## 1itaea2021001

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### Context and pre-pandemic background
- Infections and fatalities high across three waves; contact-intensive services (tourism, hospitality, transport) especially hard hit.
- By end-2019, per capita income remained 7 percent below its pre-GFC level.
- Public debt rose despite two decades of mostly continuous primary surpluses.
- Current account tipped from a deficit to a surplus due to rising saving and declining investment since the GFC.
- Regional income disparities sizable (North–South); youth especially affected.
- Banks made good progress reducing high nonperforming loans (NPLs), though ratios remained above the EU average.

### Output, sectoral dynamics, and labor market
- Output and sectoral effects:
  - Output dropped almost 9 percent in 2020.
  - By end-2020, output remained about 6½ percent below end-2019.
  - Industry returned close to pre-COVID levels; contact-intensive services recovery incomplete.
  - Consumption and investment fell sharply; net exports supported growth.
  - Inflation moderated on lower world energy prices and a widening output gap.
- Labor market:
  - Unemployment rate rose from 9.7 percent pre-COVID to 10.1 percent in March 2021.
  - Shadow unemployment rate peaked at 20 percent in April 2020 and stood at 15 percent in February 2021.
  - Around 9 million workers (36 percent of the total) employed in contact-intensive services.
  - STW programs cap benefits at 80 percent of a worker’s normal wage; workers receive 80 percent of foregone earnings up to a monthly ceiling of about €1,119 under expanded CIG.
  - Household disposable income declined by only 2¾ percent in 2020.

### Fiscal and liquidity support measures (high-level)
- Large fiscal resources allocated to fight the health crisis and cushion social and economic effects.
- Income lifelines: short-time work (STW) programs, special grants, tax relief, Citizenship Income program.
- Temporary moratoria on taxes and loan servicing; government-guaranteed loans to firms of all sizes.
- Banks given temporary flexibility on capital and liquidity requirements; ECB low-cost funding conditioned on banks maintaining lending.
- Many firms reported having adequate liquidity; excess household saving in 2020 amounted to about 7½ percentage points of GDP (based on the average 2015–19 saving rate).
- Equity support approved for the national airline and for a steel company; recapitalization funds for small and larger firms established.

### Financial market and external sector developments
- Credit expanded since March 2020, larger increases to nonfinancial corporates than households; interest rates on new lending remain low.
- Italian sovereign yields fell below pre-crisis levels and yield curve flattened after early crisis spike.
- Banks’ (including CDP) claims on the domestic sovereign stand at 17.6 percent of assets.
- Current account surplus increased marginally to 3.7 percent of GDP.
- Italy’s TARGET2 liabilities rose to a record €516 billion in March 2021.
- As of end-February, 14 percent of loans (11 percent of GDP) benefitted from moratoria; households accounted for one fifth of these.
- 18 percent of NFC loans (8 percent of GDP) covered fully or partially by a government guarantee.
- Debt service payments covered by moratoria amounted to €40 billion.

### Political situation and priorities
- National-unity government formed February 2021 with priorities:
  - Address health emergency and accelerate vaccination campaign aiming to reach 80 percent of adults by early fall.
  - Implement Italy’s National Recovery and Resilience Plan (NRRP) to draw NGEU funds; extensive spending under the Plan alongside structural reforms.
  - Italy holds 2021 G-20 presidency and co-hosts COP26 with the UK.
  - Next general election due by end-May 2023; number of parliamentary seats in both chambers will be reduced by about a third.

### Outlook and risks (staff baseline and scenarios)
- Baseline projections and assumptions:
  - Growth could reach 4¼ percent in 2021 on-track vaccine rollout and continued support.
  - Potential growth currently 0.6 percent; NRRP investment could marginally lift potential growth above this level over the longer term.
  - Under baseline, output could return to pre-COVID level by early-2023.
  - Cumulative real foregone output by then could reach 14¼ percent of 2019 GDP.
  - Medium-term level of output forecast to remain around 1 percent below the no-COVID-19 trend.
- Authorities’ vaccination scenario:
  - If 80 percent vaccinated by October, authorities expect growth of 4.5 percent in 2021 and 4.8 percent in 2022; output surpassing pre-COVID level by mid-2022.
- Key upside risks:
  - Effective vaccination passports reviving tourism earlier; U.S. fiscal plans boosting exports.
- Key downside risks:
  - Slower virus defeat delaying lifting of mobility restrictions, deeper scarring, financial sector risks and contingent fiscal liabilities depressing banks’ capital and lending, weakening potential growth and pushing public debt onto a higher path.
  - Political/implementation risk: inefficient NGEU utilization or inadequate NRRP execution.
  - Financial conditions risk: faster-than-warranted tightening or adverse market reactions to Italy’s debt dynamics.

### Fiscal impact, 2020 outcomes and 2021 plans
- 2020 fiscal outcomes:
  - Primary deficit reached 6.0 percent of GDP (versus a primary surplus of 1.8 percent of GDP in 2019).
  - Public debt ratio rose by 20 percentage points to 155 percent of GDP.
  - Gross financing needs rose to 34 percent of GDP (from 22 percent in 2019).
- Authorities’ 2021 target:
  - Primary deficit targeted at 8.5 percent of GDP.
  - Headline deficit of 11.8 percent of GDP.
  - Public debt ratio forecast to peak at 160 percent of GDP in 2021 and moderate thereafter (authorities project return to pre-pandemic ratio in 2032).
- NGEU grant-financed investment projections include some 4½ percent of GDP in NGEU grant-financed investment spending during 2021–26.

### Fiscal measures, composition and staff estimates (selected figures)
- Staff estimates of fiscal measures (in percent of 2019 GDP; entries preserved as presented in source):
  - Total spending: 4.7 (2020 total), 4.0 (2021 discretionary), 6.4 (2020 total?), 5.7 (2021 total?)
  - Transfers to households and businesses: 4.0, 3.3, 5.5, 4.8
  - Other spending measures: 0.7, 0.7, 0.9, 0.9
  - Health: 0.5, 0.5, 0.5, 0.5
  - Investment: 0.0, 0.0, 0.2, 0.2
  - Total revenue: 0.4, 0.1, 0.7, 0.4
  - Tax policy measures: 0.4, 0.1, 0.7, 0.4
  - Below-the-line measures: Tax deferrals 0.5; Public guarantees on bank loans uptake as of March 2021 from an approved envelope of close to 30 percent of GDP; Direct equity support 0.2
- Tax deferrals around ½ percent of GDP provided firms additional temporary liquidity support.
- Cumulative lost nominal income due to COVID during 2020–21 projected at about 11 percent of 2019 GDP.

### Staff fiscal assessment and recommendations
- Staff view: public sector appropriately absorbed much income loss, but future spending should be better targeted.
- Recommended priorities:
  - Ensure health system and vaccination program adequately funded.
  - Improve targeting of compensation to those most affected and accelerate payout of benefits.
  - Publish information on broad categories of beneficiaries and provide ex post audit reports on crisis-related spending.
  - Review eligibility and benefit levels to align compensation with lost income and avoid compounded benefits.
- Suggested temporary targeted demand stimulus if hard-hit sectors remain weak, using vouchers, subsidies, or VAT cuts for specific activities to reward spending rather than saving.
- Note: automatic stabilizers played a minor role because they were not allowed to fully operate (e.g., ban on firing and reliance on STW reduced demand for Citizenship Income and unemployment benefits).

### Medium-term fiscal strategy, risks and staff views on debt dynamics
- Authorities’ strategy:
  - Exploit EU financing and favorable debt dynamics to boost investment.
  - Assume a permanent 1 percentage point improvement in the structural balance from 2025.
  - Plan comprehensive tax reform beginning with personal income tax; aim to strengthen revenue collection and participate in EU/global tax initiatives.
  - Plan a large 15 percent of GDP program of public investment and incentives for private investment for 2021–26.
- Staff cautions:
  - Risks from lower-than-expected spending efficiency on investment could reduce GDP gains and tax revenue, requiring additional borrowing or lower investment.
  - Gross financing requirements will remain high; net financing needs more limited once NGEU loans are factored in.
  - Additional fiscal effort needed to offset higher pension spending peaking around 2035.
- Fiscal metrics highlighted:
  - A 1 percentage point structural adjustment would raise the underlying primary surplus to around 2 percent of GDP, above pre-COVID level and well in excess of the debt-stabilizing primary deficit of 1.3 percent of GDP.

### Reviving and restructuring the business sector — vulnerabilities and policy actions
- Business vulnerabilities:
  - More than 3.5 million micro firms with fewer than 10 employees generate more than a quarter of GDP and nearly half of employment; many concentrated in tourism and services.
  - NFC indebtedness rose by 10 percent of GDP, much of it government guaranteed.
  - Value added in trade, transport, food and accommodation (nearly one fifth of GDP) remains subdued.
  - Share of missed payments on business invoices elevated for small firms in vulnerable sectors.
- Restoring firms’ financial health — recommendations:
  - Quickly restore financially viable but highly-leveraged firms to health; rapid rebound in activity is the best cure.
  - Mobilize part of private savings stockpile to strengthen firms’ capital or provide long-term participatory financing.
  - Limit support to firms likely to be profitable on a forward-looking basis; use private sector-led targeting and co-financing or insurance by the state to limit moral hazard.
  - Encourage business startups by lowering legal and administrative hurdles.
- Insolvency and restructuring:
  - Need more efficient procedures to tackle debt overhangs and allow smooth exit of nonviable firms.
  - Enhance out-of-court debt resolution mechanisms; expand capacity for in- and out-of-court resolution.
  - Introduce prepackaged and simplified SME-specific procedures.
  - Expedite civil procedure reform envisaged in NRRP.
  - Postponement of the Insolvency Code’s early warning system is appropriate given COVID to avoid overloading an untested system.

### Capital injection schemes and corporate support (selected design features)
- Relaunch Fund (Patrimonio Rilancio) managed by CDP:
  - Overall budget about €44 billion; target recapitalization of nonfinancial joint-stock companies with annual turnover ≥ €50 million.
  - Maximum support per firm: €2 billion.
  - Investment maturities vary between four and six years depending on type.
- SME Capital Strengthening Scheme (Fondo Patrimonio PMI) — managed by Invitalia:
  - Endowment about €4 billion for 2020 and €1 billion for 2021.
  - Maximum securities purchase capped at €800,000 per company.
- National Tourism Fund — mobilize up to €2 billion to temporarily/partially take ownership of domestic hotels.
- Authorities expect NRRP interventions to raise GDP by 0.6 percentage points per year during projection period, for an overall increase of 3.6 percentage points by 2026.
- NRRP/RRF totals:
  - RRF for Euro 191.5 billion.
  - REACT EU for Euro 15 billion.
  - NRRP total plan: Euro 237 billion (including other domestic resources).
  - RRF financing: 68.9 billion grants; the rest loans.

### Banking sector resilience, NPLs and financial stability guidance
- Banking background and performance:
  - Prior balance sheet repair enabled banks to increase credit; lending to private nonfinancial sector grew at about 3 percent annual rate since January 2020.
  - Loan-to-deposit ratio fell to 87 percent in January 2021.
  - NPL ratios declined from 6.7 percent at end-2019 to 4.1 percent at end-2020.
  - In 2020 banks increased loan provisions by around 50 per cent relative to 2019.
- Staff views and recommendations:
  - Expect loan quality to weaken once temporary supports expire; keep credit flowing to firms with good prospects.
  - Gradually phase out moratoria as activity normalizes; consider restarting debt service with interest-only initially.
  - Lower current high guarantee coverage rates and require stronger borrower creditworthiness checks.
  - Increase government oversight of guarantee portfolio; pending Treasury acquisition of SACE welcome.
  - Maintain active secondary market in NPLs (GACS success) and plan prompt, targeted action for any distressed banks.
  - Flexible timetable for rebuilding capital as announced by ECB Single Supervisory Mechanism to avoid undue credit tightening.
- Structural priorities:
  - Modify bank business models, increase efficiency, reduce costs, address weaknesses in debt recovery frameworks and gaps in prudential regulation.
  - Improve digital infrastructure and fintech capacity.
- Model-based projection:
  - An NPL formation model projects Italy’s NPL ratio would increase by 5.6 percentage points based on macro developments in 2020 (bringing total to around 11½ percent).
  - Model does not account for COVID mitigating factors; actual NPL formation could be significantly below model estimate.

### Credit support measures — moratoria and guarantee schemes (features and take-up)
- Moratoria:
  - Two statutory loan moratorium schemes introduced March 2020, partly extended to June 2021; automatic approval for eligible SMEs.
  - Government guarantees one-third of payments affected by moratorium.
  - As of end-March 2021, SME loans under moratorium account for 17 percent of all loans to firms, but debt service amounts covered by moratoria are about 5 percent.
  - As of end-March 2021, 38 percent (€108 billion) of moratoria granted since start of pandemic have expired.
- Guarantee schemes:
  - SME guaranteed loans account for 16 percent of total loans to firms.
  - Guarantees for larger firms by SACE with coverage of 70–90 percent (falling with firm size); weighted-average guarantee rate across both schemes is 87 percent; schemes available until June 2021.
  - As of end-March 2021, €138 billion of €160 billion in guaranteed loans had been issued by SME fund; some 1.4 million fully-guaranteed micro loans issued.
  - Take-up by larger firms low: 3 percent of all loans to firms.
- Implications:
  - Guaranteed loans likely refinanced existing loans: bank loans to private nonfinancial sector grew by 4 percent in 2020 while non-guaranteed loans fell by 6 percent.
  - Guaranteed loans have lower capital requirements and help banks meet ECB lending performance thresholds; as of end-2020 Italian banks among largest users in Europe of these schemes: 11 percent of Italian bank loans compared with EU average 3.6 percent.

### Box findings on credit quality and staging (selected)
- Reported end-2020:
  - Guaranteed loans: 0.2 percent classified as non-performing.
  - Moratorium loans: 2.9 percent classified as non-performing.
- Share of loans classified as Stage 2 rose sharply to 29 percent of all loans covered by moratoria.
- Some signals that credit quality of guaranteed-loan borrowers may be weaker (e.g., higher missed payments to suppliers); higher supplier-missed payments increase share of loan losses absorbed by government.

### Public debt and external debt projections and scenarios
- Baseline public debt projection:
  - Gross public debt projected to remain within 155–160 percent of GDP during 2021–26, supported by historically-low interest rates.
  - Excluding postal saving bonds (BPF), public debt projected broadly unchanged over forecast horizon.
- Baseline macro assumptions:
  - Real GDP growth projected to average 2¼ percent during 2021–26, then converge to ¾ percent.
  - GDP deflator projected to rise from 0.7 percent in 2019 to around 1.5 percent.
  - Government assumed to maintain average structural primary deficit of about 1 percent of GDP over 2021–26.
  - Stock of BPF projected to decline from €55 billion in 2019 to about €24 billion in 2026, reducing public debt by 2½ percent of GDP.
  - Effective nominal interest rate about 1¾ percent over medium term; average interest bill about 2¾ percent of GDP.
  - Spreads vis-à-vis German bunds assumed to rise gradually to about 145 basis points by 2026.
  - Baseline assumes use of an envelope of about 8 percent of GDP in NGEU loans through 2026 to finance higher public investment.
- Shock scenarios (selected impacts):
  - Standard growth shock: average growth -½ percent in 2022–23; primary balance would decline further to -5¼ percent of GDP by 2023; debt ~175 percent of GDP in 2023.
  - Interest rate shock: spreads increase by 150 bps (to about 300 bps); implicit average interest rate on debt rises to 2½ percent by 2025; debt ~160 percent of GDP by 2024.
  - Contingent liability shock: one-time increase in non-interest expenditure ~10 percent of GDP; primary balance worsens by 14 percent of GDP in 2022; debt rises to 185 percent of GDP by 2023.
- External debt:
  - External debt rose from 124 percent of GDP in 2019 to 150 percent of GDP in 2020; baseline projects decline to 143 percent of GDP in 2026.
  - Table (selected baseline external debt series in percent of GDP): 2016: 117.0; 2017: 128.0; 2018: 116.0; 2019: 123.7; 2020: 150.1; 2021: 143.8; 2026: 142.6.
  - Gross external financing needs (US$ billions): 2016: 850.7; 2017: 977.0; 2018: 1,145.4; 2019: 1,177.7; 2020: 1,107.5; 2021: 1,306.1; 2026: 1,369.8.
  - External debt-to-exports ratio examples: 2019: 368.6; 2020: 388.8; 2021: 506.9; 2026: 394.2.
- Public DSA selected rows (percent of GDP):
  - Nominal gross public debt: 2019: 130.2; 2020: 134.6; 2021: 155.6; 2022: 159.9; 2026: 156.5 (alternate 155.5).
  - Primary deficit (percent of GDP): 2019: -1.2; 2020: -1.7; 2021: 6.0; 2022: 8.4; 2026: 0.4.
  - Public gross financing needs (percent of GDP): 2019: 26.4; 2020: 22.2; 2021: 34.2; 2026: 28.9.

### External Sector Assessment (Annex IV) — key messages
- Overall assessment: External position in 2020 broadly in line with medium-term fundamentals and desirable policies.
- NIIP close to balance at end-2020: 1.8 percent of GDP.
- Gross assets and liabilities jumped to 187 and 185 percent of GDP, respectively, in 2020.
- TARGET2 liabilities rose to record high of 31 percent of GDP.
- Current account (2020): 3.7 percent of GDP; cyclically adjusted CA 2.7 percent; EBA norm 2.8 percent; staff gap 0.3 percent.
- Policy responses recommended:
  - Raise productivity and improve business climate via structural reforms.
  - Increase investment under NRRP; upskill workforce; improve judiciary and public administration effectiveness.
  - Improve budget efficiency by curtailing wasteful spending and removing extensive tax loopholes.

### Staff appraisal — consolidated policy recommendations (selected)
- Maintain lifeline income and liquidity measures until recovery entrenched, but progressively target support to those most affected.
- Transition from pandemic lifelines toward supporting robust recovery while mitigating financial, sovereign and corporate risks.
- Restore financial health of firms likely to be profitable using partial government guarantees or co-financing to mobilize private resources; delegate targeting decisions to private sector.
- Facilitate exit of nonviable firms by boosting court resources and streamlining insolvency and debt restructuring procedures.
- Continue to support bank lending but better target credit to viable firms; increase banks’ skin-in-the-game on guaranteed loans and update borrower creditworthiness assessments.
- Labor market: wind down STW and firing ban as health crisis recedes; replace compensation for hours-not-worked with rewards for rehiring and new hiring; support retraining and upskilling.
- Fiscal policy: use NRRP window to invest while entrenching public debt on a declining path; ensure efficient spending and resolute implementation of structural reforms.
- Recommendation: next Article IV consultation on standard 12-month cycle.

*Italic: IMF staff report — content unit 1itaea2021001 (extracted from the provided PDF content).*

### 1. Some Societal Effects of COVID-19 __________________________________________________________________ 27

### 1. Some Societal Effects of COVID-19

### Context
- Infections and fatalities have been high across the three waves of the pandemic; mobility restrictions and voluntary social distancing have had a severe but highly uneven effect on economic activity, with contact-intensive services—tourism, hospitality, transport—especially hard hit.
- By end-2019, Italy’s GDP had only partially recouped lost output from the earlier double-dip recession; per capita income remained 7 percent below its pre-GFC level.
- Public debt rose despite two decades of mostly continuous primary surpluses; rising saving and declining investment since the GFC recently tipped the current account from a deficit to a surplus.
- Regional income disparities remain high, with sizable North–South differences in employment and poverty rates; the young are especially affected.
- Good progress had been achieved in reducing banks’ high nonperforming loans (NPLs), although ratios remained above the EU average.

### Recent developments and policy responses
- Output and sectoral dynamics:
  - Output dropped almost 9 percent in 2020 despite a strong summer rebound.
  - By end-2020, output remained about 6½ percent below the level at end-2019.
  - Activity became highly uneven: industry returned close to pre-COVID levels while contact-intensive services recovery is incomplete.
  - Consumption and investment fell sharply; net exports supported growth.
  - Inflation moderated on lower world energy prices and a widening output gap.
- Fiscal and liquidity support:
  - Large fiscal resources allocated to fight the health crisis and cushion social and economic effects (Annex I).
  - Income lifelines: short-time work (STW) programs, special grants, tax relief, and the Citizenship Income program.
  - Temporary moratoria on taxes and servicing of bank loans; government-guaranteed loans to firms of all sizes.
  - Banks granted temporary flexibility on capital and liquidity requirements; low-cost ECB funding conditioned on banks maintaining lending.
  - Household disposable income declined by only 2¾ percent in 2020.
  - Many firms reported having adequate liquidity.
  - Equity support approved for the national airline and for a steel company; foreign direct investment framework tightened for strategic assets; recapitalization funds for small and larger firms established.
- Financial market and external sector developments:
  - Credit expanded since March 2020, with larger increases to nonfinancial corporates than to households; interest rates on new lending remain low.
  - Yields on Italian sovereign bonds fell below pre-crisis levels and the yield curve flattened after an early crisis spike.
  - Linkages between banks, firms and the sovereign rose owing to the guaranteed loan program; Italian banks’ (including CDP) claims on the domestic sovereign stand at 17.6 percent of assets.
  - Excess household saving in 2020 amounted to about 7½ percentage points of GDP (based on the average 2015–19 saving rate).
  - Households’ disposable income fell by 2¾ percent relative to 2019 even as STW benefits are capped at 80 percent of a worker’s normal wage level.
  - Current account surplus increased marginally to 3.7 percent of GDP.
  - Italy’s TARGET2 liabilities rose to a record €516 billion in March 2021.
- Labor market, bank asset quality and support conceal weakness:
  - Unemployment rate rose from 9.7 percent pre-COVID to 10.1 percent in March 2021.
  - Shadow unemployment rate peaked at 20 percent in April 2020 and stood at 15 percent in February 2021.
  - Business exits suppressed by freeze on bankruptcies and temporary income/liquidity support.
  - At end-February, 14 percent of loans (11 percent of GDP) benefitted from moratoria; households accounted for one fifth of these.
  - 18 percent of NFC loans (8 percent of GDP) were covered fully or partially by a government guarantee.
  - Debt service payments covered by moratoria amounted to €40 billion.
  - Formation of new NPLs fell slightly from 1.2 percent of loans to firms in 2019 to 1.1 percent in Q4:2020, but stage 2 loans have recently risen.

### Political situation
- A national-unity government formed in February 2021 with top priorities:
  - Addressing the health emergency and accelerating the vaccination campaign, aiming to reach 80 percent of adults by early fall.
  - Implementing Italy’s National Recovery and Resilience Plan (NRRP) to draw its share of the Next Generation EU (NGEU) Fund; extensive spending under the Plan to be implemented alongside structural reforms.
  - Italy holds the 2021 presidency of the G-20 and is co-hosting COP26 with the UK.
  - The next general election is due by end-May 2023; number of parliamentary seats in both chambers will be reduced by about a third.

### Outlook and risks
- Staff baseline assumptions and projections:
  - On-track vaccine rollout and continued support to the most affected would allow growth to accelerate later in 2021; despite late-2020 and early-2021 drag, growth could reach 4¼ percent in 2021.
  - Return to pre-COVID conditions across much of the economy, reinforced by substantial investment spending mainly under the NRRP, would boost growth well above previous trend over the next several years.
  - Potential growth is currently 0.6 percent; NRRP investment could marginally lift potential growth above this level over the longer term (Annex VI).
  - Under the baseline, output could return to its pre-COVID level by early-2023.
  - Cumulative real foregone output by then could reach 14¼ percent of 2019 GDP.
  - In the medium term, the level of output is forecast to remain around 1 percent below the no-COVID-19 trend.
- Key upside and downside risks:
  - Upside: effective vaccination passports reviving tourism earlier; U.S. Rescue and American Jobs Plans providing additional support to Italian exports, possibly pushing output above pre-COVID level already in 2021.
  - Downside: slower defeat of the virus (domestic or international) delaying lifting of mobility restrictions, greater scarring of firms’ and households’ balance sheets, significant financial sector risks and contingent fiscal liabilities depressing banks’ capital and lending capacity, weakening potential growth and pushing public debt onto a higher path.
  - Political/implementation risk: inefficient utilization of NGEU resources or inadequate execution of the NRRP (possibly due to fragmenting political support for reforms) would be damaging for growth and public debt.
  - Financial conditions risk: faster-than-warranted tightening of monetary policy or adverse market reactions to Italy’s debt dynamics could worsen financing conditions.
- Policy implications emphasized in discussions:
  - Transition from pandemic-related lifelines toward supporting a robust recovery while mitigating financial, sovereign and corporate risks.
  - Efficient utilization of NGEU resources combined with resolute implementation of structural reforms to reinvigorate longer-term growth.

*Source: IMF staff report — 1. Some Societal Effects of COVID-19 (extracted from the provided PDF content).*

### 12.      The authorities agreed the near-term outlook is highly dependent  on pace  of

### 12. The authorities agreed the near-term outlook is highly dependent on pace of vaccinations

### Near-term outlook and growth projections
- Renewed containment measures caused GDP to decline in Q1:2021 by -0.4 percent (from -1.8 in Q4:2020).
- Authorities’ vaccination scenario: if 80 percent of the population is vaccinated by October, enabling the economy to fully reopen, the authorities expect:
  - Growth of 4.5 percent in 2021.
  - Acceleration to 4.8 percent in 2022.
  - Output surpassing its pre-COVID level by mid-2022.
- Main near-term risks: slow vaccinations or variant break-through of existing vaccines.
- Observed policy mix: better targeting of mobility restrictions, continued fiscal support to those most affected, and accommodative monetary and financial conditions have moderated economic consequences of pandemic waves.

### Fiscal impact of the pandemic and near-term fiscal plans
- 2020 outcomes:
  - Primary deficit reached 6.0 percent of GDP (versus a primary surplus of 1.8 percent of GDP in 2019).
  - Public debt ratio rose by 20 percentage points to 155 percent of GDP.
  - Gross financing needs rose to 34 percent of GDP (from 22 percent in 2019).
- Authorities’ 2021 target:
  - Primary deficit targeted at 8.5 percent of GDP.
  - Headline deficit of 11.8 percent of GDP.
  - Public debt ratio forecast to peak at 160 percent of GDP in 2021 and moderate thereafter (authorities project an eventual return to pre-pandemic ratio in 2032).
- NGEU grant-financed investment: projections include some 4½ percent of GDP in NGEU grant-financed investment spending during 2021–26 (noted as less than one quarter of total planned investment during this period).

### Fiscal measures, coverage, and composition
- For 2020–21 combined, fiscal lifeline spending is expected to fully cover the amount of foregone income attributed to COVID.
- Above-the-line discretionary spending on income lifelines and tax relief, together with automatic revenue and spending stabilizers, exceeded 5 percent of GDP in 2020.
- Fiscal measures (in percent of 2019 GDP) — staff's estimates:
  - Total spending: 4.7 (2020 total), 4.0 (2021 discretionary), 6.4 (2020 total?), 5.7 (2021 total?) — (table entries preserved as presented).
  - Transfers to households and businesses: 4.0 (2020 total), 3.3 (2021 discretionary), 5.5, 4.8 (entries as in source).
  - Other spending measures: 0.7, 0.7, 0.9, 0.9.
  - Health: 0.5, 0.5, 0.5, 0.5.
  - Investment: 0.0, 0.0, 0.2, 0.2.
  - Total revenue: 0.4, 0.1, 0.7, 0.4.
  - Tax policy measures: 0.4, 0.1, 0.7, 0.4.
  - Below-the-line measures: Tax deferrals 0.5; Public guarantees on bank loans uptake as of March 2021 from an approved envelope of close to 30 percent of GDP; Direct equity support 0.2.
- Tax deferrals noted at about ½ percent of GDP provided firms additional temporary liquidity support.
- Cumulative lost nominal income due to COVID during 2020–21 projected at about 11 percent of 2019 GDP.

### Staff assessment and recommendations on fiscal policy targeting and transparency
- Staff view: public sector appropriately absorbed much income loss, but future spending should be better targeted.
- Recommended priorities:
  - Ensure health system and vaccination program are adequately funded.
  - Improve targeting of compensation to those most affected and accelerate payout of benefits.
  - Publish information on broad categories of beneficiaries and provide ex post audit reports on crisis-related spending.
  - Review eligibility and benefit levels of above- and below-the-line support programs to align compensation with lost income and avoid compounded benefits.
- Suggested temporary targeted demand stimulus if hard-hit sectors remain weak after the health crisis, with instruments such as vouchers, subsidies, or VAT cuts for specific activities to reward spending rather than saving and increase fiscal multipliers.
- Note on automatic stabilizers: they played a minor role because they were not allowed to fully operate (example: ban on firing and reliance on the STW scheme reduced demand for citizenship income and unemployment benefits).

### Medium-term strategy, risks, and staff views on investment and debt dynamics
- Authorities’ strategy:
  - Exploit EU financing and favorable debt dynamics to boost investment.
  - Assume a permanent 1 percentage point improvement in the structural balance from 2025 (supporting measures not identified in projections).
  - Increase investment financed through grants, loans and additional tax revenue from stronger activity.
  - Further lengthen borrowing maturities to lock in low rates.
  - Plan a comprehensive tax reform beginning with personal income tax, focusing on revenue collection and EU/global tax initiatives.
- Staff view:
  - Support using the favorable window to invest while entrenching public debt on a declining path, but emphasize inherent risks.
  - Risks include lower-than-expected spending efficiency on investment, which would reduce GDP gains and tax revenue, potentially requiring additional borrowing or lower investment to meet primary balance targets.
  - Gross financing requirements will remain high; excluding rollovers, net financing needs would be more limited and decline once NGEU loans are factored in.
  - Over longer term, additional fiscal effort will be needed to offset higher pension spending peaking around 2035 prior to full realization of past reform savings.
- Fiscal targets and metrics highlighted by staff:
  - A 1 percentage point structural adjustment would raise the underlying primary surplus to around 2 percent of GDP, slightly above its pre-COVID level and well in excess of the debt-stabilizing primary deficit of 1.3 percent of GDP.
  - Recommendation for a comprehensive base-broadening tax reform to promote growth, inclusion, and tackle tax evasion.
  - Caution that recent amnesty on old tax liabilities could weaken future tax compliance.
  - Suggest further lengthening debt maturity and considering saving additional resources arising from BdI’s holdings of government debt.

### Authorities’ views
- Dual priorities: resolving the pandemic and transforming the economy; reforms are instrumental to achieve quantitative and qualitative fiscal goals.
- Emphasis: ensuring an efficient and adequately-funded vaccination program is the most cost-effective economic policy.
- Justification for emergency income support: solidarity, social cohesion, and preventing loss of viable jobs and firms that would lower potential GDP.
- Compensation system recalibrated to better target those most affected; resources for health emergency, income lifelines, and infrastructure investment expected to increase the deficit to 11.8 percent of GDP in 2021.
- Authorities view temporary nature of COVID and investment-related spending as preventing structural balance weakening.
- Authorities plan a large 15 percent of GDP program of public investment and incentives for private investment for 2021–26 aimed at catching up foregone public investment since the GFC.
- To support the envisaged 1 percentage point structural adjustment, authorities plan a comprehensive tax reform starting with personal income tax, focusing also on revenue collection mechanisms and EU/global initiatives on corporate, digital and green taxes.

### Reviving the business sector: vulnerabilities and support
- Prevalent vulnerabilities:
  - Prevalence of micro firms (more than 3.5 million micro firms with fewer than 10 employees), generating more than a quarter of GDP and nearly half of employment, concentrated in tourism and services—heightening vulnerability to COVID shock.
  - Indebtedness of NFCs rose by 10 percent of GDP, much of it wholly or majority government guaranteed.
  - Total deposits of NFCs increased by even more, suggesting firms borrowed to build liquidity buffers.
  - Value added in trade, transport, food and accommodation sectors (nearly one fifth of GDP) remains subdued.
  - Share of missed payments on business invoices has remained elevated for small firms in vulnerable sectors.
- Measures and structural issues:
  - Comprehensive set of support measures attenuated widespread liquidity shortfalls.
  - Implementation of the new insolvency code planned for 2020 has been pushed back to September 2021, with further delay anticipated.
  - Several strategic firms and key sectors (agriculture, tourism) have received equity support.
- Staff note: distribution of debt and deposit increases may differ across firms and sectors; net financial liabilities may have risen considerably for some groups of firms; prolongation of the pandemic would be expected to increase equity shortfalls.

*Source: IMF staff report (Italy): excerpts on near-term outlook, fiscal policy, and business sector vulnerabilities.*

### 19.      Quickly restoring to financial health those highly-leveraged firms that are likely to be

### 1itaea2021001 - 19.      Quickly restoring to financial health those highly-leveraged firms that are likely to be

### Restoring firms’ financial health — key findings and recommendations
- Quickly restoring to financial health those highly-leveraged firms that are likely to be profitable in the future would provide a solid footing for the recovery.
- A rapid and vigorous rebound in activity is the best cure for the business sector.
- Even with a strong recovery and extensive income compensation, many firms could emerge from the crisis with excessive debt, impeding their capacity to invest and grow.
- Liquidity support may continue to be needed as activity normalizes and the backlog of overdue business payables is cleared.
- Smaller firms and those in contact intensive and affiliated sectors are likely to have been most affected by the crisis.
- Part of the private savings stockpile could be mobilized to:
  - strengthen firms’ capital, or
  - provide long-term participatory financing.
- Some firms may require debt restructuring.
- Support should address weaknesses due to COVID rather than pre-existing conditions, with eligibility limited to firms likely to be profitable on a forward-looking basis, although identification could be difficult while the pandemic is ongoing.
- Private sector-led decisions on targeting and amount of financing would limit moral hazard and diversify risk, with co-financing or insurance by the state to counter likely private under-provision from a societal perspective.
- The scheme for investing in large firms appears to be primarily state led and financed (Annex VII).
- Business startups should be encouraged by lowering legal and administrative hurdles.

### Debt overhang, insolvency, and restructuring — findings and policy actions
- More efficient procedures are needed to tackle debt overhangs and enable the smooth exit of firms that have little chance of survival.
- Demands on the debt restructuring and insolvency regimes, among the least efficient in the EU, will increase sharply once temporary support measures are lifted.
- Preventing a surge in unwarranted insolvencies is critical to limit costly bottlenecks and value loss.
- Recommended measures:
  - Enhance out-of-court debt resolution mechanisms with economic incentives that reward timely-yet-efficient outcomes.
  - Expand capacity for in- and out-of-court debt resolution.
  - Introduce prepackaged and simplified SME-specific procedures to help avoid excessive liquidations.
  - Increase reliance on technology-based procedures, building on the pandemic-triggered switch to online court proceedings.
  - Expedite long-awaited civil procedure reform as envisaged in the NRRP to streamline in-court processes and shorten procedural deadlines.
- The postponement of one major novelty of the new Insolvency Code—an early warning system with a sequence of mandatory restructuring and liquidation triggers—is appropriate in the context of COVID because:
  - The potential wave of post-pandemic financially distressed companies, combined with the rigid nature of the rules, would create a significant risk of overloading the untested system.
- Notes on the early warning mechanism (as described in the source):
  - Obliges debtor’s statutory and external auditors and certain public creditors to inform company directors of signs of crisis and, if unaddressed, to turn to a special “crisis-assistance commission” (OCRI) at the local Chamber of Commerce.
  - Triggered according to a set of financial distress indicators recently adopted, which uses undercapitalization of the debtor as one criterion.
  - Applies to SMEs and intends to signal distress and trigger restructuring at early stages; failure to resolve distress within a certain time frame may lead to start of insolvency processes.

### Authorities’ views on firm support and restructuring
- Authorities observed that support to firms has kept the production base largely intact while the pandemic provides an opportunity to make the business sector more dynamic and resilient.
- Unprecedented support measures have successfully mitigated liquidity and insolvency risks so far.
- Support is still needed and withdrawal should be gradual and take account of policy interactions to avoid cliff effects.
- Debt service moratoria might be phased out by initially requiring only payment of interest.
- Companies heavily impacted by the crisis could become overindebted and many firms have cut back on investment.
- To reduce excessive leverage, a rebalancing of liquidity and solvency support may be needed, especially for small companies.
- Triaging firms eligible for future support will be challenging given residual uncertainty related to COVID and forthcoming green and digital transformations; private sector (notably banks) is best positioned to take such decisions, with government providing grants and tax incentives for investment and equity injections that avoid moral hazard and channel private savings.
- The recently activated Relaunch Fund will help medium and large companies to finance new investments through a range of debt, equity and hybrid capital instruments.
- Authorities concurred on the need to facilitate the smooth exit of unviable firms; planned hiring by the courts of additional magistrates and administrative staff, and increased digitalization, would increase capacity to deal with distressed firms.
- Further delay in implementing the new Insolvency Code is envisaged on concerns that the inflexible early warning system may capture many firms facing only temporary financial difficulty; more voluntary and flexible instruments should be applied.

### Cushioning the labor market — background and staff recommendations
- Background facts:
  - Around 9 million workers (36 percent of the total) are employed in contact intensive-services, many in micro firms.
  - STW schemes and a ban on layoffs have contained overall income and employment loss but provided less protection to the young and to women, who are over-represented in non-standard employment (temporary, part-time, or seasonal contracts).
  - Use of STW schemes peaked in Q2:2020; usage rose again with second and third waves in sectors affected by social distancing (trade, transportation, hospitality) and a large stable base of users in industry.
  - During 2021–26, firms in the South will be exempted from the employers’ share of social security contributions (about 12 percent of gross wages), with a decreasing exemption until 2029.
  - Employers of women and youth across the country will be exempted from all social security contributions (40 percent of gross wages) for the next several years.
- Staff’s views and recommendations:
  - Once the pandemic is over, labor market support should decouple from preserving existing employment contracts.
  - STW schemes and firing ban should be wound down as the health crisis recedes; compensation for hours-not-worked should be replaced with rewards for getting employees back to work and for new hiring.
  - Combine gradual winding down of exceptional labor market measures with a strictly temporary wage subsidy for heavily-affected businesses that restart operations to incentivize reopening and restore labor market turnover.
  - Semi-permanent wage subsidies to groups and regions with eligibility unrelated to the pandemic would not address persistent weak productivity; consideration should be given to a faster phasing out of these measures.
  - Strengthen social safety nets and enhanced training programs to buffer employment transitions:
    - Existing unemployment benefits and the Citizenship Income program provide income support for transitions.
    - Effective retraining and skills upgrading programs (including online platforms) are crucial to increase within-sector productivity and facilitate across-sector mobility.
    - Modify the Citizenship Income program to ensure adequacy of benefits (especially for large families), avoid disincentives to work by limiting the rate of benefit withdrawal in response to earned income (especially at low levels), and keep fiscal costs contained.

### Authorities’ views on labor measures
- Authorities agreed exceptional wage and employment measures should be gradually withdrawn to normalize the labor market.
- The firing ban will be lifted at end-June for employees of medium and large companies in industry and agriculture who have continuous access to the regular STW schemes.
- The ban will be extended until end-October for workers in smaller firms and in the service sector who are currently ineligible for the regular STW schemes to allow time to bring them into the schemes.
- Future access to STW schemes will be conditioned on using part of non-worked hours for training purposes.
- Authorities observed subsidizing social security contributions for groups with chronically poor labor market outcomes could potentially increase their employment, but agreed this would not be an effective long-term solution.
- Some changes to the Citizenship Income program are being considered, including allowing beneficiaries to return to work while maintaining benefits for a short period and simplifying application and approval processes.

### Maintaining financial stability — background, staff views, and structural priorities
- Background facts:
  - Prior balance sheet repair and capital replenishment enabled banks to increase credit during the pandemic, aided by state guarantees and regulatory relief.
  - After declining for a decade, lending to the private nonfinancial sector has grown at an annual rate of about 3 percent since January 2020 to meet liquidity demand from firms and households.
  - The increase is more than fully accounted for by government guaranteed credit.
  - Bank funding is ample, with the loan-to-deposit ratio falling to 87 percent in January 2021.
  - NPL ratios declined from 6.7 percent at end 2019 to 4.1 percent at end-2020 on continuing loan sales (including to the state-owned asset management company) and securitizations.
  - In 2020 banks increased loan provisions by around 50 per cent relative to 2019, but defaults remain at levels well-below those seen in the wake of the euro area debt crisis.
- Staff’s views and recommendations:
  - Banks’ loan quality is expected to weaken once temporary policy supports expire, but keeping credit flowing to firms with good prospects is essential to underpin the recovery.
  - Gradually phasing out moratoria as firms' activity levels normalize would help avoid renewed liquidity pressures on borrowers.
  - Guarantees have been instrumental in encouraging lending and will cushion the effect on banks from an anticipated increase in NPLs.
  - Strengthen banks’ incentives to direct guaranteed loans to firms in temporary difficulty but with good prospects by:
    - Lowering current high guarantee coverage rates, and
    - Requiring more stringent checks on borrower creditworthiness based on timely data.
  - Incentivize banks to actively manage their fully-guaranteed loans.
  - With the government assuming a large share of banks’ credit risk, increase government oversight of the guarantee portfolio; the pending acquisition by the Treasury of SACE is therefore welcome.
  - Banks and authorities should intensify efforts to improve understanding of underlying loan quality, taking account of current conditions, borrowers’ strong liquidity buffers and expected post-pandemic performance once temporary supports are lifted.
  - A flexible timetable for rebuilding capital, as announced by the ECB Single Supervisory Mechanism, would avert undue tightening of credit conditions.
  - Maintain the active secondary market in NPLs, building on the success of the GACS scheme, and plan for prompt, targeted action to deal with any individual distressed banks.
  - As uncertainty declines, a case-by-case approach to permitting distribution of dividends would avoid penalizing banks with strong capital positions and solid profit generation; weaker institutions should continue to face restrictions.
- Structural weaknesses and reform priorities highlighted:
  - Italian banks’ profitability is pressured by low interest rates and a flat yield curve depressing net interest margins and interest income.
  - Slow debt restructuring and insolvency processes lead to poor loan recovery rates and increase provisioning requirements.
  - Room exists to strengthen arrangements for managing distressed banks in the context of enhancing the EU crisis management framework.
  - The uptick in digital payments during the pandemic highlights the need for Italy’s banks to catch up in digital infrastructure and fintech capacity.
  - Banks have further increased their exposure to the Italian sovereign, raising concentration risk.
  - Imperatives: modify business models, increase efficiency, continue to reduce costs, address weaknesses in debt recovery frameworks and gaps in prudential regulation.
- Numerical model note:
  - Using an NPL formation model, Italy’s NPL ratio would be expected to increase by 5.6 percentage points based on macroeconomic developments in 2020 (bringing the total NPL ratio to around 11½ percent).
  - The model does not account for unique COVID mitigating factors (income support to borrowers, sizable credit guarantees with high coverage rates, borrowers’ liquidity buffers), so actual NPL formation could be significantly below the model-predicted estimate and would in any event be well short of the post-euro area crisis peak of 18 percent in 2015.

*Source: INTERNATIONAL MONETARY FUND*

### 29.      The authorities highlighted the success of their policy response in maintaining credit

### 1itaea2021001 - 29.      The authorities highlighted the success of their policy response in maintaining credit

### Credit support measures, banking sector risks, and policy stance
- Authorities highlighted success of policy response in maintaining credit supply and financial stability amid high uncertainty.
- Extensions of moratoria and guarantee schemes were necessary as the pandemic lengthened, but consideration is being given to making these more targeted.
- Incentives for providing and maintaining guarantees will be revised, including by lowering the guarantee coverage ratio to contain risks to the State and to reinforce banks’ issuance decisions.
- Proposed gradual restart of debt service once moratoria expire, initially requiring that only interest be paid.
- Authorities expected credit quality to weaken once support measures (in particular debt moratoria) expire, but were confident banking sector losses would be manageable and remain well below levels seen following the euro area debt crisis, although the pandemic might compound prior structural challenges for some banks.
- Authorities are improving monitoring of credit risk in the banking sector and in government loan guarantee schemes; banks should remain alert to loan quality deterioration and provision adequately; bank-specific supervisory action will be adopted if required.
- Banks are expected to be pro-active in reducing any NPL buildup; maintaining the strong secondary market in NPLs would support banks’ NPL reduction strategies.
- The State-owned asset management company may play a role in managing NPLs with very high guarantee coverage.

### Main features and take-up of moratoria and guarantee schemes (Box 2 summary)
- Moratoria:
  - Two statutory loan moratorium schemes introduced in March 2020, in part extended to June 2021.
  - SMEs with exposures not non-performing when scheme began are eligible for deferral of interest and principal payments or to prevent revocation of undrawn credit lines; approval is automatic.
  - Government guarantees one-third of payments affected by the moratorium.
  - For mortgages on primary residences, workers whose hours cut by at least 20 percent and self-employed whose turnover declined by at least one-third can defer payments, with half of accrued interest during suspension paid by the government.
  - Additional voluntary moratoria by banking industry association and targeted moratoria by individual banks.
- Guarantee schemes:
  - For SMEs, 100 percent guaranteed loans available up to €30,000, maturity up to 15 years (extended from six years) and two-year grace period.
  - For firms with fewer than 500 employees, 80–90 percent guarantees for loans up to €5 million, double their 2019 wage bill, or 25 percent of 2019 turnover, with up to six years maturity; no guarantee fees charged.
  - For larger firms, guarantees by SACE with coverage of 70–90 percent (falling with firm size), grace periods up to three years, loan amounts up to double 2019 wage bill or 25 percent of 2019 turnover; guarantee fees charged.
  - The weighted-average guarantee rate across both schemes is 87 percent; schemes available until June 2021.
  - No guarantee scheme for household loans.
- Scale of take-up (as of end-March 2021):
  - SME loans under moratorium account for 17 percent of all loans to firms, but debt service amounts covered by moratoria are about 5 percent.
  - SME guaranteed loans account for 16 percent of total loans to firms.
  - Take-up of guarantees by larger firms has been low: 3 percent of all loans to firms.
  - As of end-March 2021, €138 billion of the total €160 billion in guaranteed loans had been issued by the SME fund.
  - Some 1.4 million fully-guaranteed micro loans have been issued.
  - Around 6.5 percent of loans to consumer households are covered by either statutory or voluntary moratoria.
  - As of the same date, 38 percent (€108 billion) of moratoria granted since the start of the pandemic have expired (partly reflecting loans moving from voluntary to statutory schemes).
- Implications for banks:
  - Guarantees likely refinanced existing loans: stock of bank loans to the private nonfinancial sector grew by 4 percent in 2020 while non-guaranteed loans fell by 6 percent.
  - Acceptance rate of SME guarantees above 90 percent reflecting simplified assessment process.
  - Guaranteed loans have lower capital requirements and help banks meet lending performance thresholds under the ECB’s long-term refinancing programs, increasing loan profitability; banks expected to pass on gains through lower lending rates.
  - As of end-2020, Italian banks among largest users in Europe of these credit support schemes scaled by loan portfolios: 11 percent of Italian bank loans compared with an EU average of 3.6 percent.

### Investing for the recovery — NRRP resources, allocation, and reform priorities
- Significant resources from the NGEU will be available to Italy during 2021–26 to address structural weaknesses and public investment for green and digital transition.
- Italy’s NRRP covers six missions: (1) green revolution and ecological transition; (2) digitalization, innovation, competitiveness and culture; (3) infrastructure for sustainable mobility; (4) education and research; (5) equity and inclusion; and (6) health.
- Allocation of NRRP resources:
  - Nearly 70 percent of total NRRP resources to public infrastructure investment (renewable energy, high speed railways and road maintenance, rehabilitation of public buildings, sustainable agriculture).
  - About 20 percent to support tax credits encouraging firms and households to spend on digital and environmentally-friendly investments.
  - Remaining resources allocated to other current spending (e.g., hiring, training services).
- Planned reforms in NRRP: public administration, justice and competition, with frontloading of legislation and key implementation decrees.
- Staff cautions that tax incentives could be effective but the 110 percent subsidy may result in inefficiencies and excessive fiscal cost.
- Suggested governance and implementation measures:
  - Strengthen coordination between central, regional and municipal governments due to most spending responsibility at local level.
  - Enhance accountability at spending level because EU funds disbursement tied to performance benchmarks.
  - Backloading of public investment in Plan intended to allow time for project preparation and tendering.
  - Propose a “fund of funds” to leverage private sector financing (loans, equity, quasi equity backed by government first-loss guarantee) for social housing, tourism and circular economy.
  - Use own resources, financed in part by green bonds, to boost environmental projects.
  - Lower regulatory barriers to competition and strengthen governance of public investment via enhanced transparency and accountability of public procurement.

### Staff views, growth outlook, and policy recommendations (Staff appraisal)
- Staff’s assessment:
  - An investment boost—if spent efficiently and accompanied by growth-enhancing reforms—could help recoup lost ground on productivity and accelerate green, digital, and fair transition.
  - NRRP can modernize the economy, increase growth potential, and secure more balanced gender, regional and intergenerational outcomes.
  - Frontloading structural reforms and backloading some public investment affords time to strengthen capacity for project preparation, execution and ex post evaluation, raising absorption capacity and spending efficiency.
- Growth outlook and risks:
  - While 2021 began weak, GDP growth could reach 4¼ percent this year if vaccine rollout proceeds as planned and remain above trend over the medium term.
  - Scarring may be sizable as many businesses could face excessive debt or changing consumer preferences; workers and students have lost employment and education.
  - Spending under NRRP will temporarily elevate growth well above previous trend and could boost potential growth if accompanied by successful structural reforms.
  - Risks two-sided: speed of vaccination, efficiency of investment spending, and extent to which accumulated savings are drawn down.
- Fiscal and financial policy guidance:
  - Maintain lifeline income and liquidity measures until recovery firmly entrenched, but target those most affected; damp precautionary savings and allow financial liabilities to be gradually paid down.
  - Budgetary spending appropriate to address pandemic effects but should be prudent, well targeted, calibrated to foregone income and strictly temporary.
  - A temporary, targeted demand stimulus could help recovery of hard-hit sectors and encourage drawdown of accumulated savings.
  - A credible plan needed to anchor sustained and significant reduction in public debt ratio by end of decade; ability to spend efficiently and implement reforms is critical.
  - Restore financial health of firms likely to be profitable: use partial government guarantees or co-financing to mobilize private sector resources for equity or long-term debt, delegating targeting decisions to private sector.
  - Facilitate exit of nonviable firms by boosting court resources and streamlining insolvency and debt restructuring procedures.
  - Continue to support lending by banks but better target credit to viable firms; strengthen incentives for prudent guaranteed lending by increasing risk banks retain on balance sheets.
  - Any extension of loan moratoria should be accompanied by updated assessment of borrowers’ creditworthiness.
  - Improve understanding of loan quality by banks and authorities, looking through temporary conditions and supports, and accounting for deposit buildup and government guarantees.
  - Proactive classification and provisioning needed; problem loans should be restructured expeditiously.
  - Maintain active secondary market for problem loans; banks encouraged to address structural pressures on business models.
  - Labor market: resume turnover as health crisis recedes, accompany with training and education assistance; temporary targeted wage subsidies could draw workers back to active employment and support new hiring.
  - Social safety nets should cushion transitions; comprehensive reskilling and upskilling programs critical.
- Recommendation: the next Article IV consultation should take place on the standard 12-month cycle.

*Italic: IMF staff report content as provided in the supplied source text.*

### Box 2. Covid-19 Credit Support Schemes (Concluded)

### Box 2. Covid-19 Credit Support Schemes (Concluded)

### Outlook for credit quality
- Assessing the quality of these loans is complicated by no required payments for loans under moratoria or the presence of grace periods.
- ECB bank supervisors have identified strengthening credit risk monitoring as a priority for all euro area banks in 2021.

### Italy: end-2020 reported position
- Reported NPLs covered by credit support schemes remain relatively low at end-2020.
- Guaranteed loans: 0.2 percent are classified as non-performing.
- Moratorium loans: 2.9 percent are classified as non-performing.
- Moratorium loans have been partially exempt from European guidelines on loan classification.

### Deterioration signals and staging
- The share of loans classified as Stage 2 (i.e., for which credit risk has risen significantly) rose sharply, to 29 percent of all loans covered by moratoria.
- There are some signals that credit quality of borrowers with guaranteed loans may be weaker than the average, such as a higher rate of missed payments to suppliers.
- A higher rate of missed payments to suppliers would increase the share of loan losses absorbed by the government.

### Policy interpretation
- The presence of weaker credit signals among guaranteed-loan borrowers is consistent with the goal of the guarantee scheme: to provide credit to firms facing temporary difficulties but likely to have good prospects.

*International Monetary Fund.*

### Box 3. Italy: Design of COVID Income  Support to Firms

### Box 3. Italy: Design of COVID Income Support to Firms

### Evolution of compensation mechanisms during the health emergency
- First lockdown (broad based)
  - Micro and small firms across all sectors were eligible for compensation for part of their lost turnover in the initial stage of the pandemic (in addition to some tax credits for rent and utility expenses).
- Second lockdown (focused on contact-intensive activities)
  - Partial compensation for lost turnover was targeted only to firms in activities directly affected by mobility restrictions, thereby excluding those indirectly affected through supply chain linkages.
  - Based on Italy’s input-output relationships, value added losses for domestic firms upstream in Italy’s hospitality supply chain (but which were ineligible for compensation) would have been 75 percent as large as losses for firms in the hospitality sector itself.
- New system introduced in early 2021
  - Addressed past coverage gaps.
  - Benefits were proportional to the average drop in turnover during all of 2020 and with a higher compensation rate for smaller firms.

### Key takeaways on design, equity, and efficiency
- Eligibility design
  - Eligibility should extend beyond sector-based indicators to capture firms indirectly—but nonetheless significantly—impacted.
- Target variable: turnover versus value added
  - The goal should be to cushion lost income (i.e., value added), but turnover is an imperfect proxy as the turnover-to-value added ratio likely varies by firm size and sector of activity.
- Compensation rates and discontinuities
  - Applying different flat compensation rates creates sizable discontinuities and discrepancies between firms with only modest differences in revenues.
  - With flat rate compensation, rates of marginal compensation equal the average rate.
  - While higher average compensation may be appropriate for smaller firms (because they tend to have a higher value added-to-turnover share than larger firms, which also have better access to alternative forms of support, e.g., loans and other financing), this would be better achieved by a scheme with declining marginal compensation brackets.
- Incentives to pay suppliers
  - Directly compensating firms does not provide a mechanism to incentivize the recipient to use the proceeds to pay its suppliers for overdue bills.
  - Providing tax credits for expenses paid would overcome this concern, but benefits would accrue with a delay only to firms that will be profitable in the future.
- Reporting and tax evasion
  - Where tax evasion is high and hence turnover is underreported, benefits paid on the basis of reported financial statements may not adequately compensate for actual losses.

### Implementation challenges highlighted
- Timeliness versus accuracy trade-offs in payout design.
- Coverage gaps when relying on narrow eligibility criteria (sector-only).
- Imperfect measurement of income loss when using turnover instead of value added.
- Distortions and inequities introduced by flat-rate compensation schemes.
- Limited leverage of direct transfers to enforce use of proceeds for supplier payment.
- Risk of under-compensation in contexts of high underreporting of turnover due to tax evasion.

### Footnote: comparison with progressive PIT
- The flat-rate compensation outcome contrasts with a standard progressive PIT schedule where the average tax rate rises gradually with income due to increasing marginal tax brackets.

*Italic: Source — Box 3. Italy: Design of COVID Income Support to Firms (extracted from the provided content).*

### Annex I. Selected Policy Measures in Response to COVID-19

### Annex I. Selected Policy Measures in Response to COVID-19

### Emergency / Mitigation Measures — Healthcare and Income Support
- Additional funds for public healthcare and civil security, mainly to hire and purchase medical equipment.
  - Objective: Strengthen the health care system.
- Expand the short-time work scheme (CIG).
  - Coverage expanded to all businesses.
  - Workers receive 80 percent of their foregone earnings in the event their working hours are reduced, up to a monthly ceiling of about €1,119.
  - The benefit duration has been extended into 2021.
  - Objective: Temporarily support workers’ incomes and mitigate firms’ revenue shortfall; encourage retention of existing employer-employee relationships to avoid a large and abrupt increase in unemployment, thereby obviating the need for firing and re-hiring costs.
- Bonus for the self-employed.
  - Self-employed and seasonal workers (including in tourism) can receive one-off monthly payments of around €600–1,000 during March and May, and in August and November, provided they meet eligibility criteria on lost income and turnover.
  - Objective: Mitigate liquidity and income pressures for the self-employed and small firms.
- Emergency income.
  - Monthly emergency income (between €400–800) has been made available to low-income households that were excluded from other support measures and existing social safety nets.
  - Objective: Temporary support poor households who are affected by the pandemic and are not eligible for other support.
- Incentives for workers.
  - A bonus of €100 is granted to workers whose gross annual income is below €40,000 and continue going to work in March.
  - Objective: Compensate workers for risks from in-person work during the lockdown period.
- Extend duration of unemployment benefits.
  - Unemployment benefits were extended for two months for those beneficiaries whose benefits would have expired between May and June 2020 (and who are not receiving the emergency bonus for the self-employed).
  - Objective: Support the unemployed while the job market is largely frozen due to lockdowns.
- Firing ban.
  - Individual and collective dismissals for business-related reasons are prohibited, and all pending redundancy procedures initiated after February 23, 2020 are suspended until mid-2021 for workers who have access to the regular STW schemes.
  - The prohibition on firing will remain in place for longer for those who are currently ineligible for the regular STW schemes but have access to the extended STW schemes.
  - Objective: Avoid an abrupt increase in layoffs when the job market is largely frozen.

### Family-related Measures and Workplace Safety
- Other family-related benefits (non-exhaustive list).
  - Babysitter bonus of up to €1,200 per family with children under the age of 12 (or €2,000 for employees in the health sector) for two months.
  - Paid family leave, paying half of normal income for up to 30 days (to be used by end-July) for parents with children under the age of twelve. An additional twelve days is provided (during March and April 2020) to workers needing to provide at-home care for disabled family members.
  - Right to work from home is provided to parents with a child under the age of 14 (provided another parent is not at home or receiving unemployment benefits).
  - Sick leave can be used for quarantining.
  - Objective: Ensure financial support for families in response to school closings and to accommodate other household responsibilities.
- Incentives for sanitization and safety at work.
  - A tax credit (of 60 percent) for expenses related to the safety of the reopening of business.
  - Objective: Help defray businesses’ costs of applying sanitization and safety standards.

### Direct Support to Businesses and SMEs
- Grants for heavily-affected businesses (annual turnover up to €10mn in 2019), most recently based on the average turnover loss during 2020.
  - Compensation rate ranges between 20 and 60 percent depending on firms’ pre-COVID revenues.
- Cancellation of corporate regional tax (IRAP) for all companies below €250mn annual turnover, for the final balance payment for 2019 and the first advance payment for 2020.
- Cancellation of municipal tax on real estate (IMU) installments for certain productive activities particularly affected by the pandemic.
- Compensation for rent and utility expenses paid during the lockdown.
- One-off subsidy to companies affected by the second set of containment measures; beneficiaries were identified by economic sector and geographic area. The support ranges between 37–53 percent of companies’ monthly turnover.
  - Objective: Mitigate SME’s liquidity and income issues.
- Tax deferrals.
  - Postponement of tax obligations (VAT, CIT, IRPEF, and social security contributions) due in several months of 2020 for firms particularly affected by the pandemic.
  - Objective: Mitigate firms’ liquidity pressures.
- Law Decree to amend the Golden Power Law (effective during April 8–December 31, 2020; temporarily extended until end 2021).
  - Provides the Italian government with temporary power to prohibit or impose restrictions on acquisitions by EU entities of control of companies in certain sectors, in addition to acquisitions by non-EU entities representing at least 10 percent of the corporate capital or voting rights.
  - Objective: Consistent with EU guidelines, protection of strategic assets and technologies.

### Credit, Guarantees, and Financial Sector Measures
- Loan moratoria.
  - Debt servicing moratorium for micro and SME loans until June 2021, for companies with <€50mn annual turnover or <€43mn annual total assets, and <250 employees. All payments postponed by the duration of the moratorium.
  - Debt servicing moratorium for primary residence mortgages of <€400k for individuals laid off for 30 days or more or (if self-employed) suffering at least a 33-percent fall in turnover. Since December 2020, the coverage was reduced to mortgages <€250k with the equivalent economic status indicator (ISEE) of less than €30,000.
  - Objective: Mitigate liquidity pressures for SMEs and households.
- Loan guarantees.
  - All payments postponed for the duration of the loan moratorium benefit from a 33-percent government guarantee.
  - Central Guarantee Fund for SMEs (until end-June 2021): (i) 100 percent guarantee for loans of <€30k, with maturity up to 120 months; and (ii) 80–100 percent guarantees for larger loans.
  - 70–90 percent guarantees (depending on firms’ turnover and number of employees) by SACE S.p.a. available for firms of all sizes (until end-June 2021).
  - Trade credit insurance programs.
  - Objective: Mitigate liquidity pressures, with targeted programs for firms of different sizes.
- Bank capital and liquidity relief (European measures).
  - Supervisors will not require immediate capital/liquidity restoration plans if CET1 or LCR buffer requirements are breached.
  - Planned relaxation of requirements on the composition of Pillar 2 capital requirements brought forwards.
  - Temporary suspension of requirements on loan classification and provisioning for loans subject to moratoria and guarantees.
  - Extension of IFRS 9 transition period and guidance on application of expected credit loss methodology during the pandemic.
- Central bank liquidity facilities (European measures).
  - Strengthening of ECB refinancing operations already in place (TLTRO3) and introduction of PELTROs, offered at 25 bps below the average main refinancing operation rate (MRO) and maturing in a staggered sequence between July and January 2023.
  - Relaxation of collateral standards.

### Recovery Measures and Structural Support
- Exemption from / reduction in social security contributions (SSC).
  - After the initial reopening: exemption from SSCs is granted (i) for up to five months for firms that do not use the 24-week STW extension; and (ii) for up to six months for new hires.
  - 30 percent relief on SSCs is granted for three months for companies in the South until 2025 (and 20 percent subsidy in 2026-27 and 10 percent subsidy in 2028–29).
  - Exemption from SSCs is granted to hiring of young people (aged under 35) and women. The benefit duration ranges between three and four years (longer in the South).
  - Objective: Support firms and employment during the recovery period through lower employment costs and to incentivize hiring.
- Renewal of fixed-term contracts.
  - Until end-2020, fixed-term contracts can be renewed or extended for a maximum period of twelve months, without prejudice to the maximum overall duration of 24 months.
  - Objective: Support firms during the recovery by providing additional hiring flexibility.
- New Skills Fund.
  - Through 2021, employer associations can implement specific agreements to allocate a number of working hours to training courses. The costs of training, including the related social security and welfare contributions, will be covered by a special fund called the "New Skills Fund", set up at the National Agency for Active Labor Policies (ANPAL).
  - Objective: Support the recovery by encouraging training for new skills.
- Sectoral support.
  - Subsidies for the transport sector. Compensation for travel restrictions during the lockdown for local transport services, air carriers, rail transport, etc.
  - Capital injection for state-owned Alitalia.
  - Subsidies for tourism and leisure. Reduction in property taxes for hotels and restaurants, and a €500 voucher for households with annual income <€40,000 to be spent on tourism in Italy.
  - Objective: Mitigate liquidity and (future) solvency issues for the transport sector; support the recovery of the tourism sector both by lowering business cost and subsidizing demand.
- NPL disposal support.
  - Conversion of DTAs related to NPL disposals to tax credits (budgeted amount up to €10 billion).
  - Objective: Encourage balance sheet repair for banks and trade creditors.
- Small bank restructuring support.
  - Availability of state aid for compulsory administrative liquidation of banks with <€5 billion of assets.
  - Objective: Contingency measure in case of small bank failures.
- Recapitalization schemes and corporate restructuring funds.
  - Creation of funds for the restructuring of corporates under the “Rilancio” decree. Target firms: (i) firms with historical brands or brands that are strategically important for the country; (ii) firms with less than 250 employees; or (iii) firms that hold strategically important assets or relationships.
  - For firms in financial distress, funds will provide an equity injection, at market conditions, jointly with a private (third party) investor.
  - Specific funds and budgets:
    - Creation of the SME Equity Fund (“Fondo Patrimonio PMI”) with an overall budget of about €4 billion, aimed at subscribing bonds or debt securities issued by SMEs that have carried a capital increase of at least €250,000.
    - Creation of an ad-hoc special purpose vehicle “Patrimonio Rilancio” with an overall budget of about €44 billion, which could be used for equity injections, investments in companies’ convertible bonds and subordinated debt.
    - Creation of a fund (“Fondo Rilancio”) with an overall budget of €200 million to support investment in start-ups’ and innovative SMEs’ share capital.
    - Creation of the National Tourism Fund (“Fondo Nazionale del Turismo”) to mobilize up to €2 billion to temporarily and/or partially take ownership of domestic hotels.
  - Objective: Support enterprises affected by the coronavirus outbreak.

*Source: 1itaea2021001 - Annex I. Selected Policy Measures in Response to COVID-19*

### 2.      Public debt is projected to moderate somewhat

### 2.      Public debt is projected to moderate somewhat

### Baseline projection
- Gross public debt is projected to remain within the 155–160 percent of GDP range during 2021–26, supported by historically-low interest rates.
- Debt increases in the longer term due to higher pension spending.
- Excluding postal saving bonds (BPF), public debt is projected to remain broadly unchanged over the forecast horizon.

### Assumptions underpinning the baseline
- Real GDP growth is projected to average 2¼ percent during 2021–26 (the recovery phase after the COVID crisis). After that, growth converges to ¾ percent.
- The GDP deflator is projected to rise from 0.7 percent in 2019 to a steady state of around 1.5 percent over the next few years.
- Under current policies, the government is assumed to maintain an average structural primary deficit of about 1 percent of GDP (against a debt-stabilizing primary deficit of 1¼ percent of GDP) over the 2021–26 period.
- Thereafter, the primary balance deteriorates by about 3 percentage points of GDP due to higher pension spending over the period 2017–35 under unchanged policies.
- The stock of postal saving bonds (BPF) is projected to decline from €55 billion in 2019 to about €24 billion in 2026, reducing the stock of public debt by 2½ percent of GDP during this period.
- Over the medium term, staff projects an effective nominal interest rate of about 1¾ percent, or an average interest bill of about 2¾ percent of GDP.
- The marginal cost of borrowing at issuance declined to 0.5 percent in 2020 from 1.1 percent in 2018.
- Spreads vis-à-vis German bunds are assumed to rise gradually to about 145 basis points by 2026 following the expiration of the ECB’s PSPP and PEPP.
- In the longer term, the effective nominal interest rate is assumed to increase to around 2 percent by 2035 (½ percent in real terms).
- The baseline assumes the government uses an envelope of about 8 percent of GDP in loans from the Next Generation EU (NGEU) Fund through 2026 to finance higher public investment.
- Contingent liabilities: government guarantees amounted to 4.3 percent of GDP at end-2018. Government guarantees on bank loans amounted to 8 percent of GDP at end-2020, while one-third of suspended debt service payments under loan moratoria are guaranteed around ¾ percent of GDP.

### Important risks embedded in the baseline
- Staff’s forecast track record for Italy is comparable to that of other surveillance countries, but the projected fiscal position is subject to significant downside risks.
- Rollover risk from phasing out ECB bond purchases and political or pandemic-related shocks could raise debt spreads.
- The NGEU loan envelope (about 8 percent of GDP through 2026) partially offsets these risks by providing low-yield, longer-maturity financing.
- Large holdings of sovereign debt by domestic banks create a risk of a vicious cycle between the sovereign and banks.

### Shock scenarios and their projected impacts
- Standard growth shock:
  - Real output growth rates are assumed to be lower by one standard deviation for two years starting in 2022, resulting in average growth of -½ percent in 2022–23.
  - For every 1 percentage point decline in growth, inflation is assumed to decline by 25 bps.
  - The primary balance would decline further, reaching -5¼ percent of GDP by 2023.
  - Debt increases to about 175 percent of GDP in 2023 and declines only gradually afterwards.
- Interest rate shock:
  - Spreads increase further by 150 bps (to about 300 bps).
  - 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 2½ percent by 2025.
  - Debt increases to around 160 percent of GDP by 2024.
- Contingent liability shock:
  - One-time increase in non-interest expenditure standardized to about 10 percent of GDP.
  - 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 14 percent of GDP in 2022.
  - Debt rises to 185 percent of GDP by 2023. Gross financing needs would be significantly higher.

### External Debt Sustainability Analysis (summary)
- External debt rose from 124 percent of GDP in 2019 to 150 percent of GDP in 2020.
- Under the baseline, external debt is projected to decline gradually to 143 percent of GDP in 2026.
- The 2020 increase in nominal gross external debt is mainly driven by the unprecedented economic contraction (one-time large jump in the external debt-to-GDP ratio).
- External debt dynamics are closely linked to public external debt and TARGET2 liabilities.
- Strengthening public and financial sector balance sheets and reinvigorating domestic growth are necessary to lower external vulnerabilities.

### Recent external debt and NIIP trends
- External debt grew by 40 percentage points between euro adoption and 2019, plateauing in 2017 at around 128 percent of GDP.
- Over the past five years, Italy’s Net International Investment Position (NIIP) turned from negative to close to balanced.
- The improvement in Italy's NIIP is due to outflows in portfolio investments by the nonfinancial private sector, leading to faster increases in IIP assets than liabilities.
- Both IIP assets and liabilities reached record levels in 2020, reflecting increased financial integration with the rest of the world.

*Sources: Haver and IMF staff calculations*

### 6.      Under  the baseline scenario, external debt is projected  to decrease from 150 percent

### 1itaea2021001 - 6.      Under  the baseline scenario, external debt is projected  to decrease from 150 percent 

### Baseline projections for external debt
- External debt projected to decrease from 150 percent of GDP in 2020 to 144 percent of GDP in 2021.
- Over the medium term, post-COVID recovery would bring the ratio gradually lower to 143 percent of GDP in 2026.
- Table III.1 — Baseline: External debt (in percent of GDP)
  - 2016: 117.0
  - 2017: 128.0
  - 2018: 116.0
  - 2019: 123.7
  - 2020: 150.1
  - 2021: 143.8
  - 2022: 142.3
  - 2023: 142.6
  - 2024: 143.2
  - 2025: 143.0
  - 2026: 142.6

### Drivers and composition of the 2020 increase
- Increase in gross external debt in 2020 is €92 billion (4 percent y/y change).
- About 80 percent of the 2020 increase is due to an increase in the Bank of Italy’s external debt (mainly TARGET 2 liabilities).
- The unprecedented economic contraction due to the COVID-19 pandemic is the major contributing factor to the large increase in the external debt to GDP ratio in 2020.
- Large portfolio outflows of debt liabilities (reduction of foreign holdings of Italian sovereign bonds) are mostly offset by accumulation of TARGET 2 liabilities (recorded in “other investment” in the financial account).
- External debt dynamics reflect contributions from:
  - Current account deficit, excluding interest payments: e.g., 2020: -5.3 (percent of GDP); 2021: -4.9 (percent of GDP).
  - Deficit in balance of goods and services: e.g., 2020: -3.8 (percent of GDP); 2021: -3.5 (percent of GDP).
  - Net non-debt creating capital inflows (negative): e.g., 2020: 0.8; 2021: -0.7.
  - Automatic debt dynamics: 2020: 12.0; 2021: -4.3.

### External financing needs and trade/flows indicators
- Gross external financing need (in billions of US dollars):
  - 2016: 850.7
  - 2017: 977.0
  - 2018: 1,145.4
  - 2019: 1,177.7
  - 2020: 1,107.5
  - 2021: 1,306.1
  - 2022: 1,332.8
  - 2023: 1,350.3
  - 2024: 1,358.3
  - 2025: 1,364.8
  - 2026: 1,369.8
- External debt-to-exports ratio (in percent) examples:
  - 2019: 368.6
  - 2020: 388.8
  - 2021: 506.9
  - 2026: 394.2
- Exports (percent) and imports (percent) series (selected):
  - Exports: 2019: 31.8; 2020: 29.6; 2021: 31.3; 2026: 36.2
  - Imports: 2019: 28.4; 2020: 25.8; 2021: 27.9; 2026: 33.5

### Stress tests and alternative scenarios
- Standardized shocks are calibrated to one-half standard deviations for growth, interest rate, and the current account.
  - Under these standardized scenarios, external debt would worsen by a few percentage points at the end of the forecast horizon.
  - Under the growth shock, external debt increases by 12 percentage points.
- Historical scenario (based on 10-year averages including past crises) outcomes:
  - Historical scenario projects debt climbing to 192 percent of GDP.
  - Ten-year historical-average scenario line in Table III.1 shows a scenario value reaching 192.4 (percent of GDP) for the projection horizon.
- External Debt Sustainability Bound Tests (Figure III.6) — key scenario averages:
  - Baseline average projection shown as 143 (percent of GDP).
  - Historical scenario average shown as 192 (percent of GDP).
  - CA shock average shown as 146 (percent of GDP).
  - Combined shock average shown as 152 (percent of GDP).
  - Real depreciation 30% shock average shown as 150 (percent of GDP).
  - Growth shock average shown as 155 (percent of GDP).
- Individual shocks are permanent one-half standard deviation shocks; combined shocks use permanent 1/4 standard deviation shocks to real interest rate, growth rate, and current account balance; one-time real depreciation of 30 percent occurs in 2020 in the specified scenario.

### Public sector DSA and macro-fiscal context (selected highlights)
- Public DSA — Baseline scenario (Figure III.3, selected rows, in percent of GDP unless noted):
  - Nominal gross public debt: 2019: 130.2; 2020: 134.6; 2021: 155.6; 2022: 159.9; 2023: 157.9; 2024: 157.7; 2025: 157.4; 2026: 156.5; 2026 (alternate) 155.5.
  - Net public debt: 2019: 126.9; 2020: 131.2; 2021: 151.9; 2022: 156.3; 2023: 154.4; 2024: 154.2; 2025: 154.0; 2026: 153.1; 2026 (alt) 152.1.
  - Real GDP growth (in percent): 2019: 0.3; 2020: 0.3; 2021: -8.9; 2022: 4.3; 2023: 4.0; 2024: 1.6; 2025: 1.1; 2026: 1.1; 2026 (alt): 1.0.
  - Inflation (GDP deflator, in percent): 2019: 1.1; 2020: 0.8; 2021: 1.2; 2022: 0.5; 2023: 1.0; 2024: 1.1; 2025: 1.3; 2026: 1.3; 2026 (alt): 1.4.
  - Effective interest rate (in percent): 2019: 3.4; 2020: 2.5; 2021: 2.4; 2022: 2.2; 2023: 2.0; 2024: 1.9; 2025: 1.8; 2026: 1.8; 2026 (alt): 1.5.
  - Primary deficit (percent of GDP): 2019: -1.2; 2020: -1.7; 2021: 6.0; 2022: 8.4; 2023: 2.8; 2024: 1.3; 2025: 0.9; 2026: 0.4; cumulative: 5.7.
  - Change in gross public sector debt (cumulative): 2019: 2.0; 2020: 0.2; 2021: 21.0; 2022: 4.3; 2023: -2.0; 2024: -0.2; 2025: -0.3; 2026: -0.9; cumulative to 2026: -1.1; cumulative over projection: -4.5.
- Public gross financing needs (percent of GDP): 2019: 26.4; 2020: 22.2; 2021: 34.2; 2022: 35.1; 2023: 30.7; 2024: 29.3; 2025: 28.5; 2026: 28.9; projection example: 28.4.

### Policy implications and vulnerabilities
- Although standard macroeconomic shocks would not significantly influence external debt over the medium term, ensuring that external debt remains on a downward path is ultimately tied to:
  - Public debt dynamics.
  - The strength of the growth path.
- This underscores the need for comprehensive structural and fiscal reforms to support sustainable debt dynamics.

*Source: IMF staff.*

### Annex IV. External Sector Assessment

### Annex IV. External Sector Assessment

### Overall assessment and potential policy responses
- Overall Assessment: The external position in 2020 was broadly in line with the level implied by medium-term fundamentals and desirable policies.
- Observations:
  - Chronic weak productivity and uncertainty about medium-term growth prospects continue to dampen investment and consumption.
  - During 2020, large public support for income losses caused by the pandemic, while the household saving rate increased sharply, offset government dissaving and kept the current account broadly unchanged.
- Potential Policy Responses:
  - Raise productivity and improve the business climate through structural reforms.
  - Increase investment under the National Recovery and Resilience Plan to allow the current account balance to remain near its norm as household saving declines and the underlying primary fiscal surplus returns to its pre-COVID-19 level over the medium term.
  - Specific measures: upskilling the workforce; increasing the quality of infrastructure; improving the effectiveness of the judiciary and public administration to boost productivity, reduce high unemployment, and raise output and domestic absorption.
  - Improve budget efficiency by curtailing wasteful spending and removing extensive tax loopholes to reduce vulnerabilities associated with rollover of external debt.

### Foreign asset and liability position and trajectory
- Background:
  - Italy’s NIIP was close to balance (1.8 percent of GDP) at end-2020, having trended gradually upward from a strongly-negative position since 2013 owing to sustained current account surpluses.
  - Gross assets and liabilities jumped sharply during 2020 to 187 and 185 percent of GDP, respectively.
  - Increase in TARGET 2 liabilities to a record high of 31 percent of GDP following a moderate decrease in 2019, which offset reduced foreign holdings of Italian sovereign bonds.
  - About half of the gross external liabilities is attributable to the general government and the Bank of Italy.
- Assessment:
  - Further strengthening public balance sheets and undertaking reforms would lessen vulnerabilities associated with the high public debt and reduce potential for negative feedback loops between the debt stock and debt servicing costs, as well as between sovereign debt and the financial system.
- Key 2020 figures (% GDP):
  - NIIP: 1.8
  - Gross Assets: 186.9
  - Res. Assets: 45.4
  - Gross Liab.: 185.0
  - Debt Liab.: 118.0

### Current account
- Background:
  - Italy’s CA averaged –1¼ percent of GDP during the decade following euro adoption.
  - In 2013 it moved to balance and in 2019 it registered a multiyear-high of +3.0 percent of GDP, which is surpassed marginally in 2020 as weak domestic demand weighed on imports.
  - The COVID shock negatively affected exports, imports and tourism, but the estimated net impact on trade balance is small.
  - The rising current account in the last decade mirrors the increase in the private sector net savings. More than half the increase since 2013 was due to the trade surplus, with the rest reflecting a higher income balance as the nonfinancial private sector’s net holdings of foreign assets increased and interest payments on external liabilities declined owing to the ECB’s accommodative monetary stance.
  - Positive primary income balance also reflects the larger share of equity in foreign assets than in liabilities.
  - In terms of saving and investment, the increase in the CA since 2010 is due to higher gross national saving and lower gross domestic investment, particularly private investment.
- Assessment:
  - The cyclically adjusted CA is estimated at 2.7 percent of GDP in 2020, 0.1 percentage point below the EBA-estimated CA norm of 2.8 percent of GDP.
  - Because pandemic-specific impacts (tourism, oil, household consumption shift) are not captured by usual cyclical adjustment, an adjustor of 0.4 percent of GDP (mostly reflecting impact on tourism) has been applied, indicating the CA gap is around 0.3 percent of GDP.
  - Taking into account estimation error, staff assesses the CA gap to be in the range of –0.7 to 1.3 percent of GDP.
- Key 2020 figures (% GDP):
  - CA: 3.7
  - Cycl. Adj. CA: 2.7
  - EBA Norm: 2.8
  - EBA Gap: –0.1
  - COVID-19 Adj.: 0.4
  - Other Adj.: 0
  - Staff Gap: 0.3

### Real exchange rate (REER)
- Background:
  - During 2010-19, the CPI-based and ULC-based REER depreciated by 10 percent and 20 percent, respectively, and both indicators lie below their 1999 levels.
  - Because of a stronger euro, the CPI-based REER appreciated in 2020 (by 0.6 percent relative to the 2019 average), although official statistics may not fully capture actual price and wage dynamics during the pandemic period.
- Assessment:
  - The staff CA gap implies a REER gap of -1.2 percent in 2020 (applying an estimated elasticity of 0.25).
  - The level and index CPI-based REER models suggest an overvaluation in 2020 of 2.9 percent and 8.2 percent, respectively, with an average of about 5 percent.
  - Taken together, staff assesses a REER gap of -5.2 to 2.8 percent with a midpoint of –1.2 percent.

### Capital and financial accounts: flows and policy measures
- Background:
  - The financial account posted net outflows of 3.0 percent of GDP in 2020, reflecting residents’ net purchases of foreign assets.
  - Portfolio investment shifted from inflows to outflows as foreign investors reduced their holdings of Italian sovereign debt securities at the beginning of the COVID-19 pandemic.
- Assessment:
  - The current low global interest rate environment is conducive to the smooth functioning of the sovereign debt market.
  - However, large refinancing needs of the sovereign and the banking sector, as well as COVID-related balance sheet weakness in some banks, suggests Italy remains vulnerable to market volatility.

### FX intervention and reserves level
- Background:
  - The euro has the status of a global reserve currency.
- Assessment:
  - Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

*Source: Annex IV. External Sector Assessment (content unit 1itaea2021001).*

### 1.      Italy has launched several schemes for injecting capital into businesses whose finances

### 1itaea2021001 - 1.      Italy has launched several schemes for injecting capital into businesses whose finances

### Capital injection schemes (design and parameters)
- Relaunch Fund (Patrimonio Rilancio) — managed by CDP (state-controlled fund and deposit institution)
  - Overall budget: about €44 billion.
  - Target: recapitalization of nonfinancial joint-stock companies with an annual turnover of at least €50 million.
  - Forms of temporary investment: subscription to convertible bonds, participation in capital increases, secondary market purchases of listed shares for strategic companies.
  - Maximum support per firm: €2 billion.
  - If investment is not on market terms (EU state aid considerations apply):
    - Eligible companies must be significant for the economy, have experienced at least 10 percent reduction in turnover due to the COVID-19 crisis.
    - Amount of support must be less than 25 percent of the firm’s equity, 25 percent of revenue, or two times salary expenses.
  - Incentives to repay: cost of financing (and for equity participation, either dividend payout or number of shares assigned to the Fund) increases over time.
  - Maturity varies between four and six years depending on investment types; early repayment is possible.

- SME Capital Strengthening Scheme (Fondo Patrimonio PMI) — managed by Invitalia
  - Endowment: about €4 billion for 2020 and €1 billion for 2021.
  - Instrument: purchases of bonds or debt securities.
  - Eligibility: firms must not have been in difficulty prior to the health emergency, have experienced revenue losses (at least one-third) from the pandemic, and have carried out a capital increase of at least €250,000 after mid-May 2020.
  - Maximum securities purchase: lower of three times amount of capital increase or 12.5 percent of turnover in 2019; purchases must not exceed €800,000 per company.
  - Tax incentive: investors and firms receive up to a 50-percent tax credits on the amount of their investment.
  - Repayment: financial instruments must be repaid within six years; early repayment possible after three years; interest rates step up to encourage repayment.

- National Tourism Fund (Fondo Nazionale del Turismo) — established by CDP
  - Mobilize up to €2 billion over the next few years to temporarily and/or partially take ownership of domestic hotels distressed by the pandemic.
  - Management remains with former owners; they are granted a right of repurchase within a specific period consistent with recovery estimates of the international hospitality market.

### Key comparative design features (as presented in the table)
- Eligibility
  - SME capital-strengthening scheme: Firms with €5–50mn annual turnover; fall in revenue of at least 33 percent year-on-year in March–April 2020; firms in difficulty in December 2019 and firms with tax or other irregularities are excluded; must have <250 employees for subordinated debt investments.
  - Relaunch Fund: Firms with >€50mn annual turnover; if investment is not on market terms, firm must meet economic significance tests (>300mn turnover, in strategic sector, or large local employer); firms in difficulty in December 2019 and firms with tax or other irregularities are excluded.
- Type of support
  - SME scheme: A. Tax credits for investors in a firm’s share capital (until end-2020); B. Tax credits for firms which raise capital; C. Subordinated debt investments for firms which raise capital.
  - Relaunch Fund: A. Equity; B. Mandatory convertible bonds; C. Subordinated convertible bonds; D. Subordinated debt. Investments may be on market terms (with co-investment) or involve state aid.
- Amount of support / caps
  - SME scheme: For each instrument:
    - A. 20 percent of the capital investment
    - B. 50 percent of 2020 losses, capped at 50 percent of the capital increase
    - C. Lower of three times the capital increase or 12.5 percent of 2019 turnover
    - Support subject to caps per company (€800,000) and budget (initially €6 billion).
  - Relaunch Fund: If investment is not on market terms (EU state aid applies):
    - Investment sufficient to lower firm leverage to target levels specified in the law, capped at €2 billion.
    - Resulting shareholding capped at 25 percent.
    - Subordinated debt investments capped at 25 percent of revenue or two times salary expenses.
  - Relaunch Fund total budget: €44 billion.

- Decision-making and governance
  - SME scheme: Eligibility automatic for firms meeting requirements; subordinated debt investments managed by Invitalia.
  - Relaunch Fund: Managed by CDP (Italy’s national promotional bank).

- Incentive structure and conditionality
  - SME scheme: Support subject to minimum holding periods for associated capital investment / dividend restrictions. For debt investments, mandatory conditionality on spending in Italy.
  - Relaunch Fund: For state aid investments, mandatory conditionality on investment in Italy, M&A, remuneration, dividends and buy-backs.
  - Investment duration and exit options:
    - Subordinated debt: six-year term, repayable early after three years; interest can be capitalized; interest rates increase gradually to encourage repayment.
    - For capital investments under Relaunch Fund: Fund’s shareholding increases after four years to incentivize redemption; Fund may sell its shareholding.

### Policy context, objectives, and macro projections referenced
- Immediate pandemic response
  - 2020 immediate measures amounted to 6 percentage points of GDP, focused on: (a) health emergency; (b) income support for firms and households; (c) loan moratoria and public guarantee schemes mostly for SMEs.
  - Two additional packages to address later waves:
    - First: 1.8 percent of GDP — help to the most vulnerable households and firms; financed short-term working scheme.
    - Second: 2.2 percent GDP — extended support to those not covered earlier (e.g., self-employed).
- National Recovery and Resilience Plan (NRRP)
  - Six priorities: (a) Digitalization, innovation, competitiveness, and culture; (b) Green revolution and ecological transition; (c) Infrastructures for sustainable mobility; (d) Education and Research; (e) Inclusion and social cohesion; (f) Health.
  - Authorities expect NRRP interventions to raise GDP by 0.6 percentage points per year during the projection period, for an overall increase of 3.6 percentage points by 2026.
  - NRRP components and totals:
    - Recovery and Resilience Facility (RRF) for Euro 191.5 billion.
    - Recovery Assistance for Cohesion and the Territories of Europe (REACT EU) for Euro 15 billion.
    - NRRP total plan: Euro 237 billion (including other domestic resources).
    - Financing of RRF: 68.9 billion grants; the rest are loans.
- Structural reforms to support NRRP priorities
  - Four broad reforms: (a) public administration; (b) justice system; (c) regulation simplification; (d) fostering competition.
  - Comprehensive tax reform beginning with personal income tax; authorities intend to present tax reform proposal to Parliament in the second half of 2021, aiming to implement it by next year.
- Fiscal strategy and projections
  - General government deficit projections and history:
    - 2019: 1.6 percent of GDP.
    - 2020: 9.5 percent of GDP.
    - 2021: expected to be 11.8 percent of GDP.
  - Public debt-to-GDP expectations:
    - Expected to peak at about 160 percent this year, then decline starting in 2022 and reach about 153 percent in 2024.
  - Government objective: bring deficit ratio close to the Maastricht (3 percent) threshold already in 2024 and return debt ratio towards pre-crisis level by the end of the decade via growth and fiscal adjustment.

### Financial sector assessment and outlook
- Banking sector resilience and credit provision
  - Despite the severe recession, the banking sector ensured adequate lending to the private sector, particularly to non-financial firms, avoiding a credit crunch.
  - Reasons: pre-pandemic balance sheet repair and bold government support.
  - Sovereign exposure: basically unchanged as share of assets despite the pandemic.
  - Credit quality and provisioning: banks are carefully monitoring credit quality and have increased credit provisioning, reducing profitability.
  - Non-performing loans (NPLs): remained on a decreasing trend so far; modest indications of increased credit risk in hardest-hit sectors.
- Outlook and risks
  - Staff view: NPLs will inevitably increase given the challenging environment, but starting from much more solid balance sheets than a decade ago and with accommodative monetary and fiscal policy, NPLs are likely to remain well below early-2010s levels.
  - Quantitative assessment of public policies’ effects on NPL formation is highly uncertain due to newly introduced Pillar-1 regulations and limited past comparability.
  - Continued active dismissal of banks’ NPL stock has improved positions; capitalization improved in the second half of 2020 for both significant and less-significant institutions, reducing the capital gap with euro area significant institutions.
  - Overall: risks to financial stability remain contained.

*Prepared by European Department (Informational Annex, May 11, 2021).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1itaea2021001.pdf_