.6; 2019: 10.0; 2020: 10.4; 2021: 10.2; 2022: 10.1
- Public Finances
  - General government net lending/borrowing (percent of GDP): 2017: -2.4; 2018: -2.2; 2019: -1.6; 2020: -2.6; 2021: -2.4; 2022: -2.3
  - Structural overall balance (percent of potential GDP): 2017: -1.8; 2018: -1.9; 2019: -1.3; 2020: -1.5; 2021: -1.8; 2022: -1.8
  - General government gross debt (percent of GDP): 2017: 134.1; 2018: 134.8; 2019: 134.8; 2020: 137.0; 2021: 136.9; 2022: 136.2
- Balance of Payments (percent of GDP)
  - Current account balance: 2017: 2.7; 2018: 2.6; 2019: 3.0; 2020: 3.1; 2021: 3.2; 2022: 3.0
  - Trade balance: 2017: 3.0; 2018: 2.5; 2019: 3.3; 2020: 3.3; 2021: 3.3; 2022: 3.2
- Exchange rate
  - Exchange rate regime: Member of the EMU
  - Exchange rate (national currency per U.S. dollar): 2017: 0.9; 2018: 0.8; 2019: 0.9

### Context, recent developments, and outlook (additional mission excerpts)
- Structural and social context:
  - Real income per capita remains below pre-euro levels and has fallen further behind peers.
  - Unemployment is high at 9.8 percent, with regional and demographic disparities:
    - Over 17 percent in the South.
    - Over 25 percent among youth.
  - Female labor force participation is the lowest in the EU.
  - Emigration of Italian citizens is near a five-decade high.
  - Staff projects potential growth at around ½ percent.
- Banking sector (selected figures at September 2019):
  - Fully loaded Common Equity Tier 1 ratio of major Italian banks: 13 percent (gap to EU average narrowed to 1.5 percentage points).
  - Nonperforming loans (NPLs): 7.3 percent of gross loans (down from 16 percent in 2016).
  - Banca Carige assets: €25 billion; Banca Popolare di Bari assets: €13 billion (administrators preparing recapitalization and restructuring with implementation expected in 2020:Q3).
  - ECB tiered remuneration prompted a one-off increase in reserves of around €50 billion and contributed to narrowing the Target 2 balance to -25 percent of GDP at end-2019.
- Credit developments:
  - Bank credit to households grew by 2.6 percent year-on-year in December 2019.
  - Credit to non-financial corporates contracted by -2.0 percent in December 2019.
  - The credit gap is negative at 10 percent of GDP.
  - Bank of Italy kept the countercyclical capital buffer rate at zero for 2020:Q1.
- Outlook and risks:
  - Staff projects growth at about ½ percent in 2020 and 0.6–0.7 percent thereafter.
  - Real income per capita projected to return to pre-crisis levels only in the mid-2020s.
  - Downside risks include global trade tensions, geopolitical events, oil price hikes, weakness in key trading partners, increases in sovereign spreads, broader/longer COVID-19 restrictions.
  - Upside: timely resolution of trade tensions and stronger demand response to lower yields could raise growth to about 1 percent.
  - Italian sovereign rating sits between one and three notches above sub-investment grade; downgrades below investment grade by all major rating agencies would be required for the ECB to exclude Italy from QE or increase collateral haircuts.

### Structural reform priorities and expected effects
- Labor market:
  - Decentralize wage bargaining, giving primacy to firm-level contracts.
    - Estimated growth dividend: about 5 percent of GDP over a decade (IMF working paper 18/60).
  - Consider statutory minimum wage discussions (de facto minima average €7½ per hour; possible statutory proposal at €9 per hour) with caution about effects on investment and informality.
  - Complementary measures: reduce tax wedge on secondary earners, expand child- and elderly-care services, lower dismissal costs uncertainty, improve higher education and skills.
- Product markets and public administration:
  - Remove entry barriers in professional services, foster consolidation in retail, strengthen enforcement powers of the Competition Authority.
  - Improve implementation capacity, digitization, procurement reform completion, and performance monitoring in public administration.
- Insolvency and justice:
  - Implement new insolvency code by August 2020; streamline civil judicial procedures; specialize courts.
- Governance and AML/CFT:
  - Implement 2019 anti-corruption law effectively.
  - Strengthen customer due diligence, beneficial ownership registers, and international cooperation in AML/CFT.

### Fiscal policy and tax reform
- Fiscal stance:
  - Authorities target an overall deficit of 2.2 percent of GDP in 2020, declining to 1.4 percent of GDP in 2022.
  - Staff forecasts a higher deficit path, at about 2 .4 percent of GDP in 2020 and declining very modestly thereafter.
  - Recommendation: deliver an overall surplus of ½ percent of GDP by around 2025 via gradual and balanced adjustment.
- Pension and safety net priorities:
  - Preserve indexation of retirement age to life expectancy; ensure actuarial fairness; address “Quota 100” discontinuity.
  - Redesign citizenship income: avoid very high marginal effective tax rates, consider gradual phase-outs, cap benefits at 40–70 percent of the relative poverty line, adjust regionally, and strengthen controls.
- Tax reform:
  - Average labor tax wedge: 47.9 percent (EU-15 average 41.8 percent).
  - Authorities’ plan: modest reduction by 0.2–0.3 percent of GDP in 2020–21 (extend national income tax bonus from €80 to €100 per month in 2020).
  - Staff recommendation: aim for reduction to the EU average; estimated cost could be 2 percent of GDP, to be offset by significant base broadening.
  - Estimated compliance gaps (foregone revenues): €109 billion (about 6 percent of GDP).
  - VAT and property tax reforms: streamline reduced VAT rates; update cadastral valuations; simulations indicate property tax reform (all properties subject to 0.55 percent rate) could raise 1 percent of GDP.

### Climate policy options
- Commitment: reduce carbon emissions by 20–25 percent by 2030.
- Staff estimate: reducing carbon emissions by 20 percent would require a uniform carbon tax of €70 per ton of CO2; any pre-existing excise taxes should be added.
- Policy options: phased-in carbon tax, targeted public infrastructure investment (Green New Deal), energy price liberalization, fiscal incentives for R&D, regulatory standards.
- Authorities: consider EU-level coordination for carbon taxes to avoid competitiveness impacts.

### Financial stability: progress, vulnerabilities, and recommendations
- Progress:
  - Improvements in bank capitalization and asset quality; NPLs down from 16 percent (2016) to 7.3 percent (September 2019) for major banks; consolidation of cooperative banks.
- Remaining vulnerabilities:
  - CET1 ratios remain below EU average on a fully-loaded basis.
  - NPL ratio remains more than twice the EU average for the system; some banks have double-digit ratios.
  - Reliance on ECB TLTRO by some banks.
  - Profitability remains below cost of equity; cost reduction needs estimated at about 15 percent aggregate to break even; severance costs estimated circa €10 billion.
- Recommendations:
  - Boost capital buffers guided by stress test findings and provisioning reviews.
  - Continue NPL reduction and extend SSM expectations to LSIs with high NPLs.
  - Promote cost rationalization, consolidation, technology investment.
  - Strengthen crisis management: timely escalation of measures, limit use of public funds, avoid preventive use of DGS except in exceptional rehabilitation cases, build additional loss-absorbing capacity, remove active bankers from DGS boards, assign power to Bank of Italy for compulsory administrative liquidation.
  - Establish national macroprudential authority; broaden toolkit (SyRB, borrower-based tools); consider phased prudential policies to moderate sovereign-bank nexus.

### Debt sustainability and stress scenarios (Annex IV highlights)
- Public debt: increased from about 100 percent of GDP in 2007 to 135.7 percent of GDP in 2019; projected to remain broadly stable at 130–135 percent of GDP in the medium term.
- Key debt structure facts:
  - About two-thirds of debt held by domestic investors.
  - Average residual maturity around 7½ years.
  - About 75 percent of debt at fixed interest rates.
  - Since March 2015, Eurosystem net purchases of Italian public debt were €364 billion.
- Baseline assumptions:
  - Real GDP growth projected to average 0.6 percent annually.
  - GDP deflator projected to rise from 0.9 percent in 2018 to around 1.5 percent steady state.
  - Government assumed to maintain average structural primary surplus of about 1 percent of GDP over 2018–2023.
  - Staff projects an effective nominal interest rate of about 2½ percent over medium term; marginal cost of borrowing at issuance projected to decrease to 0.7 percent in 2020 from 1.1 percent in 2018.
  - Spreads vis-à-vis German bunds assumed about 180 basis points through 2023.
- Shock scenarios and impacts:
  - Standard growth shock: growth lower by one standard deviation for two years starting 2020 → average growth of -1½ percent in 2020–21; primary balance reaches -1½ percent of GDP by 2021; debt increases to about 148 percent of GDP.
  - Interest rate shock: increase in spreads of 200 bps → implicit average interest rate on debt rises to 3 percent by 2024; debt increases to around 145 percent of GDP by 2024.
  - Contingent liability shock: one-time increase in non-interest expenditure standardized to about 10 percent of banking sector assets; primary balance worsens by 11 percent of GDP in 2020; debt rises to 170 percent of GDP by 2024.
- External debt:
  - Baseline external debt projected to decline from 121 percent of GDP in 2019 to 119 percent of GDP in 2024.
  - Growth shock has largest impact among standardized shocks, leaving external debt at 126 percent of GDP; historical scenario yields external debt at 158 percent of GDP by 2024.

### Annexes and implementation progress (Annex I highlights)
- Structural reforms — progress and next steps:
  - Labor markets: increased staffing at ANPAL; plans for electronic matching platforms; new decree to protect certain workers; next steps: decentralize wage bargaining, reduce dismissal uncertainty, coordinate ALMPs.
  - Product markets: limited progress since 2018; next steps: remove entry barriers in high-markup sectors, foster consolidation in low-productivity sectors.
  - Public administration: public administration bill approved June 2019; emergency decree to speed procurement; next steps: accelerate implementation, publish KPIs.
  - Insolvency: new insolvency code adopted early 2019; pending secondary legislation; code expected to enter force in August 2020.
- Fiscal consolidation:
  - Recommendation: adjust structural primary balance by about 2½ percent of GDP cumulatively over 2019–23.
  - Next steps: credible medium-term consolidation targeting a small overall surplus by about 2025; legislate upfront pro-growth and inclusive measures.
- Financial stability follow-up:
  - NPL reduction strategies agreed with SIs; GACS extended; SSM LSI SREP rollout to be completed by 2020.
  - Next steps: continue supervisory emphasis on provisioning and NPL strategies; extend SSM expectations to LSIs with high NPLs; build loss-absorbing capacity for LSIs.

### Key policy implications and sequencing
- Implement a mutually-reinforcing package: labor and product market reforms, financial-sector repair and consolidation, and credible medium-term fiscal consolidation.
- Use current low interest rates as a window to legislate reforms and consolidations.
- Prioritize implementation capacity, enforcement, and sequencing to maximize reform credibility and growth impact.
- Recommended timing: next Article IV consultation in the usual 12-month cycle.

*International Monetary Fund — Supplementary Information to the Staff Report for the 2020 Article IV Consultation with Italy (material in this summary is drawn from the document prepared by IMF staff as provided).*

### 2020. It focuses on Italy’s medium-term challenges and policy priorities and was

### ITALY — Staff Report for the 2020 Article IV Consultation (Supplementary Information)

### Executive Board assessment and context
- The staff report reflects discussions with the Italian authorities in January 2020 and is based on the information available as of January 28, 2020. It focuses on Italy’s medium-term challenges and policy priorities and was prepared prior to the outbreak of COVID-19 in Italy; it therefore does not cover the outbreak or the related policy response.
- Executive Directors expressed deep sympathy and solidarity with Italy for the high human and economic costs of the COVID-19 pandemic and commended authorities for resolute, decisive actions.
- Directors recognized the authorities’ near-term priority shift to combating the pandemic and supporting health care, workers, firms and households.
- Directors recommended that, once the health crisis has passed, Italy implement a comprehensive package to boost potential growth and enhance resilience comprising:
  - structural reforms to raise productivity and investment;
  - a credible medium-term fiscal consolidation to put public debt on a firm downward path; and
  - measures to support financial sector health.

### COVID-19 developments and policy response (Supplement: as of March 11, 2020)
- Epidemic developments:
  - As of March 9, Italy ranked second behind China in the number of COVID-19 cases worldwide.
  - Over 9,000 people contracted the virus, up from three in mid-February.
  - The daily net inflow exceeded 1,000 net new cases in recent days.
  - About 80 percent of cases are concentrated in Lombardy, Veneto, and Emilia Romagna (constituting close to 40 percent of national GDP).
- Containment measures:
  - Local quarantines and public health safety measures were implemented early.
  - On March 7, several provinces were put in lockdown; schools, universities, and public offices were to be closed until early April.
  - On March 9, a nation-wide lockdown was announced.
  - Companies in services asked employees to work from home; a ban on exports of personal protective equipment was imposed.
- Fiscal package:
  - On March 5, the government planned one-off measures increasing the overall deficit by €6.3 billion in 2020, including additional funds for healthcare and civil protection, income support for laid-off workers, suspension of tax payments for small- and medium-size enterprises, and state guarantees for banks to support credit.
  - The European Commission acknowledged the need for flexibility in the fiscal framework.
- Financial market impact (as of March 9):
  - 10-year sovereign spread vis-à-vis German bunds rose to 228 basis points, over 90 basis points above pre-outbreak levels (February 21).
  - 10-year sovereign yield increased to around 1.4 percent.
  - Stock market index fell 25 percent; bank stocks fell around 30 percent.

### Data revisions for 2019
- 2019 fiscal deficit: 1.6 percent of GDP (better than authorities’ November estimate of 2.2 percent of GDP).
- Real GDP growth in 2019: 0.3 percent (marginally higher than preliminary estimates).
- Public debt/GDP ratio: remained constant (despite higher tax burden).
- Higher social benefit and public capital spending than previously estimated.
- National accounts revisions confirmed contraction at end-2019.

### Staff updated projections and risks
- Growth projections:
  - Staff revised 2020 growth forecast from about ½ percent to about ‒½ percent.
  - Growth over the medium term projected at around 0.7 percent (subject to uncertainty).
  - Staff note a high risk of a notably weaker outturn given escalated lockdown measures and the wider outbreak across Europe.
- Fiscal projections:
  - Staff projects an overall deficit of 2.6 percent of GDP in 2020.
  - The deficit could be higher if the virus impact is prolonged and growth substantially weaker.
  - The deficit improves slightly over the medium term consistent with government’s previously announced plans.
- Risks:
  - Uncertainty is very high and risks are sharply to the downside.
  - Continued infections and prolonged disruptions could cause a further sharp contraction in activity and potentially reignite the sovereign-bank nexus.
  - Prolonged weakness in key trading partners would further impact Italy; the public debt/GDP ratio would also worsen.
- Staff support:
  - Staff strongly supports authorities’ prompt near-term response focused on limiting human and economic effects of COVID-19.

### Key issues identified (pre-outbreak medium-term focus)
- Developments:
  - Fiscal policy implementation in 2019 was better than expected; engagement with the European Commission helped avoid launch of EU Excessive Deficit Procedure.
  - Following the formation of a pro-EU government in September 2019, borrowing costs fell sharply.
  - Despite improvements, domestic policy uncertainty and a weakening external environment have taken a toll; low potential growth and a marked economic slowdown persist.
  - Average real income per capita remains 7 percent below pre-crisis (2007) levels.
  - Unemployment is close to 10 percent (historical average) with higher rates in some regions and among youth.
- Overarching challenges:
  - Raise growth and enhance resilience.
  - Staff projects growth in Italy to be the lowest in the EU over the next five years.
  - High public debt remains a key vulnerability.
  - Important financial sector weaknesses remain despite progress in strengthening bank balance sheets.

### Policy recommendations (medium-term priorities)
- Structural reforms:
  - Further liberalize product and service markets.
  - Decentralize wage bargaining to realign wages with labor productivity at the firm level.
  - Enhance public sector efficiency.
  - Deploy the new insolvency code.
- Fiscal policy:
  - Implement a credible medium-term consolidation that targets a small overall surplus and puts debt on a firmly declining path.
  - Establish credibility by legislating upfront pro-growth and inclusive measures such as:
    - reforming the tax system to broaden the base, lower statutory rates and help fight evasion;
    - cutting current primary spending; and
    - improving the design of the social safety net.
- Financial sector:
  - Improve bank profitability by rationalizing costs and encouraging further consolidation.
  - Bolster capital in weak banks.
  - Continue reducing nonperforming loans.
  - Strengthen the crisis management framework.
  - Use prudential policies to attenuate still strong sovereign-bank links.

### Selected economic indicators (excerpt)
- Real Economy (change in percent)
  - Real GDP: 2017: 1.7; 2018: 0.8; 2019: 0.3; 2020: -0.6; 2021: 0.8; 2022: 0.8
  - Final domestic demand: 2017: 1.5; 2018: 1.2; 2019: 0.4; 2020: -0.1; 2021: 0.7; 2022: 0.7
  - Exports of goods and services: 2017: 5.4; 2018: 2.3; 2019: 1.2; 2020: -1.9; 2021: 5.3; 2022: 3.2
  - Imports of goods and services: 2017: 6.1; 2018: 3.4; 2019: -0.4; 2020: -2.0; 2021: 4.9; 2022: 3.1
  - Consumer prices: 2017: 1.3; 2018: 1.2; 2019: 0.6; 2020: 0.7; 2021: 1.0; 2022: 1.2
  - Unemployment rate (percent): 2017: 11.3; 2018: 10.6; 2019: 10.0; 2020: 10.4; 2021: 10.2; 2022: 10.1
- Public Finances
  - General government net lending/borrowing (percent of GDP): 2017: -2.4; 2018: -2.2; 2019: -1.6; 2020: -2.6; 2021: -2.4; 2022: -2.3
  - Structural overall balance (percent of potential GDP): 2017: -1.8; 2018: -1.9; 2019: -1.3; 2020: -1.5; 2021: -1.8; 2022: -1.8
  - General government gross debt (percent of GDP): 2017: 134.1; 2018: 134.8; 2019: 134.8; 2020: 137.0; 2021: 136.9; 2022: 136.2
- Balance of Payments (percent of GDP)
  - Current account balance: 2017: 2.7; 2018: 2.6; 2019: 3.0; 2020: 3.1; 2021: 3.2; 2022: 3.0
  - Trade balance: 2017: 3.0; 2018: 2.5; 2019: 3.3; 2020: 3.3; 2021: 3.3; 2022: 3.2
- Exchange rate
  - Exchange rate regime: Member of the EMU
  - Exchange rate (national currency per U.S. dollar): 2017: 0.9; 2018: 0.8; 2019: 0.9

*International Monetary Fund — Supplementary Information to the Staff Report for the 2020 Article IV Consultation with Italy (material in this summary is drawn from the document prepared by IMF staff as provided).*

### 2020. It comprised Rishi Goyal (head), Ernesto Crivelli, Daniel Garcia-

### ITALY

### CONTEXT
- Real income per capita remains below pre-euro levels and has fallen further behind peers.
- Unemployment is high at 9.8 percent, with regional and demographic disparities:
  - Over 17 percent in the South.
  - Over 25 percent among youth.
- Female labor force participation is the lowest in the EU.
- Emigration of Italian citizens is near a five-decade high.
- Low productivity growth has persisted for over two decades; sustained high unit labor costs, barriers to competition, elevated tax rates on labor, and inefficiencies in the public sector and judicial system have weighed on employment and growth.
- High public debt forces Italy to run larger primary fiscal surpluses than peers and limits shock absorption.
- Staff projects potential growth at around ½ percent.

### RECENT DEVELOPMENTS
- Political and market backdrop:
  - A new government took office in September 2019; sovereign yields declined notably.
  - The 10-year yield fell to around 100 basis points, down from about 340 basis points in late 2018.
- Growth trajectory:
  - 2017 real GDP growth: 1.7 percent.
  - 2018 real GDP growth: 0.8 percent.
  - 2019 estimated real GDP growth: 0.2 percent (weakest quarterly growth in Q4 2019 in nearly 7 years).
  - Mid-February 2020: COVID-19 outbreak led to quarantines in some localities across five provinces.
- Labor market and inflation:
  - Labor force participation and employment rates at record highs but remain low by EU standards.
  - Hours worked per employee below historical average; involuntary part-time elevated.
  - Wage growth modest.
  - Headline inflation at end-2019: 0.5 percent.
  - Core inflation at end-2019: 0.7 percent.
- Output gap and estimates:
  - 2019 output gap estimated at nearly -1 percent of potential GDP (staff judgment favors a larger gap).
- Fiscal developments:
  - 2019 overall deficit estimated at 2.1 percent of GDP (better than the projected 2.4 percent of GDP at budget approval).
  - Structural primary deterioration in 2019: 0.1 percent of GDP.
  - New 2019 social programs (“Quota 100” and citizenship income) were under-executed; revenue collection stronger than expected.
- External sector:
  - Current account surplus estimated at 2.9 percent of GDP in 2019.
  - Real effective exchange rate suggests modest overvaluation.
  - Net international investment position in balance.
- Banking sector:
  - Fully loaded Common Equity Tier 1 ratio of major Italian banks: 13 percent at September 2019 (gap to EU average narrowed to 1.5 percentage points).
  - Nonperforming loans (NPLs): 7.3 percent of gross loans at September 2019 (down from 16 percent in 2016).
  - About half of NPL reduction involved government guarantees under the GACS scheme.
  - Two mid-sized failing banks were put under administration and recapitalized via deposit guarantee schemes.
  - Banca Carige assets: €25 billion; Banca Popolare di Bari assets: €13 billion (administrators preparing recapitalization and restructuring with implementation expected in 2020:Q3).
  - ECB tiered remuneration prompted a one-off increase in reserves of around €50 billion and contributed to narrowing the Target 2 balance to -25 percent of GDP at end-2019.
- Credit developments:
  - Bank credit to households grew by 2.6 percent year-on-year in December 2019.
  - Credit to non-financial corporates contracted by -2.0 percent in December 2019.
  - The credit gap is negative at 10 percent of GDP.
  - Bank of Italy kept the countercyclical capital buffer rate at zero for 2020:Q1.

### OUTLOOK AND RISKS
- Growth projections:
  - Staff projects growth at about ½ percent in 2020 and 0.6–0.7 percent thereafter (lowest in the EU).
  - Real income per capita projected to return to pre-crisis levels only in the mid-2020s.
- Risks:
  - Downside: global trade tensions, geopolitical events, oil price hikes, weakness in key trading partners (e.g., Germany), increases in sovereign spreads given high public debt and gross fiscal financing needs, broader/longer COVID-19 restrictions, and adverse confidence effects.
  - A spike in sovereign or bank borrowing costs could have large adverse spillovers through confidence channels.
  - Upside: timely resolution of trade tensions and stronger demand response to lower yields could raise growth to about 1 percent.
- Sensitivities:
  - Italian sovereign rating sits between one and three notches above sub-investment grade; downgrades below investment grade by all major rating agencies would be required for the ECB to exclude Italy from QE or increase collateral haircuts.

### POLICY DISCUSSIONS
- Authorities’ intentions:
  - Plan a modestly expansionary fiscal stance in 2020.
  - Prioritize fight against tax evasion to help finance spending and create space for tax cuts.
  - Envisage a Green New Deal to increase sustainable infrastructure investment.
  - Continue reforms of public administration and the justice system.
  - Expect further strengthening of the banking system.
- Staff advice and policy priorities:
  - Italy needs higher potential growth and lower public debt to break vulnerability to episodic market pressures.
  - Recommended package: mutually-reinforcing labor and product market reforms, a healthier banking system, and credible medium-term fiscal consolidation.
  - Consolidation should be pro-growth and inclusive, including lower tax rates on labor, base broadening, and lower current spending (especially on the pension bill).
  - Current low interest rates provide an opportunity to implement reforms that would narrow the income gap with euro area peers, raise productivity, and lower the public debt ratio over time.
  - Comprehensive reforms—including growth-friendly fiscal adjustment, decentralizing wage bargaining, other structural reforms (closing half of gaps in product market regulations and public sector efficiency vis-à-vis EU peers at the frontier, and reallocating untargeted transfers towards ALMPs and targeted safety nets), and financial sector reform (steady reduction in the NPL ratio)—would increase real GDP sizably over time.

### A. Structural Reforms (introductory points from the report)
- Structural reforms are central to raising potential growth and include:
  - Labor market reforms (decentralizing wage bargaining).
  - Product market reforms to reduce barriers to competition.
  - Public administration and judicial system efficiency improvements.
  - Reallocation of spending toward active labor market policies (ALMPs) and a targeted social safety net.
  - Financial sector reforms to steadily reduce the NPL ratio toward the long-term average.

*International Monetary Fund — Italy: Selected Chapter (mission and staff report excerpts).*

### 17.      Over the past two decades, several reforms were initiated but the results were limited.

### 1itaea2020001 - 17.      Over the past two decades, several reforms were initiated but the results were limited.

### Overview and assessment of past reforms
- Finding: Over the past two decades, several reforms were initiated in labor, product markets, public sector simplification, insolvency and civil justice, but results were limited owing to shortfalls in implementation, weakening or reversal of reform efforts, or an incomplete set of measures.
- Areas targeted by reforms: labor market (temporary contracts, new permanent contract, clarification of dismissal costs and procedures), select product market liberalization, public sector simplification, insolvency and civil justice reforms.
- Consequence: Limited reform outcomes have compounded the costs of doing business and constrained investment and job creation.

### Addressing rigidities in the labor market
- Finding: Wages remain high relative to productivity despite recent wage moderation; wage rigidities stem from a nation-wide sectoral wage bargaining system favoring labor market insiders and compressing the nominal wage distribution across regions.
- Impacts:
  - Depressed investment and hindered job creation.
  - Contributed to high structural unemployment and reliance on temporary contracts that disproportionately affect younger workers.
  - Contributed to large regional differences in unemployment and competitiveness.
- Policy recommendation:
  - Ideally, decentralize wage bargaining, giving primacy to firm-level contracts.
    - Estimated growth dividend: about 5 percent of GDP over a decade (IMF working paper 18/60).
    - Combined with liberalizing product market competition and enhancing public sector efficiency—namely, closing half of the gap vis-à-vis EU peers at the frontier over the medium term—would yield large benefits (¶16).
  - Alternative authorities’ approach: encourage second-tier firm-level bargaining within the existing system; limited impact to date due to low trust among social partners.
  - Trade-offs: Authorities prefer raising productivity through other measures than wage bargaining reform; such packages could deliver gains but would fall short of a comprehensive strategy that includes labor market reform.
- Statutory minimum wage and ALMPs:
  - Italy currently has no statutory minimum wage; de facto minima set in nation-wide sectoral contracts average €7½ per hour (70 percent of the median wage, above the 40–60 percent range in the EU).
  - Consideration being given to a statutory minimum wage possibly at €9 per hour.
  - Risk: A high statutory minimum relative to labor productivity could add wage rigidities, depress investment, and exacerbate informality and regional employment differences. Could be considered alongside decentralization and regional differentiation.
  - Active Labor Market Policies (ALMPs): authorities increasing staffing of employment centers, developing electronic matching platforms, and providing financial incentives conditional on job placement; coordination with local administrations and careful design/monitoring are essential.
- Complementary measures:
  - Well-designed reductions in the tax wedge on secondary earners and increased supply of child- and elderly-care services to raise female labor force participation.
  - Lowering high cost and uncertainty of dismissals to encourage hiring.
  - Improvements in higher education and skill acquisition to address low tertiary attainment and skills mismatches.

### Promoting competition and improving the business environment
- Finding: Service market reforms remain a priority; no major reforms since a competition law in 2017 and implementation of pro-competitive measures has been repeatedly postponed.
- Problem sectors: professional services, retail, and local services face high barriers to competition and low/declining productivity.
- Policy prescriptions:
  - In sectors with high markups (e.g., professional services): remove entry barriers (abolish quotas for regulated professions, eliminate minimum tariffs).
  - In sectors with many low-productivity firms (e.g., retail): foster consolidation, lower exit barriers, lift impediments to firm growth.
  - Strengthen enforcement powers of the Competition Authority.
- Public administration reforms:
  - Authorities’ plans: simplify procedures, increase digitization, enhance accountability via performance evaluations, hire new skilled talent to replace retiring workers.
  - Key implementation lessons: improve implementation capacity, timely and consistent follow-through, resist backtracking, and establish/publish key performance indicators to track progress.
  - Public procurement: about half of the 2016 procurement code has entered into force; remaining provisions should be implemented while balancing simplification with transparency.
  - Local SOEs: limited progress from the 2016 reform; only 2 percent of total shareholdings divested by the target deadline; enforcement could be enhanced by more assertive involvement of the Court of Auditors.

### Insolvency, civil justice, and court specialization
- Reform actions planned:
  - Streamline civil judicial procedures to reduce trial length and pending cases (Italy remains among highest in the EU on pending cases).
  - Implement new insolvency code by August 2020 by issuing pending secondary legislation (insolvency practitioners, early warning indicators).
  - Pursue stronger specialization of courts and fold the special insolvency regime for large enterprises into the general framework.
- Expected outcome: Lower cost of doing business and facilitate balance sheet clean-up.

### Enhancing governance and AML/CFT
- Anti-corruption:
  - A new anti-corruption law adopted in 2019 aims to reinforce prosecution and sanctioning of corruption, including criminal corporate liability and amendments to statute of limitations for corruption and complex financial crimes.
  - Effective implementation is key.
- AML/CFT framework:
  - Italy has a mature AML/CFT framework with well-developed legal and institutional arrangements; money laundering offences are generally investigated and prosecuted effectively.
  - Italy updated its AML/CFT national risk assessment in 2019; corruption is considered a highly significant threat among money laundering related offenses.
- Identified areas for strengthening:
  - Reporting entities (lawyers, accountants, notaries) should enhance implementation of customer due diligence for beneficial owners and foreign politically-exposed persons and continue reporting suspicious transactions.
  - Cross-checking beneficial ownership information to ensure reliability.
  - Improve effectiveness of international cooperation through an effective case management system.
  - Authorities are in the process of establishing a register of beneficial ownership.
- Progress noted in the 2019 follow-up report to FATF (legislative framework, risk-based supervision, guidance for designated professions).

### Authorities’ views
- National reform program: Authorities plan a three-year national reform program to raise productivity via investment and improve the business climate while reducing carbon emissions; priorities include simplification/digitization in public administration, a spending review, lower taxes, and civil justice reforms.
- Product markets: Authorities consider they have made substantial progress in liberalizing product markets.
- Labor markets: Authorities do not view enhancing wage bargaining flexibility as necessary; emphasize wage moderation, current collective bargaining allowing firm-level productivity-related bonuses, incentives to encourage their use, and active policies to enhance employability.
- Statutory minimum wage: Authorities see a statutory minimum, set at an appropriate level, as necessary to secure a minimum standard of living without diminishing the role of collective bargaining.
- AML/CFT: Authorities emphasize strong commitment, inter-institutional coordination, rise in reported suspicious transactions, and implementation of EU instruments on judicial cooperation and asset recovery.

### Fiscal policy stance and medium-term priorities
- Policy stance:
  - Authorities target an overall deficit of 2.2 percent of GDP in 2020, declining to 1.4 percent of GDP in 2022.
  - Staff forecasts a higher deficit path, at about 2 .4 percent of GDP in 2020 and declining very modestly thereafter (reflects lower nominal GDP growth and excludes activation of future VAT safeguard clauses).
  - Structural primary balance: deteriorates by 0.4 percent of GDP in 2020 and is neutral thereafter.
  - 2020 budget: postpones planned VAT and excise hikes; lowers taxes marginally; strengthens fight against tax evasion; extends investment incentives.
  - Public investment plans: authorities plan to bring public investment gradually back to pre-crisis levels, including through the Green New Deal targeting an increase in sustainable infrastructure investment of 3 percent of GDP over 15 years.
- Debt and consolidation needs:
  - Baseline debt ratio projected close to 135 percent of GDP through the medium term, rising in the longer term due to pension pressures.
  - Risk: modest adverse shocks (e.g., a recession) would cause debt to rise sooner and faster, increasing the likelihood of sharp consolidation during economic weakness.
  - Recommendation: implement credible medium-term consolidation taking advantage of low interest rates.
    - Specific target: deliver an overall surplus of ½ percent of GDP by around 2025 via gradual and balanced adjustment.
    - Build credibility by legislating upfront well-designed measures to promote growth and inclusion (¶s 32–34).
    - Reduce current primary spending, refocus social protection to the poor, and gradually increase public investment; broaden the tax base to allow lower tax burdens.

### Reducing current primary spending: options and priorities
- Rationale: Current primary spending has grown faster than real GDP over the past decade, largely due to rising pension spending crowding out capital spending and tax reductions.
- Options for spending cuts and rebalancing:
  - Lowering pension spending:
    - Pension spending/GDP projected to be high and rising in coming decades due to low employment and productivity growth projections, population aging, and system generosity.
    - Evidence: replacement rates are 15–20 percent higher than in the EU; weighted average accrual rate is 2 percent compared to around 1.5 percent in the EU; benefits based on relatively short earnings histories and low early retirement penalties.
    - The experimental “Quota 100” early retirement rule introduced in 2019 further increased pension spending and introduced a discontinuity in the retirement age that needs addressing.
    - Staff advice: preserve indexation of retirement age to life expectancy; ensure actuarial fairness including for early retirement options (closely link lifetime benefits with lifetime contributions); adjust pension parameters to secure affordability (IMF working paper 18/59).
    - Quota 100 specifics: workers at least 62 years of age with minimum 38 years contributions eligible for early retirement during 2019–21; women at least 59 years with minimum 35 years contributions eligible; potential pool expanded by allowing subsidized filling of contribution gaps; automatic adjustments of statutory retirement age to life expectancy canceled for 2019–20.
  - Improving the social safety net:
    - Citizenship income program (introduced 2019) targets the most vulnerable but needs redesign to avoid welfare dependence and disincentives to work.
    - Issues: benefits decline sharply if an eligible household starts work, implying very high marginal effective tax rates at low wages; benefits set at 100 percent of the relative poverty line—well above international good practice; marginal benefits decline too quickly with family size, penalizing larger (poorer) families.
    - International good practice suggests: (i) include gradual benefit phase-outs, income disregards, or conditional in-work benefits to incentivize work; (ii) cap benefit at 40–70 percent of the relative poverty line; (iii) adjust benefits for regional cost-of-living differences; (iv) implement adequate controls to prevent abuse and ensure effective local administrative capacity.
  - Supporting investment:
    - Strengthen quality of public investment management: improved feasibility studies and project prioritization, faster decision-making, enhanced implementation capacity.
    - Policies to enhance investment in R&D and innovation to support productivity growth.

*Italicized source attribution line provided separately by the pipeline.*

### 33.      A comprehensive base-broadening tax reform can promote growth and inclusion and

### 33.      A comprehensive base-broadening tax reform can promote growth and inclusion and

### Tax system assessment and reform objectives
- The tax system is described as overly complex, with high statutory rates on a base eroded by exemptions and incentives, and large gaps (Annex V I, IMF working paper 20/37).
- Reform goal: lower high statutory rates on labor and broaden the tax base to promote growth and benefit lower- and middle-income households by collecting revenues from less distortionary sources such as VAT and recurrent taxes on immovable property (including primary residences).

### Lowering the tax wedge on labor
- Current average labor tax wedge in Italy: 47.9 percent.
- EU-15 average labor tax wedge: 41.8 percent.
- Authorities’ plan: modest reduction by 0.2–0.3 percent of GDP in 2020–21.
- Planned implementation: extend the national income tax bonus from € 80 per month to €100 per month in 2020, and potentially fold into a planned tax reform in 2021.
- Staff recommendation: aim for a more ambitious reduction to the EU average; estimated cost could be 2 percent of GDP, which should be offset by significant base broadening.

### Broadening the tax base
- Personal income tax: rationalize tax credits and deductions, especially those poorly targeted or that disincentivize labor supply (e.g., the national income tax bonus).
- VAT: streamline the use of reduced rates; several goods and services subject to the 10 percent reduced rate are consumed largely by wealthier families and can be streamlined without negative distributional consequences.
- Property taxation: cadastral system significantly erodes the tax base on immovable property and imposes a disproportionate burden on poorer households; the gap between market and cadastral valuations is largest for the rich.
  - Recommendation: update the property valuation system to address equity concerns and increase revenue collection at significantly lower statutory rates.

### Tackling tax evasion and compliance
- Estimated compliance gaps (foregone revenues): €109 billion (about 6 percent of GDP).
- Measures undertaken and proposed:
  - Renewed fight against evasion, breaking from a history of granting amnesties.
  - Mandated electronic invoicing and transmission to the tax agency.
  - 2020 budget measures: strengthen monitoring in high-risk areas (such as in fuels); add incentives to use traceable payment methods; extend the VAT split-payment mechanism.
  - Seek to strengthen risk analysis by accessing data from financial institutions (requires addressing privacy concerns).
  - Strengthen institutional and governance arrangements of the tax agency, address staffing gaps, and remove legal obstacles to tax debt collection.

---

### Italy’s climate commitment and policy options
- Commitment: reduce carbon emissions by 20–25 percent by 2030.
- Trend: Italy’s CO2 emissions have been declining steadily since 2005.
- Policy option: Carbon taxation
  - Rationale: taxes on carbon content of fossil fuels are the most powerful and efficient tool to reduce emissions (Fiscal Monitor, October 2019).
  - Current carbon taxation: specific taxes on energy use and, to a lesser extent, permit prices from the EU emissions trading system.
  - OECD assessment: effective tax rates vary widely:
    - Bulk of emissions (mostly in electricity) taxed below €10 per ton of CO2.
    - Other sectors (residential, commercial, road) taxed between €30–240 to reflect externalities such as congestion, accidents, and local air pollution.
  - Staff estimate: reducing carbon emissions by 20 percent would require a uniform carbon tax of €70 per ton of CO2; any pre-existing excise taxes should be added to correct for other externalities.
  - Implementation notes: the tax would require increases mostly in electricity and industry and should be phased-in gradually. Revenues could compensate impacted households or offset distortionary taxes.
- Policy option: Additional public sector intervention
  - Rationale: private investment in low-carbon technologies may be insufficient owing to technology-related market failures and other impediments.
  - Proposed Green New Deal measures: targeted public infrastructure investment to tackle network externalities (e.g., smart electricity grids, charging stations for electric vehicles).
  - Other options: energy price liberalization to reduce market distortions; targeted fiscal incentives to support R&D; regulatory standards to promote clean energy deployment.

---

### Authorities’ views on fiscal targets and carbon taxes
- Authorities’ stance:
  - Confident of achieving fiscal targets and lowering public debt over the medium term.
  - Strong commitment to the deficit target of 2.2 percent of GDP for 2020; safeguard clauses have worked with offsetting measures to meet EU-agreed targets.
  - Prefer very gradual consolidation to avoid jeopardizing the economic recovery and social cohesion.
  - Note that higher growth and a return of inflation would facilitate faster debt decline; prudent budget execution and past reforms (including pension reform) underpin sustainability.
  - “Quota 100” early retirement rule described as temporary and set to expire next year as planned; options for further flexibility in early retirement could be considered with possible actuarially neutral cuts in benefits.
  - Plan for a tax reform in 2021 to further reduce the tax wedge on labor and address equity concerns.
  - Consider new carbon taxes should be coordinated at the EU level to avoid adverse competitiveness impacts.

---

### C. Financial Stability

### Progress and remaining vulnerabilities
- Progress:
  - Improvements in bank capitalization and asset quality supported by EU regulatory strengthening, creation of the Single Supervisory Mechanism (SSM), and Italian measures to reduce NPLs, improve governance and raise prudential requirements.
  - Restructuring/recapitalization actions taken for several weak banks; 270 cooperative banks consolidated into two banking groups supervised by the SSM and one Institutional Protection Scheme.
- Remaining vulnerabilities:
  - Capital ratios (fully loaded Common Equity Tier 1) remain below the EU average.
  - NPL ratio has declined sharply but remains more than twice the EU average; several large banks still have double-digit ratios.
  - Some banks continue to rely heavily on ECBs’ TLTRO.
  - Downside risks and a modest growth outlook make many banks with material aggregate total asset share vulnerable to an adverse scenario.

### Recommendations to enhance resilience
- Boost capital buffers and continue NPL reduction:
  - Supervisory action on capital should be guided by stress test findings and further review of provisioning of unlikely-to-pay (UTP) portfolios.
  - Continue emphasis on reducing NPLs, including extending the SSM approach to setting bank-specific expectations for gradual full provisioning of existing NPL stock to LSIs with high NPLs and robustly challenging banks’ NPL reduction plans.
- Address operating profitability and technology gaps:
  - Banks face limited revenue growth prospects in low interest rate environment, high share of income from fees and commissions, and low projected economic growth.
  - Many banks need to reduce costs and invest in technology; facilitate further consolidation.
- Strengthen Bank of Italy powers and frameworks:
  - Supervision and crisis management:
    - Consider more timely escalation of corrective measures for weak banks to effect improvement or enable consolidation or orderly winddowns.
    - Limit use of public funds in bank failures to exceptional events that could undermine system-wide financial stability.
    - Avoid using deposit guarantee scheme (DGS) funds for preventive measures outside resolution or liquidation except in exceptional cases with strong prospects for rehabilitation.
    - Build additional loss-absorbing capacity over an appropriate transition period to support orderly resolution or liquidation of LSIs.
    - Remove active bankers from DGS boards to strengthen operational independence.
    - Assign power to put financial institutions under compulsory administrative liquidation to the Bank of Italy.
  - Bank governance:
    - Close legislative gaps in implementing EU fit and proper rules for bank management; issue necessary government decree and ensure implementation.
  - Macroprudential policies:
    - Establish a national macroprudential authority with the Bank of Italy playing a lead role.
    - Enhance toolkit to include a systemic risk buffer and borrower-based tools.
    - Consider prudential policies to moderate the sovereign-bank nexus with gradual phasing-in to minimize market disruptions.

### Authorities’ perspectives on financial stability recommendations
- Authorities’ views and reservations:
  - Emphasized substantial progress in repair and consolidation of the banking sector given difficult context (sharp output fall, weak recovery, limited fiscal support, new EU crisis management framework and state aid interpretations).
  - Noted banks’ strong liquidity positions and ability to replace TLTROs when needed.
  - Considered cooperative bank reforms significant; additional consolidation may be needed, especially in the South.
  - Raised concerns that some FSAP recommendations could affect broader financial stability given contagion risk and EU constraints.
  - Specific points:
    - Argued FSAP stress-test credit risk loss assumptions are overly conservative and reflect future credit quality migration rather than provisioning shortfalls; highlighted improvement since stress tests.
    - Considered that imposing additional full-provisioning expectations on LSIs is not necessary and could adversely affect restructuring of SME loans.
    - Preferred market solutions and cautioned against piecewise liquidation due to possible disruption.
    - Acknowledged usefulness of additional loss-absorbing capacity for some systemic LSIs but noted small banks’ limited access to wholesale capital markets; urged patience to avoid forcing reliance on local retail markets.
    - Opposed shifting private-sector DGSs into the public sector, arguing existing legal framework allows effective operation and transforming them would limit timely action under EU state aid rules.
    - Argued DGS ability to engage in failure prevention measures subject to least cost test should be maintained or enhanced.
    - On sovereign-bank nexus, argued prudential policies should be part of a broader European solution to avoid disruptions to the Italian sovereign bond market.
    - On governance, agreed issuance of decree on fit and proper requirements should be a priority but prefer to retain ultimate decision powers on resolution and liquidation at the government level.

---

### Staff appraisal and outlook
- Economic outlook and risks:
  - Italy faces a challenging outlook: sharp slowdown; real per capita income remains 7 percent below the pre-crisis peak and continues to fall behind euro area peers.
  - Growth projected to be the lowest in the EU, reflecting weak potential growth; implies real per capita income may return to pre-crisis levels only by the mid-2020s.
  - Materialization of adverse shocks (escalating trade tensions, slowdown in key trading partners, geopolitical events, wider and longer impacts related to the spread of COVID-19) could lead to much weaker outcomes.
- Reform imperative:
  - Decisive turnaround requires broad political support for deep-seated reforms; past corrective actions have addressed episodic market strains, but there has been little buy-in for policies to durably lower debt, secure stability and raise potential growth.

*Source: IMF staff report excerpt (chapter 33–43).*

### 44.      The challenge for the new government is  to build support for a comprehensive

### 44.      The challenge for the new government is  to build support for a comprehensive

### Reform package and overarching challenge
- The authorities intend to announce a new three-year national reform program shortly, including measures to support investment and cut taxes further.
- Current low interest rates provide a window of opportunity to legislate reforms and credible medium-term fiscal consolidation.
- Objectives: raise potential growth, enhance resilience, lower public debt, and enhance competitiveness.

### Structural reforms: priorities and expected effects
- Intensify structural reforms that tackle:
  - rigid wage bargaining,
  - barriers to competition,
  - public sector and judicial inefficiencies.
- Prioritized reforms:
  - decentralize wage bargaining and liberalize markets to raise investment, create jobs, and yield sizable income gains.
  - realign wages with productivity at the firm level, ideally by decentralizing wage bargaining.
  - consider a statutory minimum wage that accounts for varying productivity levels and living costs across regions.
  - lower regulatory barriers to competition by:
    - facilitating entry into sectors with high markups,
    - removing exit barriers in sectors with many low-productivity firms,
    - lifting impediments to firm growth.
  - timely implementation of reforms to improve public sector efficiency, insolvency, and justice frameworks.
  - strengthen the AML/CFT framework and effectively implement the anti-corruption law to enhance governance and the business environment.

### Labor costs, wages, and investment (Box 1 findings)
- Historical pattern: labor costs in Italy rose faster than labor productivity prior to the global financial crisis and have remained high since, weighing on job creation.
- Empirical estimates:
  - A one percent increase in real wages is estimated to cause a ⅓ percent fall in fixed capital.
  - Profits absorb only ½ of the cost increase.
- Illustrations:
  - A simple extrapolation suggests that a 6 percent real wage devaluation would bring net investment back to its pre-crisis average, although complementary reforms that credibly boost productivity would reduce the need for such wage adjustment.
  - Introducing a €9 minimum wage (as was put before Parliament in a draft legislation) could reduce the fixed capital stock by 0.8 percent.
- Data definitions and sources:
  - Capital return = net income plus gross interest and dividends.
  - Net investment = fixed capital formation minus depreciation.
  - Unit labor costs = labor compensation over value added, normalized to 100 in year 2000.
  - Source: OECD National Accounts.

### Service market reform priorities (Box 2 findings)
- Italy’s labor productivity in market services has declined since 2000, underperforming manufacturing and peer European countries, especially in strongly regulated sectors.
- Policy guidance from a model of firm competition with entry and exit barriers:
  - Remove entry barriers in sectors with high markups (e.g., administrative and professional services) by abolishing quotas for regulated professions, eliminating minimum tariffs, and repealing the requirement for a manager or owner to be a professional.
  - Facilitate exit in sectors with a large mass of unproductive firms (e.g., retail) by fostering consolidation, removing impediments to factor reallocation, modernizing the insolvency framework, improving active labor policies, and redesigning the social safety net.
- Sector classification used firm-level data and markups estimated following De Loecker and Warzynski (2012) using data for 2005–16.

### Fiscal consolidation: need, design, and priorities
- Rationale:
  - Public debt is projected to remain high over the medium term and to rise in the longer term owing to pension spending.
  - If adverse shocks materialize, debt would rise sooner and faster.
- Recommendation:
  - Implement credible medium-term consolidation while interest rates are low by legislating upfront high-quality measures.
  - Aim for a gradual and balanced adjustment targeting a small overall surplus in 4–5 years to ensure debt declines firmly over time.
- Consolidation should be underpinned by pro-growth and inclusive measures:
  - Reduce current primary spending over the medium term to meet deficit targets while improving protection of the poor.
  - Contain pension spending pressures by:
    - preserving the indexation of retirement age to life expectancy,
    - ensuring actuarial fairness including for early retirement,
    - adjusting pension parameters to secure affordability.
  - Design poverty alleviation programs in line with international best practice to avoid disincentives to work and welfare dependence.
  - Continue to increase public investment gradually, underpinned by better quality public investment management.
  - Limit uncertainty in tax matters to improve the investment climate.

### Tax reform and environmental taxation
- A comprehensive tax reform would promote growth and labor force participation and benefit low- and middle-income households.
- Proposal:
  - Consider an ambitious reduction in the labor tax wedge to the EU average, paid for with significant base broadening.
- Scope for tax policy actions:
  - (i) Rationalize tax credits and deductions in the personal income tax system, especially those that are not well targeted or disincentivize labor supply.
  - (ii) Streamline the use of VAT reduced rates, with attention to distributional consequences.
  - (iii) Update the property valuation system that imposes a disproportionate burden on poorer households to address equity concerns and increase tax collection at significantly lower statutory rates.
- Continue the fight against tax evasion.
- Environmental tax:
  - Raise carbon taxes gradually over the next decade to meet emissions reduction target.
  - Use revenues to compensate impacted households or offset distortionary taxes.

### Banking sector: progress, remaining challenges, and recommendations
- Progress and remaining gaps:
  - Substantial progress made in strengthening bank balance sheets; capitalization and asset quality have improved.
  - Further efforts needed to bring capital buffers and NPL ratios closer to EU averages and to promote further consolidation.
  - Profitability of many Italian banks remains low, reflecting:
    - limited potential to increase revenue,
    - structurally high operating costs,
    - challenges to business models,
    - governance weaknesses.
  - Exposures to the Italian sovereign are relatively large.
- FSAP-aligned recommendations to bolster banking sector resilience:
  - Continue robustly challenging NPL reduction plans, with further attention to unlikely-to-pay loans.
  - Extend the SSM’s approach to setting bank-specific expectations for the full provisioning of the existing NPL stock to less significant institutions with high NPLs.
  - Maintain and intensify strong supervisory focus on business model viability and cost reduction plans.
  - Strengthen the crisis management framework by:
    - considering more timely escalation of corrective measures for weak banks;
    - avoiding use of the deposit guarantee scheme for preventive measures except in exceptional cases with strong prospects for successful rehabilitation and restoring long-term viability;
    - strictly limiting the use of public funds in bank failures to exceptional events that could undermine system-wide financial stability;
    - building up additional loss absorbing capacity over an appropriate transition period to facilitate orderly resolution or liquidation of less significant institutions, particularly those for which a resolution strategy is foreseen.
- Bank profitability analysis (Box 3 key points):
  - Despite improvements, Italian banks’ profitability remains below the cost of equity.
  - Constraints and metrics:
    - NPL ratios have fallen significantly but remain more than twice the EU average.
    - Fully loaded CET1 capital ratios are almost 1.5 percentage points below EU peers.
    - Material expected costs related to building loss-absorbing capacity and meeting revisions to the EU bank capital rules.
  - Income growth opportunities limited: operating income grew by 2 percent in nominal terms for the largest banks in 2014–18 but fell by a similar amount for smaller banks; fee income did not grow as a percentage of assets.
  - Cost reduction needs:
    - To break even (achieve a return on equity equal to the cost of equity), Italian banks would need to reduce operating expenses by about 15 percent in aggregate.
    - Achieving this through staff reduction alone would incur upfront costs circa €10 billion in the aggregate based on industry estimates of severance costs.
    - The cost of equity is estimated at about 9 percent based on EBA survey responses.
  - Policy implications: actively promote cost reduction, facilitate restructuring and exit of weak institutions, mitigate restructuring costs or facilitate investment in digitization, and prepare for market exit of weaker banks through consolidation or orderly closure by strengthening bank resolution and liquidation regime.

### Institutional and operational recommendations
- Strengthen public sector and judicial efficiency to unlock medium-term potential.
- Improve insolvency framework and active labor policies to facilitate reallocation and firm restructuring.
- Intensify measures to improve governance (AML/CFT, anti-corruption law implementation).

### Consultations and sequencing
- It is recommended that the next Article IV consultation be held in the usual 12-month cycle.

*ITALY  INTERNATIONAL MONETARY FUND*

### Box 3. Profitability of Italian Banks (Concluded)

### Box 3. Profitability of Italian Banks (Concluded)

### Data sources and sample
- Sources: EBA Risk Dashboard; S&P Market Intelligence; and IMF staff estimates.
- Note on sample: EBA Risk Dashboard data is for 11 Italian banks (all Italian SIs excluding Banca Carige). ‘Other SIs’ exclude Banca Carige and BCC (which was not an SI in 2018).
- Note: 1/ Property & IT costs are included in ‘other’ for LSIs due to data availability.
- Indicative cost of equity (9%)

### Key findings on bank profitability, balance sheet, and costs
- Major Italian banks continue to lag behind EU peers on capital adequacy, especially on a fully-loaded basis.
- NPL stock has fallen notably since its 2015 peak, but the NPL ratio remains above EU average.
- The system as a whole has adequate liquidity and collateral currently.
- Deposit inflows remain strong, offsetting the decline in retail bonds.
- Credit dynamics:
  - Credit to households has been growing since 2015, but credit to firms has been declining.
- Real estate prices have yet to rebound.
- Market valuations and risk perceptions:
  - The Italian financial sector is heavily exposed to the Italian sovereign.
  - Redenomination risk has declined sharply.
  - The CDS spreads of Italian banks have declined.
  - Italian bank equity prices remain relatively weak (price-to-book ratios and price performance shown as lower than U.S. and many European peers).

### Economy-wide context presented in the figures
- Productivity and growth:
  - Total Factor Productivity (2000=100) and Real Investment (2000=100) series show weak productivity growth and lagging investment relative to peers (France, Germany, Spain).
  - Real exports (national accounts definition, 2000=100) and export growth have been slower than peers.
- Labor market and social outcomes:
  - At-risk-of-poverty measure defined as share below 60 percent of national median equivalized disposable income after social transfers.
  - Unemployment remains high and is significantly higher in lower-productivity regions; regional labor productivity shows North–Center–South disparities.
  - Employment and labor force participation rates are at or near historical peaks, but overall LFP remains among the lowest in the EU.
  - The share of involuntary part-time workers is high; temporary contracts remain widely used; gender gaps in employment and participation remain large.
- Recent macro developments and high-frequency indicators:
  - GDP growth has slowed sharply; contributions to GDP growth show weaker domestic and external demand, with industrial production and retail sales weakening.
  - Business and consumer confidence, PMI manufacturing output show weakness; HICP inflation remains subdued.
- Fiscal and public debt dynamics:
  - There has been a sizable (structural) fiscal relaxation in recent years.
  - Interest expense as a percent of GDP has declined even as social benefits (including pensions) continue to increase as a share of GDP.
  - Government bond yields have declined sharply since June 2019.
  - Bond redemptions coming due over the next 12 months are notable.
  - The labor tax wedge on low-wage earners (2018) remains high.
- External sector:
  - Target2 liabilities improved following the ECB’s new excess reserve remuneration.
  - The ULC-gap vis-à-vis Germany remains high.
  - The persistent current account surplus is being sustained by a sizeable trade balance.
  - Real effective exchange rates (HICP-deflated and ULC-deflated) tracked relative to Germany.
  - Financial flows: portfolio and other investment components show volatility; FDI and portfolio movements illustrated.
- Financial sector health and liquidity:
  - Net liquidity position defined as difference between eligible assets for use as collateral for Eurosystem refinancing operations and cumulative expected net cash flows over the next 30 days.
  - ECB liquidity support and bank financing series shown; liquidity indicators for significant and less significant groups presented.

### Selected exact statistics from tables and projections
- Table 1. Italy: Summary of Economic Indicators, 2016–25 — Real GDP (annual percent change):
  - 2016 1.3 2017 1.7 2018 0.8 2019 0.2 2020 0.4 2021 0.7 2022 0.7 2023 0.6 2024 0.6 2025 0.6
- Table 1. Selected lines (exact sequences as presented)
  - Real domestic demand: 1.8 1.7 1.1 0.0 0.2 0.8 0.7 0.6 0.6 0.7
  - Private consumption: 1.2 1.5 0.8 0.6 0.6 0.7 0.7 0.6 0.6 0.6
  - Gross fixed capital formation: 4.0 3.3 3.2 2.4 1.6 1.5 1.3 1.1 1.1 1.1
  - Current account balance (percent of GDP): 2.6 2.7 2.6 2.9 3.0 2.9 2.9 2.8 2.7 2.6
- Table 3. Italy: Summary of Balance of Payments, 2016–25 — Current account balance (billions of euros):
  - 2016 44.0 2017 46.5 2018 46.0 2019 52.4 2020 54.9 2021 54.0 2022 53.9 2023 53.5 2024 53.3 2025 51.6
  - Corresponding percent of GDP series: 2.6 2.7 2.6 2.9 3.0 2.9 2.9 2.8 2.7 2.6
- Table 2. Italy: Statement of Operations–General Government (GFSM 2001 Format), selected headline (billions of euros and percent of GDP)
  - Revenue (2012–2019 snapshot shown): e.g., 2012 773.9 2013 775.7 2014 779.5 2015 790.7 2016 789.9 2017 803.0 2018 816.1 2019 828.9
  - Expenditure (same format): e.g., 2012 821.8 2013 821.7 2014 827.6 2015 832.9 2016 830.7 2017 845.1 2018 854.6 2019 867.0
  - Net lending/borrowing (percent of GDP): -2.9 -2.9 -3.0 -2.6 -2.4 -2.4 -2.2 -2.1 -2.4 -2.3 -2.2 -2.2 -2.1 -2.1 (as shown across projections)
- Table 4. Italy: Financial Soundness Indicators, 2012–19 — selected indicators (percent, unless noted)
  - Regulatory capital to risk-weighted assets (series): 13.4 13.7 14.3 14.8 13.8 16.7 16.0 16.5 (years covered in table)
  - Nonperforming loans to total gross loans (series): 13.7 16.5 18.0 18.1 17.1 14.4 9.9 8.1 (years covered in table)
  - Return on assets (series): -0.1 -0.8 -0.2 0.3 -0.5 0.6 0.3 0.3
  - Return on equity (series): -0.9 -11.5 -2.8 3.4 -7.7 7.5 4.0 3.9
  - Customer deposits to total (noninterbank) loans (series): 67.9 70.5 70.6 75.2 86.1 80.9 70.9 77.6

### Policy-relevant implications (as depicted in the content)
- Bank-level:
  - Strengthen capital positions to close the gap with EU peers on a fully-loaded basis.
  - Continue to sustain liquidity and collateral buffers to absorb market and funding volatility.
  - Monitor and address persistent weaknesses in bank profitability and equity valuations despite lower CDS spreads.
- Macro and structural:
  - Support recovery in investment and export performance to lift growth and reduce dependency on domestic demand.
  - Address structural labor market issues (low labor force participation, high involuntary part-time work, regional disparities) to boost employment and productivity.
  - Manage fiscal trajectories given sizable social spending trends and upcoming bond redemptions.
- External/sovereign exposure:
  - Reduce sovereign–bank interconnectedness over time and diversify investor base to lower systemic exposures to sovereign stress.

*Source: IMF staff using EBA Risk Dashboard; S&P Market Intelligence; Bank of Italy; Eurostat; Haver Analytics; and national authorities as presented in the PDF content unit.*

### Annex I. Progress Against IMF Recommendations

### 1itaea2020001 - Annex I. Progress Against IMF Recommendations

### Structural Reforms — Labor Markets
- Recommendation: Decentralize wage bargaining to facilitate the re-alignment of wages with productivity at the firm and regional levels; consider introducing a minimum wage, differentiated by regions.
- Recommendation: Lower the uncertainty over and costs of dismissals; ensure effective coordination of active labor market policies (ALMPs) between central and local administrations.
- Actions since 2018 Article IV:
  - A decree law sought to protect certain groups of (vulnerable) workers, such as those working through digital platforms, those registered in the separate management (Gestione Separata) account of INPS, and those hired for community and public works.
  - On ALMPs, the authorities increased staffing at the national employment agency (ANPAL) and in regional employment centers.
  - Plans to develop electronic platforms to help matching job seekers and employers.
- Next steps: The policy advice provided previously remains germane.

### Structural Reforms — Product Markets
- Recommendation: Tackle barriers to competition in sectors such as local services, professions, and retail; strengthen enforcement powers of the Competition Authority; avoid reversing past reforms.
- Actions since 2018 Article IV:
  - There has been limited progress in this area.
- Next steps:
  - Remove entry barriers for sectors characterized by high markups, such as professional services.
  - Lower exit barriers and foster consolidation for sectors with many low productivity firms, such as retail.
  - Avoid recurrent delays in implementing legislated pro-competition measures (example: liberalization of energy tariffs and local public transport).

### Structural Reforms — Public Administration
- Recommendation: Improve managerial and administrative capacity to implement reforms; enhance effectiveness of procurement reform; streamline, consolidate or privatize local state-owned enterprises; publish targets or key performance indicators.
- Actions since 2018 Article IV:
  - A public administration bill approved in June 2019 with measures for targeted recruitment, improved digitization, and combating absenteeism.
  - An emergency decree in mid-2019 to speed up public procurement by reversing and/or suspending some earlier provisions.
  - A monitoring report on rationalizing local state-owned enterprises published in mid-2019 indicated limited progress.
- Next steps:
  - Accelerate implementation and effective enforcement of reform initiatives.
  - Publish key performance indicators to track and communicate progress.
  - Implement remaining provisions of the public procurement reform code while balancing simplification and transparency.
  - Ensure transparent and consistent rules for shareholding divestment and strengthen the role of the Court of Auditors in enforcement.

### Structural Reforms — Insolvency Reforms
- Recommendation: Adopt and implement legislative insolvency reform decrees; fold the special insolvency regime for large enterprises into the modernized insolvency framework; improve court functioning and ensure qualified insolvency administrators; reform civil procedures to simplify processes and reduce backlogs.
- Actions since 2018 Article IV:
  - The new insolvency code was adopted in early 2019. Corrective decrees are being drawn up to address implementation challenges.
  - Pending issuance of secondary legislation, the code is expected to enter into force in August 2020.
  - On civil justice, government adopted guidelines for reform aimed at simplifying court procedures and digitizing proceedings.
- Next steps:
  - Implement the new insolvency code in line with best international practice within the targeted timeline.
  - Fold the special insolvency regime for large enterprises into the general insolvency framework.
  - Reform civil procedures to simplify processes and reduce the length of trials.

### Fiscal Policy — Fiscal Consolidation and Quality
- Recommendation: Adjust the structural primary balance by about 2½ percent of GDP, cumulatively, over 2019–2 3.
- Actions since 2018 Article IV:
  - Implementation of the 2019 budget was more prudent than expected; Italy twice sought to avoid the EU’s excessive deficit procedure.
  - The 2019 fiscal stance was slightly expansionary; the 2020 budget is modestly expansionary.
- Next steps:
  - Implement a credible medium-term consolidation that targets a small overall surplus by about 2025 and puts debt on a firmly declining path.
  - Establish credibility by legislating upfront pro-growth and inclusive measures.

- Recommendation: Cut current primary spending (including pensions), modernize the safety net for the poor, and raise capital spending.
- Actions since 2018 Article IV:
  - The 2019 budget introduced a new citizenship income program and an experimental “Quota 100” early retirement rule that added to social spending.
  - Authorities plan to bring public investment gradually back to pre-crisis levels, including through a Green New Deal.
- Next steps:
  - Cut current primary spending; preserve indexation of retirement age to life expectancy; ensure actuarial fairness including for options to retire early; adjust pension parameters to secure affordability.
  - Improve design of the citizenship income program.
  - Raise capital spending and improve the quality of projects.

- Recommendation: Lower tax rates on productive factors, shift taxation toward property and consumption, and broaden the tax base.
- Actions since 2018 Article IV:
  - The 2019 budget lowered the tax rate for the self-employed and small enterprises.
  - The Growth Decree extended fiscal incentives for investment.
  - The 2020 budget cancels planned hikes in VAT and excise rates of 1.3 percent of GDP for 2020; lowers taxes marginally, including on labor income by 0.2 percent of GDP; tackles tax evasion; and extends incentives for investment.
- Next steps:
  - Undertake a comprehensive reform to broaden the tax base, lower statutory tax rates, and help fight evasion.
  - Broaden the tax base by reducing VAT policy gaps and removing other inefficient tax expenditures.
  - Introduce a modern property tax (including on primary residences) by updating the property valuation system to reflect market values.
  - Combat tax evasion through stricter enforcement, while avoiding tax amnesties.

### Financial Stability — NPL Resolution and Bank Health
- Recommendation: Continue intensive supervisory oversight to ensure ambitious and credible NPL reduction strategies for significant banks and extend fully to less significant banks (LSIs); increase capital and provisioning in weak banks.
- Actions since 2018 Article IV:
  - Significant banks agreed with the SSM on ambitious NPL reduction targets. The Bank of Italy requested NPL reduction strategies from LSIs.
  - GACS was extended to support reduction of bad loans.
  - NPL ratios fell significantly in significant institutions (SIs) and LSIs, but remain over twice the EU average, with the share of UTP increasing.
- Next steps:
  - Supervisory emphasis on NPL reduction should continue, with further attention to provisioning and strategies for UTP loans.
  - The SSM’s approach to setting bank-specific expectations for the gradual path to full provisioning of the existing NPL stock should be extended to LSIs with high NPLs.
  - Prudential policies to moderate the sovereign-bank nexus could be considered and phased-in to avoid possible market disruptions.

### Financial Stability — Profitability, Governance, and Business Models
- Recommendation: Deploy assertive supervisory oversight to promote improvements in banks’ business models, risk management, and resource allocation; ensure ambitious and credible targets.
- Actions since 2018 Article IV:
  - Business model analysis has been a mandatory component of SREP scores for SIs and is included in the LSI SREP methodology whose roll-out for all LSIs must be completed by 2020.
  - SSM-wide supervisory priorities in 2019 included several aspects of risk management and will include business model sustainability in 2020.
  - Formation of two new cooperative banking groups completed; the third group opted for an Institutional Protection Scheme (IPS). The assessment of the proposed IPS model is underway by the Bank of Italy with support from the SSM.
  - The two merged groups were moved under direct ECB/SSM supervision with AQRs and review of business and operating plans scheduled for 2020.
- Next steps:
  - Strong supervisory focus on viability of business models, governance and cost reduction plans should continue and intensify.
  - Complete asset quality reviews (AQRs) for the merged groups and ensure robust governance and risk management structures; impose ambitious and credible targets.
  - Undertake similar challenges for other banks with unsustainably low profitability.
  - Facilitate further consolidation and restructuring where needed.
  - Close quickly legislative gaps in implementation of the EU fit and proper rules for banks’ management.
  - Undertake rigorous supervisory analysis to ensure new banking groups start with a clean bill of health and are profitable over the long term.

### Financial Stability — Resolution Framework and Use of DGS
- Recommendation: Swift recapitalization of problem banks or timely use of the resolution framework; introduce safeguards to ensure expected new MREL is effective; consider limits on MREL proportions held by retail investors.
- Actions since 2018 Article IV:
  - The recapitalization—outside of resolution or liquidation—of a medium-sized bank supervised directly by the SSM was completed; further restructuring is planned. Capital was provided by the deposit guarantee scheme (DGS) and one of the cooperative banking groups.
  - A small but regionally important bank was also recapitalized by the DGS, with further capital injections from the DGS and a state-owned bank planned.
- Next steps:
  - Consider more escalated corrective measures, using all available tools.
  - Care to avoid delays from special administration; build additional loss absorbing capacity over an appropriate transition period to facilitate orderly resolution or liquidation for LSIs.
  - Avoid using the DGS for preventive measures as much as possible.

### External Sector Assessment — Overall
- Overall assessment: The external position in 2019 is broadly in line with the level implied by fundamentals and desirable policies, based on preliminary staff forecasts.
- Policy implication: Credible medium-term fiscal consolidation and structural reforms (including improving the wage bargaining mechanism and strengthening bank balance sheets) are necessary to improve competitiveness, boost potential growth, reduce vulnerabilities, and maintain investor confidence.
- Assessment of offsetting effects: The package of policies would likely have offsetting effects on the external current account (CA) by boosting export competitiveness and investment while supporting overall growth.

### External Sector Assessment — Foreign Asset and Liability Position (2019)
- Background and figures:
  - Italy’s NIIP reached an estimated -2.5 percent of GDP at end-2019.
  - Gross assets: 159.0 percent of GDP.
  - Debt assets: 59.3 percent of GDP.
  - Gross liabilities: 161.4 percent of GDP.
  - Debt liabilities: 108.6 percent of GDP.
  - TARGET2 liabilities declined to 25 percent of GDP in 2019 after peaking at 27 percent in 2018.
  - Debt securities represent about two-thirds of gross external liabilities, half of which are owed by the public sector.
- Assessment: Further strengthening of balance sheets would reduce vulnerabilities related to high public debt and negative feedback loops between debt stock and debt servicing costs, and between sovereign debt and the financial system.

### External Sector Assessment — Current Account (2019)
- Background and figures:
  - Actual CA: 2.9 percent of GDP.
  - Cycl. Adj. CA: 2.6 percent of GDP.
  - EBA CA Norm: 2.7 percent of GDP.
  - EBA CA Gap: -0.0 percent of GDP.
  - Staff Adj.: 0.0 percent of GDP.
  - Staff CA Gap: 0.0 percent of GDP.
- Assessment:
  - The cyclically adjusted CA is estimated at 2.6 percent of GDP in 2019, close to the EBA-estimated CA norm of 2.7 percent of GDP.
  - Staff assesses a CA gap in the range of -1.0 to 1.0 percent of GDP.
  - Despite the CA being in line with fundamentals, Italy’s structural rigidities hamper its ability to improve competitiveness.
  - The improvement in the CA since 2010 is almost entirely due to the increase in gross national saving while investment over GDP has remained stagnant.

### External Sector Assessment — Real Exchange Rate
- Background and figures:
  - From 2018 to 2019, the CPI-based and ULC-based REER depreciated by 3.1 and 2.5 percent, respectively.
  - The level and index REER models suggest a modest overvaluation in 2019 of 4.3 percent and 7.0 percent, respectively.
  - The elasticity of the REER to the CA gap is estimated to be 0.26.
- Assessment:
  - Stagnant productivity and rising labor costs led to a gradual appreciation of the REER since euro adoption, partially reversed since 2014.
  - The REER overvaluation estimates are generally consistent with, but slightly below, persistent wage-productivity differentials vis-à-vis key partners and correspond to a CA gap below the lower end of the staff-assessed CA gap range.

### External Sector Assessment — Capital and Financial Accounts; FX and Reserves
- Background and figures:
  - Italy’s financial account posted net outflows of 2.9 percent of GDP in 2019, reflecting residents’ net purchases of foreign assets.
  - Portfolio investment shifted from outflows to inflows as foreign investors returned to Italian sovereign debt in mid-2019.
- Assessment:
  - While supported by ample ECB monetary accommodation, Italy remains vulnerable to market volatility because of large refinancing needs of the sovereign and banking sectors and remaining balance sheet weaknesses in some banks.
  - The euro has the status of a global reserve currency; reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

### Risk Assessment Matrix — Key Risks, Channels, and Policy Responses
- Principal vulnerabilities:
  - Fiscal: High public debt and gross financing needs.
  - Banks: High NPLs and sovereign exposure; higher funding costs; low profitability.
  - Real sector: Chronically weak productivity; large corporate debt overhang.
- Key risks and transmission:
  - Higher risk premia and widening sovereign spreads could push Italy into a bad equilibrium, tighten financial conditions, increase debt service and refinancing risks, weaken bank balance sheets, and threaten market confidence.
  - Strained bank balance sheets amid legacy problems and weak profitability could lead to financial distress in one or more banks, reduce credit to the private sector, and trigger asset quality deterioration and potential bailouts.
  - Rising protectionism and retreat from multilateralism could reduce growth through lower trade and investment and adverse confidence effects.
  - Weaker-than-expected global growth or intensified geopolitical tensions could cause synchronized slowdowns and financial market volatility.
  - An abrupt reassessment of market fundamentals could trigger widespread risk-off events exposing built-up vulnerabilities.
  - Coronavirus outbreak: Causes widespread and prolonged disruptions to economic activity and global spillovers through tourism, supply chains, containment costs, and confidence effects on financial markets and investment.
- Suggested policy responses:
  - Activate OMT if needed; let automatic stabilizers support growth.
  - Repair bank and corporate balance sheets to enhance monetary transmission.
  - Run higher fiscal surpluses to put public debt on a firm downward path.
  - Implement bold structural reforms to spur investment, productivity, competitiveness, and rebalancing.
  - Restore market confidence through corrective fiscal and financial policies.
  - Supervisors to continue setting ambitious targets for reducing NPLs; reform insolvency to facilitate NPL reduction, encourage bank consolidation and better governance, and resolve weak banks in a timely manner.
  - Faster progress on banking union to clarify backstops.

*Source: Annex I–III, "Progress Against IMF Recommendations", 1itaea2020001.*

### Annex IV. Debt Sustainability Analysis

### Annex IV. Debt Sustainability Analysis

### A. Public Debt Sustainability Analysis — overview
- Italy’s public debt is very high and projected to remain broadly stable at 130–135 percent of GDP in the medium term, owing to low interest rates, but to rise in the longer term because of pension spending pressures.
- Implementing a structural reform and medium-term fiscal consolidation package is essential to putting debt on a firm downward trajectory and securing sustainability.

### A.1 Key facts and structure of debt
- Debt increased from about 100 percent of GDP in 2007 to 135.7 percent of GDP in 2019.
- It is the second highest public debt ratio in the euro area, after Greece.
- Gross financing needs are sizable, related to large rollover needs.
- About two-thirds of debt is held by domestic investors.
- Average residual maturity is around 7½ years.
- About 75 percent of debt is at fixed interest rates.
- Since March 2015, the Eurosystem’s net purchases of Italian public debt were €364 billion, compared with gross medium- to long-term bond issuances of about €900 billion, with renewed open-ended purchases since November 2019.

### A.2 Baseline projections and assumptions
- Debt is projected to remain at 130–135 percent of GDP in the baseline due to historically subdued interest rates, but to rise in the longer term under staff’s projections of pension spending.
- Baseline macro-fiscal assumptions:
  - Real GDP growth is projected to average 0.6 percent annually.
  - The GDP deflator is projected to rise from 0.9 percent in 2018 to a steady state of around 1.5 percent.
  - The government is assumed to maintain an average structural primary surplus of about 1 percent of GDP over 2018–2023; thereafter the primary balance would deteriorate with higher pension spending (by about 3 percent of GDP above the authorities’ projections over the period 2017–2035, cumulatively).
  - The stock of maturing postal saving bonds (BPF) is included and is projected to decline from €55 billion in 2019 to about €24 billion in 2025, contributing to a reduction in public debt by 3½ percent of GDP during this period. Excluding BPFs, public debt is projected to remain broadly unchanged over the forecast horizon.
  - Safeguard clauses (future VAT rate increases) are excluded from staff’s projections; in practice they have mostly not been activated. For 2020 the safeguard clause amounted to about 1.3 percent of GDP and for 2021 to 1 percent of GDP.
  - Over the medium term, staff projects an effective nominal interest rate of about 2½ percent, or an average interest bill of about 3½ percent of GDP.
  - The marginal cost of borrowing at issuance is projected to decrease to 0.7 percent in 2020 from 1.1 percent in 2018.
  - Spreads vis-à-vis German bunds are assumed to be about 180 basis points through 2023.
  - In the longer term, the effective nominal interest rate is assumed to increase to around 3½ percent by 2035 (2 percent in real terms).
  - An effective real interest rate of 2 percent, with real GDP growth of ½ percent, implies a debt stabilizing primary balance of about 2 percent of GDP.
  - Privatization receipts are assumed to be excluded from debt projections; the authorities expect receipts of 0.2 percent of GDP in 2020.
  - Contingent liabilities: government guarantees amounted to 3.9 percent of GDP at end-2017; liabilities of government-controlled entities outside general government amounted to 52.1 percent of GDP, of which approximately 30 percent of GDP involves deposits and other financial sector activities. Government intervention in SOEs has been below 1 percent of GDP in the past 15 years.

### A.3 Risks and historical context
- Italy’s forecast track record for real GDP growth and inflation is close to the median across surveillance countries.
- Projected fiscal stance is subject to significant downside risks; a small overall surplus will require sizable and sustained primary surpluses of at least 3 percent of GDP in the medium term and higher thereafter to put debt on a firm downward trajectory.
- Primary surpluses averaged 1¼ percent of GDP during 2001–19, but were insufficient to ensure debt would not rise.

### A.4 Shock scenarios and impacts
- Standard growth shock:
  - Real output growth rates are assumed to be lower by one standard deviation for two years starting in 2020, resulting in average growth of -1½ percent in 2020–21.
  - For every 1 percentage point decline in growth, inflation is assumed to decline by 25 bps.
  - The primary balance would decline, reaching -1½ percent of GDP by 2021.
  - Debt increases to about 148 percent of GDP and increases further over the projection period.
- Interest rate shock:
  - A further increase in spreads of 200 bps is assumed.
  - Higher borrowing costs are passed on to the real economy, depressing growth by 0.4 p.p. for every 100 bps increase in spreads.
  - The implicit average interest rate on debt rises to 3 percent by 2024.
  - Debt increases to around 145 percent of GDP by 2024.
- Contingent liability shock:
  - A one-time increase in non-interest expenditure standardized to about 10 percent of banking sector assets is assumed, accompanied by lower growth for two consecutive years by -1½ percentage points, and lower inflation by ½ percent.
  - The primary balance is assumed to worsen by 11 percent of GDP in 2020.
  - Debt rises to 170 percent of GDP by 2024; gross financing needs would be significantly higher.

### B. External Debt Sustainability Analysis — summary
- Under the baseline, external debt is projected to decline slightly from 121 percent of GDP in 2019 to 119 percent of GDP in 2024, benefiting from continued trade surpluses.
- In standard shock scenarios, external debt would increase very modestly.
- More than half of external debt is issued by the public sector; external debt sustainability is tightly linked to public debt sustainability.
- Further strengthening of public and financial sector balance sheets is necessary to lower vulnerabilities and the potential for negative feedback loops between these two sectors.

### B.1 Background
- External debt has grown by 40 percentage points since Italy joined the euro, plateauing in 2015 at around 120 percent of GDP.
- This is about half the euro area weighted average.
- Over the past 5 years, Italy’s net international investment position moved into balance.
- More than half of debt liabilities are issued by the public sector — a higher share than in major euro area countries.

*Source: Annex IV. Debt Sustainability Analysis (Italy), IMF country report content.*

### 6.      Assessment. In the baseline, external debt is projected to fall from 121 percent of GDP in

### 6. Assessment

### Baseline projection and main assessment
- External debt is projected to fall from 121 percent of GDP in 2019 to 119 percent of GDP in 2024, predicated on continued trade surpluses.
- Standardized shocks are calibrated to ½ standard deviation for growth, interest rates, and the current account.
- Under these standardized shock scenarios, external debt would inch up slightly by the end of the forecast horizon.
- The growth shock has the largest impact, leaving external debt modestly higher at 126 percent of GDP.
- The historical scenario yields a much less favorable outcome, with external debt climbing to 158 percent of GDP; this scenario is based on an average of the past 10 years, which include the global financial and euro area confidence crises.
- Conclusion: Although standard macroeconomic and external shocks do not threaten external debt sustainability in the medium term, sustainability is ultimately tied to the public debt dynamics, underscoring the need for a package of structural reforms and credible medium-term fiscal consolidation.

### Key public debt and macro-fiscal indicators (selected)
- Nominal gross public debt: 2019 = 134.8 percent of GDP; 2024 = 133.4 percent of GDP (table shows series 2017–2024).
- Public gross financing needs: 2019 = 22.2 percent of GDP; 2024 = 21.9 percent of GDP.
- Net public debt: 2019 = 122.9 percent of GDP; 2024 = 122.6 percent of GDP.
- Real GDP growth (in percent): 2019 = 0.8; 2020 = 0.2; 2021 = 0.4; 2022 = 0.7; 2023 = 0.7; 2024 = 0.6.
- Inflation (GDP deflator, in percent): 2019 = 0.9; 2020 = 0.6; 2021 = 1.0; 2022 = 1.0; 2023 = 1.2; 2024 = 1.4.
- Nominal GDP growth (in percent): 2019 = 1.7; 2020 = 0.8; 2021 = 1.4; 2022 = 1.8; 2023 = 1.9; 2024 = 2.0.
- Effective interest rate (in percent): 2019 = 2.8; 2020 = 2.5; 2021 = 2.5; 2022 = 2.4; 2023 = 2.4; 2024 = 2.3.
- Change in gross public sector debt (cumulative): 2019 = 0.7; 2024 = -1.4.
- Primary deficit (percent of GDP): 2019 = -1.5; projections show -0.9 (2020–2024 each year), cumulative primary deficit over projection = -5.8.
- Primary (noninterest) revenue and grants (percent of GDP): 2019 = 46.2; 2024 = 46.6.
- Primary (noninterest) expenditure (percent of GDP): 2019 = 44.7; 2024 = 45.7.
- Automatic debt dynamics (percent): 2019 = 1.5; 2024 = 0.3.
- Residual, including asset changes (cumulative): 2019 = -0.3; 2024 = -1.4.

### Public DSA realism and forecast track record
- Forecast track record (2008–2016) median forecast errors: Real GDP Growth error = -0.86 (percent), percentile rank = 34%; Primary Balance error = -0.64 (percent of GDP), percentile rank = 39%; Inflation (Deflator) error = -0.31 (percent), percentile rank = 44%.
- 3-Year Adjustment in Cyclically-Adjusted Primary Balance (CAPB): Italy has a percentile rank of 59% for the 3-year adjustment greater than 3 percent of GDP.
- 3-Year Average Level of CAPB: Italy has a percentile rank of 51% for 3-year average CAPB level.

### Alternative scenarios and stress tests (selected outcomes)
- Baseline net debt and gross nominal public debt trajectories are shown for 2017–2024 (charts): net debt and gross nominal public debt remain elevated though projected to slightly decline under baseline.
- Historical scenario (external debt): 158 percent of GDP by 2024.
- Combined shock (1/2 standard deviation shocks to real interest rate, growth rate, and current account): external debt under combined shock = 126 percent of GDP.
- Real depreciation shock (one-time real depreciation of 30 percent in 2020): external debt under 30% depreciation = 121 percent of GDP.
- Non-interest current account shock: external debt under CA shock = 123 percent of GDP.
- Growth shock alone: external debt under growth shock = 126 percent of GDP.
- Stress tests on public debt include: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock; Combined Macro-Fiscal Shock; Contingent Liability Shock — charts show gross nominal public debt and public gross financing needs under these scenarios rising materially compared with baseline (figures presented in percent of GDP and percent of revenue).

### External Debt Sustainability Framework (2014–24) — selected figures
- Baseline: External debt series (percent of GDP) includes 2014 = 115.1; 2019 = 121.4; 2024 = 118.6.
- Change in external debt (percent of GDP): 2019 change = 4.5; 2024 change = -1.1.
- Identified external debt-creating flows (percent of GDP): 2019 = -3.8; 2024 = -3.7.
- Current account deficit, excluding interest payments (percent of GDP): 2019 = -4.4; 2024 = -4.6.
- Deficit in balance of goods and services (percent of GDP): 2019 = -3.2; 2024 = -2.7.
- Exports (percent of GDP): 2019 = 33.0; 2024 = 35.6.
- Imports (percent of GDP): 2019 = 29.8; 2024 = 32.9.
- Net non-debt creating capital inflows (negative, percent of GDP): 2019 = -0.6; 2024 = -0.2.
- Automatic debt dynamics (percent): 2019 = 1.3; 2024 = 1.1.
- Contribution from nominal interest rate (percent): 2019 = 1.5; 2024 = 1.8.
- Contribution from real GDP growth (percent): 2019 = -0.2; 2024 = -0.7.
- Residual, incl. change in gross foreign assets (percent of GDP): 2019 = 4.5; 2024 = 2.6.
- External debt-to-exports ratio (in percent): 2019 = 368.4; 2024 = 333.5.
- Gross external financing need (in billions of US dollars): 2019 = 117.6; 2024 = 161.0.
- Gross external financing need (in percent of GDP): 2019 = 54.8; 2024 = 51.8.

### Policy implications and recommendations (implied by assessment)
- Maintain and implement a package of structural reforms to enhance growth and efficiency.
- Pursue credible medium-term fiscal consolidation to address public debt dynamics, given that external debt sustainability is tied to public debt dynamics.
- Monitor and limit vulnerabilities highlighted by stress tests (growth shocks, combined shocks, contingent liabilities), and strengthen buffers to absorb downside risks.

### Annex V — Lessons from two public sector reforms (summary)
- Reform focus: public administration modernization, specifically reforms since 2016 of local state-owned enterprises (SOEs) and public procurement.
- Prior situation for local SOEs: no comprehensive or regular review prior to 2016; majority owned by local public administrations (PAs); operate across all sectors including professional and business services where barriers to competition are high; around ⅓ were loss making (Karantounias and Pinelli, 2016).
- Consolidated Law on SOEs (mid-2016): objectives to reduce their number, enhance competition, and increase efficiency; integrated fragmented laws and defined qualitative and quantitative criteria for establishment, acquisition, and retaining of shareholding in SOEs.
- Criteria in the law include that PAs must justify a direct link with institutional goals of the public sector; provide services of general interest in a cost-effective manner; and be financially sustainable.
- Implementation steps mandated: PAs to carry out an Extraordinary Review of their shareholdings in 2017, identify those to be rationalized, and complete rationalization by September 2018.
- Oversight and enforcement: law mandated annual progress reviews with a system of sanctions, supervised directly by the Ministry of Economy and Finance and indirectly by the Competition Authority and the Court of Auditors.

*Source: IMF staff (Italy: Public DSA Risk Assessment and related annexes).*

### 4.      Notwithstanding good intentions, implementation and enforcement have been weak.

### 4.      Notwithstanding good intentions, implementation and enforcement have been weak.

### Extraordinary Review of Public Sector Holdings — findings
- The Extraordinary Review uncovered holdings of more than 32,000 shares by some 8,200 PAs.
- Of these holdings, PAs declared that only 7,800 shares would be rationalized, less than ½ of Ministry of Economy and Finance’s (MEF’s) own assessment.
- Of all the shares that PAs aim to retain, ⅕ are in loss-making companies, and ⅓ fail the efficiency criteria.
- Only 750 shares were rationalized successfully by the target deadline of September 2018—just 2 percent of total shareholdings.
- For nearly ¾ of the shares identified to be divested, the process has yet to be initiated.
- Most PAs report difficulties in identifying divestment procedures and reconciling transparency rules with market practices.

### Reasons for weak implementation (holdings rationalization)
- Weakening of the reform criteria through broader interpretations of the shareholding criteria that were subsequently accommodated.
- The 2019 Budget Law exempted companies that were profitable over the preceding three years.
- Enforcement mechanisms and follow-up by PAs were insufficient to achieve MEF targets.

### Public procurement — reform and performance
- A new code was approved in 2016 to improve the efficiency and transparency of public procurement and concessions and to adopt the 2014 EU Directives.
- The new code set standard time frames and conditions for participation in public tenders, criteria for awarding tenders, legal recourses, and appeal processes.
- The anti-corruption agency (ANAC) was given authority to oversee public procurement and contracts, issue implementation regulations, and establish a register for members of public-tender boards.
- Only half of the approximately 60 acts enshrined by the 2016 code and the 2017 amending decree have so far entered into force (PBO, 2019).
- Italy’s public procurement performance still lags other EU countries, with tendering times being one of the longest (EC, 2018).
- Some PAs reportedly have been waiting for the full implementation of the reform to resume public investment (EC, 2016; 2017).
- Improving Italy’s public procurement quality towards the best EU performer is estimated to increase public investment by about 0.4–0.7 percentage points of GDP.
- The 2019 Emergency Decree reversed some earlier provisions: while it aimed to simplify procedures and speed up public contracts, it reduced transparency, increased complexity, and added uncertainty through temporary suspensions of specific regulations.

### Lessons on reform implementation and enforcement
- Follow-up and implementation were lacking despite sound reform intentions.
- Legislative amendments overturned or, in some cases, weakened original provisions.
- Regulatory complexity and uncertainties in application limited the impact of the reform.
- Enforcement mechanisms were weak, including in systematically challenging and sanctioning non-compliant local public administrations (EC, 2019; OECD, 2019; PBO, 2019).
- Addressing gaps in follow-up, regulatory clarity, and enforcement is essential for Italy to successfully modernize its public sector.
- The urgency of addressing these implementation and enforcement gaps rises further if other key reforms, such as decentralizing wage bargaining, are deemed infeasible.

### Annex VI. Toward A Comprehensive Tax Reform for Italy — overview and diagnosis
- The Italian tax system is complex, imposes high statutory rates on a narrow tax base, and suffers from significant compliance gaps.
- Multiple and sizable tax expenditures complicate the system and erode the base.
- Statutory tax rates are among the highest in the EU to finance increasing public spending with a narrow base:
  - The average labor tax wedge is close to 48 percent (EU average is about 42 percent).
  - The corporate income tax rate is 24 percent (EU average is 21.3 percent).
- Significant compliance gaps with estimated losses of about 6 percent of GDP.

### Proposed comprehensive reform — objectives and simulation approach
- Objectives: simplify the system, broaden the base, and lower statutory rates.
- Microsimulation techniques are used to assess revenue and distributional implications.
- A targeted aim is to lower the labor tax wedge toward the EU average: a reduction of about 4.5 percent, equivalent to 2 percent of GDP in revenue.
- To compensate, reform options for VAT and the immovable property tax are simulated to achieve an overall revenue-neutral reform.
- VAT reform involves streamlining goods subject to reduced rates and lowering the standard rate.
- Reform of the immovable property tax entails updating valuations to reflect market values of properties.

### Personal income tax (PIT) reform design and distributional effects
- A progressive base-broadening PIT reform could:
  - Lower the statutory rate on the first taxable income bracket to 9 percent.
  - Preserve progressivity by merging the highest two brackets into one bracket for income above €55,000 at 44 percent.
  - Broaden the tax base by eliminating the National Income Tax Bonus (or €80 bonus) and the tax credit for building refurbishment and construction.
- Simulation outcomes:
  - Increases the disposable income of households in the middle deciles (with incomes between €20,000–€40,000) by 5½ percent, twice as high as the benefit for the wealthiest households.
  - Households with incomes below €20,000 pay virtually no tax under the proposed PIT reform.
- Flat or near-flat PIT reform (with two brackets and lower rates) would be exponentially costlier and regressive because higher incomes get the largest tax relief.

### VAT reform considerations and distributional impacts
- A base-broadening VAT reform needs careful design to limit negative distributional effects.
- The reduced rate of 4 percent is targeted to categories of goods largely consumed by poorer households.
- Some goods subject to the 10 percent rate and some exempted goods are not necessarily concentrated in poorer households’ consumption.
- A revenue-neutral VAT reform that eliminates the reduced rate of 10 percent while compensating consumers with a lower standard rate of 18.5 percent is almost neutral in terms of the income distribution.
- Note in model calibration: an alternative description refers to proposed standard rates of 17.5 percent (or 18.5 percent) when reassigning goods from reduced rates to the standard rate.

### Property tax reform and revenue potential
- Updating the property valuation system to reflect market values would address equity concerns and increase revenue collection.
- Closing the gap between market and taxable values would raise progressivity and revenue collections significantly, allowing for lower tax rates.
- Simulations suggest a reform where all properties are subject to a tax rate of 0.55 percent—about half the current rate—would raise 1 percent of GDP in additional revenue while significantly improving the income distribution properties of the tax.
- Low-income households (in the first two deciles) would be largely unaffected, whereas tax liability increases gradually with income.

### Aggregate reform package and expected outcomes
- A revenue-neutral shift from labor income to consumption and property tax revenue would be growth friendly and inclusive.
- Simulations of the package where the cost of a PIT reform is offset with increased VAT and property tax revenue (by 1 percent of GDP each) are less distortionary and pro-growth.
- The package benefits middle-income households the most and is broadly neutral for low-income households.

*Source: Prepared by Nazim Belhocine and La-Bhus Fah Jirasavetakul (both EUR), based on IMF working paper 20/40; Annex prepared by Ernesto Crivelli (EUR), based on IMF working paper 20/37. Content from the Report on the Results of the Extraordinary Review of Public Sector Holding (2019) and IMF staff analysis as presented in the source PDF.*

### Annex VII. Key FSAP Recommendations

### Annex VII. Key FSAP Recommendations

### Bank supervision and regulation and NPL resolution
- Enhance banks’ capital levels, as appropriate, to ensure all banks maintain adequate capital ratios under stress scenarios.  
  - Agency: Bank of Italy (BdI), SSM  
  - Time: ST
- Consider more timely escalation of corrective measures for weak banks to effect improvement (e.g., in capital levels, operational efficiency, governance) or achieve consolidation or orderly winddowns when needed.  
  - Agency: BdI  
  - Time: I
- Perform more periodic deep dives and thematic and targeted inspections on key LSI weaknesses such as bank governance, credit risk, and business models.  
  - Agency: BdI  
  - Time: ST
- Continue scrutinizing banks’ credit risk and loan classification and provisioning practices, particularly of UTP portfolios, and challenging progress and ambition of banks’ NPL reduction plans.  
  - Agency: BdI, SSM  
  - Time: C
- Consider extending the SSM approach that sets bank-specific expectations for the gradual path to full provisioning on existing NPL stocks to LSIs with high NPLs with an adequate phase-in period; and update the LSIs’ NPL management guidance.  
  - Agency: BdI  
  - Time: I
- Amend relevant laws to confer BdI and IVASS authority on removal of authorization and winding-up of banks and insurers, respectively.  
  - Agency: MEF, MISE  
  - Time: ST
- Address gaps in governance regulations of banks and insurance companies by issuing the draft MEF and MISE decrees.  
  - Agency: MEF, MISE  
  - Time: I

### Macroprudential policies and framework
- Establish a national macroprudential policy authority with a leading role for BdI.  
  - Agency: MEF, IVASS, BdI, CONSOB  
  - Time: ST
- Incorporate the Systemic Risk Buffer (SyRB) and borrower-based tools into the macroprudential toolkit.  
  - Agency: MEF, BdI  
  - Time: ST
- Consider implementing prudential policies to moderate the sovereign-bank nexus with an appropriate phase-in period to avoid possible market disruptions.  
  - Agency: BdI  
  - Time: MT

### Insolvency framework
- Enhance the enforcement and insolvency framework and ensure that courts have sufficient resources and specialization to timely handle insolvency cases.  
  - Agency: MoJ, NJC  
  - Time: ST

### Reinforcing crisis management and safety nets
- Establish additional loss absorbing capacity to enable greater loss allocation to unsecured and uninsured creditors in resolution and liquidation, notably for LSIs for which a resolution strategy is foreseen; and strictly limit the use of public funds to exceptional events that could undermine system-wide financial stability.  
  - Agency: BdI, MEF  
  - Time: ST
- Reinforce the DGS by removing active bankers from their boards; assessing the adequacy of funding targets; strengthening backstops; and avoiding the use of DGS resources for failure prevention outside of resolution or liquidation as much as possible, only using it in exceptional cases with strong prospects for successful rehabilitation and restoring long-term viability.  
  - Agency: DGS, BdI, MEF  
  - Time: ST

### Footnote on timing classification
- C = Continuous; I = Immediate (within one year); ST = Short Term (within 1–2 years); MT = Medium Term (within 3–5 years)

### Selected contextual findings and related staff/authorities views (excerpts from the STAFF REPORT)
- Fiscal and macro indicators (2019):  
  - Overall fiscal deficit declined from 2.2 to 1.6 percent of GDP in 2019.  
  - Public debt-to-GDP ratio remained at 134.8 of GDP.  
  - Primary surplus was 1.7 per cent of GDP in 2019 (national statistical institute’s data).  
  - Average interest rate on new government debt fell below 1 percent in 2019.
- Growth and labor:  
  - Growth outcome in 2019: 0.3 percent.  
  - Employment at record levels, but unemployment remains high, particularly among the young and in the Southern part of the country.
- Banking sector:  
  - System proved resilient, with increasing capitalization, declining NPLs, and improved profitability; consolidation continues among larger and smaller banks.
- COVID-19 fiscal response (early 2020):  
  - Government made euro 6.3 billion (0.3 percent of GDP) available to address the emergency and is considering measures that could bring the overall support package up to a total of euro 25 billion.
- Authorities’ views on FSAP/FSSA recommendations:  
  - Authorities emphasize the difficult European institutional setting for crisis management for small banks and consider some recommendations insufficiently tailored to Italy.  
  - Authorities note that preventive interventions by private Deposit Guarantee Schemes (DGS) have been broadly successful: out of 57 preventive interventions since 1997 by two DGSs operating in Italy, 45 were successful, 9 were not successful, and 3 are ongoing.  
  - Authorities dispute staff proposal of a “uniform carbon tax of €70”, noting an estimated implicit tax rate on CO2 emissions of euro 149 per ton in 2017 and that Italy’s energy taxation is already among the highest in Europe.
- Debt Sustainability Analysis (authorities’ concerns):  
  - Staff assumptions criticized for: (i) assuming “VAT safeguard clauses” will not be operational despite budget offsets; (ii) differing pension spending projections from authorities’ estimates; (iii) assuming a large gap between the real interest rate on government debt and the real rate of growth extending to 2050.

*STAFF REPORT FOR THE 2020 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1itaea2020001.pdf_