## 1. Italy’s Tax System and Reform Needs ## Source details **Canonical URL:** [1. Italy’s Tax System and Reform Needs](https://www.imf.org/-/media/files/publications/cr/2023/english/1itaea2023001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1itaea2023001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1itaea2023001.pdf.json) --- ### Context and long-term trends - Italy’s current level of GDP remains about 3 percent below its pre-crisis trend. - Output cushioned by highly-supportive fiscal, monetary, and financial responses to the COVID and energy price shocks, which raised public debt to very high levels. - Growth expected to enter a slower phase as support policies are unwound; ambitious structural policies urgently needed to raise productivity and grow the active workforce to offset drag from rapidly aging population. ### Recent macroeconomic developments - Output and demand: - Output expanded by 3.7 percent in 2022 and 1.9 percent y/y in Q1: 2023. - Household excess savings since the onset of the pandemic were equal to about 8 percent of GDP at end 2022. - Strong import growth related to investment demand yielded a negative growth contribution from net exports in 2022 and Q1:2023. - Sectoral: buoyant services and strong construction offset weakness in manufacturing, especially energy-intensive industries. - Prices and inflation: - Consumer prices increased by 8.7 percent in 2022; headline inflation peaked at 12½ percent in fall 2022. - Headline inflation eased to 6.7 percent in June 2023. - Core inflation averaged 4.0 percent in 2022 and was 6.0 percent y/y in June 2023. - GDP deflator growth rose to 5.7 percent y/y in Q1:2023. - Bank of Italy found international prices accounted for 90 percent of higher-than-expected increase in headline inflation in 2021-2022; staff notes inflation was overstated by about 2 percentage points in 2022 due to measurement of energy inflation. - Labor market and wages: - Employment expanded by almost 400 thousand since end-2019. - Unemployment declined by almost 490 thousand through April 2023 (to 7.8 percent). - All-in compensation per employee grew at 4½ percent in 2022. - Contractual wages grew by 2.2 percent in Q1:2023 year-on-year. - Real wages fell by nearly 4 percent in 2022 due to high inflation. - Financial conditions and external: - Sovereign yields rose sharply since mid-2021 but recently stabilized around pre-GFC levels; spreads over German bunds moderated. - Foreign holdings of Italian government securities declined over the past year; holdings of residents have risen. - Bank lending conditions tightened sharply since Q2:2022; BIS-estimated credit gap began to rewiden. - Current account swung to a 1¼ percent of GDP deficit in 2022, mainly due to a 3¼ percentage point increase in the energy deficit; returned to surplus in Q4:2022 as energy prices fell. ### Macroeconomic outlook and risks - Growth forecasts and drivers: - Growth is forecast to moderate to 1.0 percent on average in 2023-24 and to remain around 1.1 percent from 2025 as NRRP spending peaks. - NRRP-financed public investment scheduled to peak at 3.5 percent of GDP during 2024-26 before easing to 3 percent of GDP in 2028 (pre-COVID average was 2.3 percent of GDP). - Potential growth expected to edge up marginally to 0.8 percent on reforms and infrastructure improvements. - Inflation outlook: - Headline inflation expected to decline to 5.2 percent in 2023 and 2.5 percent in 2024. - Headline and core inflation will remain above 2 percent through 2025. - Official forecasts of the inflation index used for collective bargaining agreements: 6.6 percent in 2023 and 2.9 percent in 2024. - Downside scenarios: - Severe global financial stress scenario could lower Italy’s GDP by about 2 percentage points below the baseline in 2023 and 2024. - Key triggers: sharper tightening of monetary policy, renewed global financial stress, delays in NGEU disbursements, geopolitical escalation, extreme weather, stalled NRRP implementation. - Upside possibility: - Tourism could outperform if pent-up foreign demand materializes. ### Fiscal background, targets, and staff recommendations - Recent fiscal position: - Headline deficit averaged 8.9 percent of GDP during 2020-22. - Public debt ratio declined to 144 percent of GDP in 2022, some 10 percentage points below its peak in 2020. - Superbonus: originally at 110 percent (lowered to 90 percent, to be reduced to 65 percent next year); described as inefficient and regressive. - Authorities’ fiscal targets: - Aim to reduce headline deficit by 3½ percentage points to 4.5 percent of GDP for 2023 through scaling back Superbonus and lowering energy compensation. - Further adjustment to reach a headline deficit of 2.5 percent of GDP in 2026, with a primary surplus of 2 percent of GDP. - Government forecasts debt ratio to decline only modestly during 2024-26 given Superbonus claims and higher borrowing costs. - Staff fiscal assessment and advice: - Overall risk of sovereign stress assessed as moderate, but on the borderline; long-horizon risk viewed as high. - Recommends faster improvement in the primary balance; potential revenue windfall on order of 2 percent of GDP through revised treatment of tax credits and higher price deflators—advise saving much of this to reach a primary surplus of around 1 percent of GDP this year. - Cash-based central government performance Jan–May 2023 weaker than Jan–May 2022 due to delayed NGEU grants and increased tax credit claims (cash impact). ### Fiscal projections (selected figures from staff vs authorities) - Overall balance (Percent of GDP), Staff recommended path: -8.0 (2022), -3.1 (2023), -2.1 (2024), -1.2 (2025), -1.3 (2026). - Overall balance (Percent of GDP), Authorities path: -8.0 (2022), -4.5 (2023), -3.7 (2024), -3.0 (2025), -2.5 (2026). - Primary balance (Percent of GDP), Staff recommended path: -3.6 (2022), 1.0 (2023), 2.0 (2024), 3.0 (2025), 3.0 (2026). - Primary balance (Percent of GDP), Authorities path: -3.6 (2022), -0.8 (2023), 0.3 (2024), 1.2 (2025), 2.0 (2026). - Public debt (Percent of GDP), Staff recommended path: 144.7 (2022), 139.0 (2023), 136.1 (2024), 134.3 (2025), 132.7 (2026). - Public debt (Percent of GDP), Authorities path: 144.7 (2022), 140.3 (2023), 138.7 (2024), 138.4 (2025), 137.8 (2026). - Borrowing implication: claims for tax credits under Superbonus and other incentives expected to add about ¾ percentage point on average to borrowing needs for the next five years. ### Near-term spending efficiency and fiscal measures - Energy measures: - Further refine targeting of energy compensation by fully reinstating VAT and system charges on gas; limit compensation to temporary component of higher energy prices. - Balanced-budget financed spending: - Targeted income-redistribution financed from revenue windfalls was appropriate for temporary shock response in 2022; revenue windfalls are not suited to permanently raise structurally-low incomes. - Tax credits and Superbonus: - Reinforce financial controls on approvals, ensure strict compliance with program objectives, target eligibility to lower income households, and sharply reduce subsidy rates. ### Medium- and long-term fiscal framework and structural reforms - Fiscal strategy: - Save windfall revenue and over time replace with efficient measures that promote sustainable and inclusive growth and boost productivity. - Recommended spending rule: primary current spending to grow by at least 1 to 2 percentage points below nominal GDP growth while maintaining a 3 percent of GDP primary surplus from 2025 onwards; would reduce debt ratio to around 130 percent of GDP by 2028. - If combined with closing labor force participation gaps with the EU, stepping up immigration, or higher growth, debt could decline to around 90 percent of GDP within 20 years. - Tax system reform priorities: - Comprehensive reform to broaden the tax base, increase efficiency and equity, reduce compliance gaps, and rationalize tax expenditures (costing around 6 percent of GDP in foregone annual revenue). - Update property values in the cadastre (last done in the 1980s). - Shift from labor taxes towards greater reliance on consumption and property taxation to lower the labor tax wedge. - Caution: a flat tax on personal income could harm equity and cause significant revenue loss. - Continue strengthening tax compliance; lifting the ceiling on cash transactions and introducing an amnesty on tax debt are not helpful. ### Pension spending and contingent liabilities - Pensions and savings potential: - Pensions cost 16 percent of GDP against euro-area average of around 13 percent. - Pension spending expected to increase over the next 25 years, adding up to 2¼ percentage points to spending. - Scope to trim legacy defined-benefit costs by reducing wage replacement rate (67 percent) closer to euro area average of around 50 percent and raising effective retirement age (currently under 64) closer to statutory age (67 years); could yield up to ¾ percent of GDP in annual fiscal savings. - Public guarantees and contingent liabilities: - Public guarantees related to private-sector debt obligations amount to 16 percent of GDP, mainly from COVID and energy-related loan schemes. - Risks from high coverage rates: delay recognition of fiscal costs, adverse selection, and potential future deterioration given policy support and long maturities. - Recommendations: strong centralized oversight, regular reporting, stress-testing the guarantee portfolio, strictly limit new guarantees, lower coverage rates, and gradually reduce stock of guarantees to pre-pandemic levels. ### Financial sector resilience — assessment and recommendations - Current status: - Number of banks reduced to around 120 after consolidation. - Bank solvency risen; NPLs declined to close to EU average. - CRE accounts for 7 percent of banks’ total loans but 22 percent of NPLs. - Remaining TLTROs exceed excess reserves for half of banks by around €63 billion (around 2 percent of banking system assets). - Banks’ exposure to government securities edged up to around 10 percent recently; unrealized valuation losses on hold-to-maturity portfolio estimated at 200 basis points of CET1 ratio. - Potential losses on loan books cushioned by public guarantees (government exposure equal to about 25 percent of NFC loans at end-2022). - Staff’s recommendations: - Monitor banks’ funding plans and forward-looking liquidity buffers after TLTRO repayments. - Continue tailored stress tests for credit, duration, and liquidity risks. - Calibrate capital and liquidity buffers; challenge dividend and share buyback plans based on stress tests. - Strengthen supervision of LSIs, increase capital requirements/guidance there. - Collect data on current price loan-to-value for individual loans; focus on CRE lending. - Consider allowing a positive neutral rate for the countercyclical capital buffer. - Avoid windfall taxes on bank profits; limit use of non-standard financial vehicles to mutualize banking sector costs. - Cap size of the proposed GLAM scheme at proposed level of ½ percent of GDP. ### Energy security and transition - Key facts and targets: - Italy met winter 2022–23 energy needs, though at high prices. - Electricity generation from renewables at a 10-year low in 2022 due to drought; Italy added 3GW of renewable capacity in 2022, bringing total renewable capacity to 61 GW with 2.5 GW from solar. - To meet target of reducing carbon emissions by 55 percent of 1990 levels by 2030, emissions would need to be nearly halved. - 2030 Electricity Plan expected to target connecting 85 GW of new renewables and creating 80 GWh of new large-scale storage capacity. - Staff recommendations: - Prepare for adverse shocks to energy supply; ensure timely use of floating storage and regassification facilities. - Return to market-based energy pricing to encourage efficiency and renewables. - Streamline approvals for renewable projects (some cases require more than 30 approvals). - Avoid new energy contracts locking in long-term fossil fuel dependence. - Replace excise taxes on electricity with carbon taxes on input fuels and equalize carbon taxes across fuels and sectors. - Amend Superbonus to sharply reduce subsidy rate and limit eligibility to investments delivering significant energy-efficiency improvements; embed mandatory green standards in building codes. ### NRRP implementation and structural priorities - NRRP and implementation: - NRRP supported by EU grants and concessional loans totaling around 10 percent of GDP; runs 2021–26. Implementation ongoing but slower-than-envisaged pace, delaying third payment tranche. - Authorities intend to amend NRRP to reflect updated priorities and prepare a new REPowerEU chapter. - Staff structural priorities: - Promptly implement ambitious reforms to lift productivity: modernize public administration and judiciary, simplify civil procedures, strengthen competition and tax compliance, and improve education. - Address public investment bottlenecks (labor shortages, rising costs, many small projects per municipality) by improving administrative and execution capacity, providing “off-the-shelf” design plans and tender contracts, and reducing number of projects per municipality. - Address labor shortages and low activity rates by reducing social benefit and tax traps, decreasing informality, providing affordable child- and elder-care, and considering foreign workers. ### AML/CFT, beneficial ownership, and integrity of public resources - Continued efforts recommended to strengthen AML/CFT regime and tackle transnational corruption of public officials. - A dedicated AML Supervision and Regulatory Team established within the BdI for complex and cross-border financial crimes. - Further action required to operationalize the new beneficial ownership register. - Virtual assets: - MEF Decree (January 13, 2022) requires all VASPs to register with OAM and comply with Italian AML/CTF legislation; effective enforcement and supervisory mechanisms are a priority. - NRRP-related integrity: - Administrative and legal measures adopted to speed NRRP implementation should not erode competition or transparency; public officials should be appropriately qualified for decision making. ### Risk assessment highlights (Annex I) - Global risks with High relative likelihood/High impact: Intensification of regional conflicts. - Domestic risks with High relative likelihood/High impact: Ineffective tax reform. - Key external position metrics (2022): - NIIP: 3.9 percent of GDP. - Gross Assets: 174.3 percent of GDP. - Gross Liab.: 170.5 percent of GDP. - TARGET2 liabilities reached a record high of 36 percent of GDP. - Current Account (2022): –1.2 percent of GDP; staff CA gap midpoint: –2.5 percent of GDP. - REER assessment: staff assesses a REER gap in range 6.5 to 12.0 percent, midpoint 9.3 percent (2022). ### Selected quantitative indicators (from tables and macro projections) - Real GDP projections (selected): 3.7 (2022); 1.0 (2023); 0.9 (2024); 1.1 (2025); 1.1 (2026). - General government gross debt (selected): 144.4 (2022); 140.5 (2023); 138.8 (2024); 138.1 (2025); 137.2 (2026). - General government net lending/borrowing (Percent of GDP): -8.0 (2022); -4.5 (2023); -3.4 (2024); -2.8 (2025); -2.3 (2026). - Current account balance (Percent of GDP): -1.2 (2022); 0.7 (2023); 0.9 (2024); 1.2 (2025); 1.5 (2026). - Bank of Italy profit: net profit declined from €5.9bn in 2021 to €2.1bn in 2022. - BdI zero-profit policy rate (staff estimate): 2.5 percent based on end-2022 balance sheet; current policy rate cited at 3.5 percent. - Public guarantees: amount to 16 percent of GDP; many micro loans (< €30,000) with 100 percent guarantee cover; majority of COVID-related small loans due in 2026-27. - Employment: 23.5 million persons employed at a historic high (noted separately in labor section). *Source: IMF staff report excerpt, "1. Italy’s Tax System and Reform Needs" (1itaea2023001).* ### 1. Italy’s Tax System and Reform Needs _________________________________________________________ 18 ### 1. Italy’s Tax System and Reform Needs ### Context and long-term trends - Italy’s current level of GDP remains about 3 percent below its pre-crisis trend. - Output has been cushioned by highly-supportive fiscal, monetary, and financial responses to the COVID and energy price shocks, which generally strengthened private sector balance sheets but raised public debt to very high levels. - Growth is expected to enter a slower phase as support policies are unwound; ambitious structural policies are urgently needed to raise productivity and grow the active workforce to offset the drag from Italy’s rapidly aging population. ### Recent macroeconomic developments - Output: - Output expanded by 3.7 percent in 2022 and 1.9 percent y/y in Q1: 2023. - The current level of GDP is about 3 percent below its pre-crisis trend. - Household excess savings since the onset of the pandemic were equal to about 8 percent of GDP at end 2022. - Strong import growth related to investment demand yielded a negative growth contribution from net exports in 2022 and Q1:2023. - Sectoral developments: buoyant services and strong construction offset weakness in manufacturing, especially energy-intensive industries. - Inflation and prices: - Consumer prices increased by 8.7 percent in 2022; headline inflation peaked at 12½ percent in fall 2022. - Headline inflation eased to 6.7 percent in June 2023. - Core inflation averaged 4.0 percent in 2022 and was 6.0 percent y/y in June 2023. - GDP deflator growth rose to 5.7 percent y/y in Q1:2023. - The Bank of Italy found that international prices accounted for 90 percent of higher-than-expected increase in headline inflation in 2021-2022; staff notes inflation was overstated by about 2 percentage points in 2022 due to measurement of energy inflation. - Labor market and wages: - Employment expanded by almost 400 thousand since end-2019. - Unemployment declined by almost 490 thousand through April 2023 (to 7.8 percent). - All-in compensation per employee grew at 4½ percent in 2022. - Contractual wages grew by 2.2 percent in Q1:2023 year-on-year. - Real wages fell by nearly 4 percent in 2022 due to high inflation. - Financial conditions: - Sovereign yields rose sharply since mid-2021 but recently stabilized around pre-GFC levels. - Spreads over German bunds moderated on improved perceptions of political risk and ECB instruments. - Foreign holdings of Italian government securities have declined over the past year; holdings of residents have risen. - Bank lending conditions tightened sharply since Q2:2022. - The BIS-estimated credit gap has begun to rewiden after being negative and widening for most of the past decade. - Tightening monetary policy reduced the Bank of Italy’s profits in 2022 as net interest income declined. - External sector: - The current account swung to a 1¼ percent of GDP deficit in 2022. - The current account decline was mainly due to a 3¼ percentage point increase in the energy deficit. - Falling energy prices caused the current account to return to surplus in Q4:2022. - Residents continued to increase their holdings of foreign assets, largely balanced by an increase in Target 2 liabilities and portfolio inflows by nonresidents. ### Macroeconomic outlook and risks - Growth forecasts and drivers: - Growth is forecast to moderate to 1.0 percent on average in 2023-24 and to remain around 1.1 percent from 2025 as NRRP spending peaks. - NRRP-financed public investment is scheduled to peak at 3.5 percent of GDP during 2024-26 before easing to 3 percent of GDP in 2028—an increase from the pre-COVID average of 2.3 percent of GDP. - Potential growth in the next few years is expected to edge up marginally to 0.8 percent on ongoing reforms and infrastructure improvements. - Inflation outlook: - Headline inflation is expected to decline to 5.2 percent in 2023 and 2.5 percent in 2024. - Headline and core inflation will remain above 2 percent through 2025. - Rising wages and growing profit margins will keep core inflation and the GDP deflator above 2 percent until 2025. - Official forecasts of the inflation index used for collective bargaining agreements are 6.6 percent in 2023 and 2.9 percent in 2024. - Key transitional risks: - Withdrawal of fiscal stimulus and tightening of monetary policy will dampen real activity in 2023-24. - The phasing out of building tax credit schemes is projected to moderate private investment. - Uncertainties around persistence of the energy price shock and its external impacts create unusually high uncertainty for external position assessments. ### Policy implications highlighted in discussions - Manage the transition from extensive fiscal, monetary, and financial support to a more restrictive regime, focusing on: - Addressing fiscal policy challenges arising from multiple crises while phasing out exceptional support. - Ensuring financial sector resilience amid tighter monetary policy and rising yields. - Implementing ambitious structural reforms and investments to raise productivity and expand the active workforce in the face of demographic aging. - Leveraging NRRP-financed investment while preparing for its peak contribution in 2024-26 and subsequent easing. *Source: IMF staff report excerpt, "1. Italy’s Tax System and Reform Needs."* ### 10. While positive surprises are possible in the near term, downside risks dominate the growth ### 1itaea2023001 - 10. While positive surprises are possible in the near term, downside risks dominate the growth outlook ### Growth outlook and downside scenarios - Downside risks dominate the outlook; a severe global financial stress scenario (as in Box 1.3 of the April 2023 WEO) could hit Italy’s GDP harder than in many other advanced economies. - Under such a severe downside scenario, Italy’s GDP could decline by about 2 percentage points below the baseline in 2023 and 2024. - Channels and triggers of downside risk: - Sharper tightening of monetary policy from more persistent euro-area inflation transmitting asymmetrically to Italy and raising borrowing costs. - Renewed global financial stress reducing funding availability, causing public and private spending to retrench and reviving concerns about sovereign-bank-corporate linkages, including through calls on publicly-guaranteed loans. - Policies that slow public debt reduction or prolonged delays in receiving NextGenerationEU (NGEU) disbursements raising financing concerns. - Escalating geopolitical tensions or extreme weather events disrupting supply and demand. - Stalled progress on implementing the NRRP lowering support to output and weakening future productivity prospects. - Upside possibility: - Growth could be more resilient, notably if the tourism industry benefits from pent-up demand by foreign tourists. ### Authorities’ views on growth and risks - Authorities are somewhat more optimistic than staff and see risks as two-sided. - Noted strengths: - External competitiveness improved on sustained wage moderation. - Exports have grown strongly. - Adjusted for the energy terms of trade shock, external balances are in line with fundamentals. - Financial positions of households and companies are sound. - Employment has surpassed pre-pandemic levels, mainly on new permanent contracts; labor market participation has risen. - Authorities’ forecasts: - Growth forecast to reach 1.2-1.4 percent this year, and up to 1.5 percent in 2024. - Decline in energy prices expected to reverse last year’s upswing in headline and core inflation, with a more gradual path for core inflation. - Risks highlighted by authorities: - Renewed jumps in energy prices, fragmentation of foreign trade or generalized decline in external demand, further sizable increase in interest rates, and an excessive retrenchment of credit would negatively affect growth. ### Fiscal background and recent developments - Headline deficit averaged 8.9 percent of GDP during 2020-22 due to measures cushioning COVID and energy shocks, tax incentives supporting recovery, and rising interest bill on higher borrowing costs and inflation-linked debt payments. - Targeted nature of energy support has increased over time to about 2/3 of measures. - Superbonus scheme characteristics and changes: - Initially 110 percent rate of tax credit (since lowered to 90 percent and to be reduced to 65 percent next year). - Described as inefficient, regressive (property ownership required, not means tested), and achieved only modest carbon abatement. - Public debt: - Public debt ratio declined to 144 percent of GDP in 2022, some 10 percentage points below its peak in 2020, on sharp recovery in nominal GDP. ### Authorities’ fiscal targets and borrowing implications - Government targets: - A 3½ percentage point reduction in the headline deficit to 4.5 percent of GDP for 2023, to be achieved by scaling back Superbonus capital transfers and lowering spending on energy price compensation. - Further adjustment to reach a headline deficit of 2.5 percent of GDP in 2026, with a primary surplus of 2 percent of GDP. - Borrowing implications: - Claims for tax credits under the Superbonus and other incentive schemes are expected to add about ¾ percentage point on average to borrowing needs for the next five years. - Together with the higher cost of borrowing, the government forecasts the debt ratio will decline only modestly during 2024-26. ### Staff assessment of sovereign risk and fiscal policy advice - Overall risk assessment: - Italy’s overall risk of sovereign stress is assessed as moderate, but on the borderline (Annex II). - Medium-term risk judged as moderate given sizable gross financing needs and increased reliance on private sector funding as the ECB reduces sovereign bond holdings. - The risk of sovereign stress at the long horizon is viewed as high. - Staff recommendation on primary balance: - A faster improvement in the primary balance is warranted and feasible to support disinflation and build fiscal buffers. - The revised statistical treatment of previous tax credits and estimated gains from higher price deflators suggest revenue outturns through the medium term could be considerably stronger than projected—on the order of 2 percent of GDP. - Advises saving much of this revenue windfall to reach a primary surplus of around 1 percent of GDP this year. - Notes on cash-based performance: - Central government cash-based performance during January-May 2023 was much weaker than during the corresponding period of 2022, reflecting delays in receiving NGEU grants, increased claims of tax credits related to the Superbonus (cash impact but not accrual), and tax expenditures. ### Fiscal projections and staff recommended path (selected figures) - Contribution to the Headline Balance (Percent of GDP) projections and labels shown in source graphics include: - Staff recommended path for Overall balance: -8.0 (2022), -3.1 (2023), -2.1 (2024), -1.2 (2025), -1.3 (2026). - Authorities path for Overall balance: -8.0 (2022), -4.5 (2023), -3.7 (2024), -3.0 (2025), -2.5 (2026). - Staff recommended path for Primary balance: -3.6 (2022), 1.0 (2023), 2.0 (2024), 3.0 (2025), 3.0 (2026). - Authorities path for Primary balance: -3.6 (2022), -0.8 (2023), 0.3 (2024), 1.2 (2025), 2.0 (2026). - Staff recommended path for Public debt: 144.7 (2022), 139.0 (2023), 136.1 (2024), 134.3 (2025), 132.7 (2026). - Authorities path for Public debt: 144.7 (2022), 140.3 (2023), 138.7 (2024), 138.4 (2025), 137.8 (2026). ### Near-term spending efficiency and fiscal measures - Scope to increase spending efficiency, including near term: - Energy measures: - Further refine targeting of energy compensation to households and firms by fully reinstating VAT and system charges on gas. - Any compensation should be limited only to the temporary component of higher energy prices. - Balanced-budget financed spending: - Targeted income-redistribution financed from revenue windfalls was appropriate in 2022 for temporary energy shock response. - Using revenue windfalls to finance tax relief is not well suited for permanently raising structurally-low incomes; addressing that requires improving labor productivity and boosting potential growth. - Tax credits: - Reinforce financial controls on approvals of Superbonus and other tax credits, ensure strict compliance with program objectives, target eligibility to lower income households, and sharply reduce the subsidy rate to limit budgetary overruns and wasteful spending. ### Medium- and long-term fiscal framework and structural reforms - Fiscal strategy recommended: - Save windfall revenue and over time replace with more efficient fiscal measures that promote sustainable and inclusive growth and boost productivity to deliver durable debt reduction. - Structural reforms and increased public investment in physical and social infrastructure are needed—public investment was sacrificed during the last 10-15 years to make room for higher social spending and proliferation of tax expenditures. - Recommended spending path: primary current spending to grow by at least 1 to 2 percentage points below nominal GDP growth while maintaining a 3 percent of GDP primary surplus from 2025 onwards; this would reduce the debt ratio to around 130 percent of GDP by 2028. - If combined with closing labor force participation gaps with the EU, stepping up immigration, or higher growth, debt could decline to around 90 percent of GDP within 20 years. - Tax system reform priorities: - Comprehensive tax reform to broaden the tax base, increase efficiency and equity, reduce compliance gaps, and rationalize tax expenditures (costing around 6 percent of GDP in foregone annual revenue). - Update property values in the cadastre (last done in the 1980s). - Ensure reforms promote employment, abolish ineffective tax expenditures, reinforce revenue collection, and protect progressivity. - Warning: A flat tax on personal income could have adverse implications for equity and lead to significant revenue loss. - Continue strengthening tax compliance; lifting the ceiling on permitted cash transactions and introducing an amnesty on tax debt are not helpful. ### Pension spending and savings potential - Pension context and recommendations: - Pensions cost the budget 16 percent of GDP against a euro-area average of around 13 percent. - Pension spending is expected to increase over the next 25 years as the population ages, adding up to 2¼ percentage points to spending and substantially adding to public debt over the medium-to-long run. - Scope to trim costs of the legacy defined-benefit scheme by reducing the wage replacement rate (67 percent) closer to the euro area average of around 50 percent and raising the effective retirement age (currently under 64) closer to the statutory age (67 years) by avoiding any new early retirement arrangements. - These measures could yield up to ¾ percent of GDP in annual fiscal savings. ### Management of public sector guarantees and contingent liabilities - Risks and recommended actions: - Large stock of public sector guarantees requires strong centralized oversight and prudent management to limit contingent liability materialization. - Concerns: - High coverage rates can delay recognition of fiscal costs and encourage adverse selection of riskier borrowers and banks. - Current low default rate on guarantees may not be informative for future performance given ongoing policy support, recently expired grace periods on principal repayments, and long maturity of guaranteed loans. - Recommended practices: - Prudent, centralized monitoring and management of existing guarantees with regular reporting of monitoring data. - Banks should pursue borrowers with impaired guaranteed loans using similar tools and strategies as for non-guaranteed loans and with timely mandatory reporting on guarantee quality to public-sector managing entities and the Ministry of Finance. - Stress testing the guarantee portfolio under adverse scenarios to guide provisioning decisions. - Strictly limit new guarantees, lower coverage rates, require enhanced credit risk assessments by banks at origination. - Gradually reduce the stock of guarantees to pre-pandemic levels. *ITALY INTERNATIONAL MONETARY FUND* ### Box 1. Italy’s Tax System and Reform Needs (Concluded) ### Box 1. Italy’s Tax System and Reform Needs (Concluded) ### Tax reform objectives and assessment - Reform envisaged to be implemented within 2 years. - Reform aims: - Rationalize the current system of tax expenditures by reducing their number and embedding them within the corporate and personal systems. - Improve international tax competitiveness. - Staff assessment of reform design: - Objectives are sound, but it is not clear whether the proposed reforms are the most efficient and effective way to achieve them. - Intention to gradually transition to a flat PIT rate (by sequentially reducing the number of tax brackets each year) would be costly in terms of revenue and puts progressivity at risk. - Using tax credits to lower the tax burden at the bottom of the income distribution is considered good practice and should continue. - The existing family (“dependent spouse”) tax credit disincentivizes labor supply by non-working spouses at lower income levels and should ideally be replaced by an in-work tax credit. - Applying two separate corporate profit rates (lower rate for retained profits used for hiring or investment) would be extremely difficult to administer and is ill-targeted. - Recommendation to build on existing investment-targeting features (tax credits and the allowance for corporate equity) for a growth-friendly CIT design. ### Policy recommendations on tax structure and revenue - A tax reform should: - Rely on effective and efficient measures to encourage investment and employment while respecting revenue and progressivity objectives. - Lower the tax burden on labor income by reducing marginal rates, while preserving progressivity and streamlining tax credits and deductions to benefit low and middle-income households and boost formal sector employment. - Shift from labor taxes towards greater reliance on consumption and property taxation to lower the labor tax wedge, support higher labor participation and boost growth. - Update property values and reintroduce the recurrent property tax on primary residences (as in many OECD countries) to raise revenue efficiently. - Adopt a simple and stable business taxation strategy that includes an allowance for corporate equity and removes inefficient incentives to support investment and lift low growth potential (IMF working paper 18/59). ### Authorities’ fiscal stance and related targets - Authorities’ commitments and actions: - Committed to preserving fiscal sustainability and to lowering the public debt ratio within the forthcoming new EU fiscal rules. - Maintain a prudent approach to public finances and demonstrated ability to take difficult decisions. - Successful launch of several new retail savings bonds shows resilience of the Treasury’s debt management strategy. - Inefficient spending being eliminated, including the Superbonus scheme. - Temporary tax and social security cuts used to mitigate cost-of-living shocks for low- and middle-income families, contain wage demands and support growth. - Italy aims to return to a 2 percent primary surplus by 2026. - Removing remaining energy compensation measures and conservative growth in nominal spending expected to deliver envisaged targets. - A package of growth enhancing reforms and investments to be prepared by early-2024, aided by a review of spending. - Planned tax reform will be fully financed and will gradually lower the tax burden on households, workers and firms, simplify the tax system and strengthen the supply side by encouraging investment, innovation and employment. - Real interest rates expected to remain below real growth rates, at least in the short-to medium term. - Public guarantees related to the pandemic emergency will continue to decline gradually, returning to their pre-COVID level in the medium term. - Long-run pension system sustainability assured by the notional defined-contribution system; together with declining interest spreads, this will deliver a downward path for the debt ratio from 2050. ### Box 2 — Public guarantees: scale and features - Overall size and origin: - Public guarantees related to private-sector debt obligations amount to 16 percent of GDP and originate mainly from COVID and energy-related loan schemes. - Distribution and design features: - Guarantees vary by firm size; include more than 1 million loans of less than €30,000 with 100 percent guarantee cover to small and micro firms, classified as “standard,” and for which provisions equal to the expected loss are recorded as fiscal spending when the guarantee is issued. - Guarantees to large firms are “one-off,” and the budgetary impact is recorded only if and when the guarantee is called. - Performance and maturities: - Calls on guarantees have been low so far. - NPL rate of guaranteed loans was 2 percent at end-2022, although the share classified as Stage 2 has risen. - Maturity ceilings: 15 years for micro loans under the COVID temporary framework and a maximum of 8 years for energy guarantees. - Majority of COVID-related small loans is due in 2026-27. - Under existing regulation, new guarantees available with coverage rates of 60 and 80 percent for working capital and investment purposes, respectively. ### Financial sector resilience — background and vulnerabilities - Structural improvements and remaining risks: - Number of banks reduced to around 120 after consolidation from merging some 200 entities into two significant cooperative groups. - Bank solvency has risen significantly on higher capital and de-risking of assets. - NPLs—gross and net of provisions—declined sharply over the past decade to close to the EU average. - CRE accounts for 7 percent of banks’ total loans but 22 percent of NPLs. - Prices of residential and commercial real estate have declined for much of the past decade. - More complete pass-through of higher policy rates to lending rates than to deposit rates has boosted banks’ profits over the past year. - Stocks of loans and deposits have declined on higher borrowing costs, shifts to higher-yielding instruments, and repayment of firms’ loans used as liquidity buffers. - Remaining TLTROs exceed excess reserves for half of banks—but not the largest banks—by around €63 billion (around 2 percent of banking system assets). - Banks’ exposure to Italian government securities—of which more than 70 percent are classified as hold-to-maturity—has declined in recent years, but edged up to around 10 percent recently. - Unrealized valuation losses on the entire hold-to-maturity debt securities portfolio are estimated at 200 basis points of CET1 ratio. - Potential losses on banks’ loan books cushioned by public guarantees (with government exposure equal to about 25 percent of NFC loans at end-2022). ### Financial sector resilience — staff views and recommendations - Staff’s assessment of current risks: - Rising policy interest rates, quantitative tightening, and the economic slowdown have raised stability risks. - Capital and liquidity buffers remained broadly stable and NPLs declined further, but credit volumes expected to decline and NPLs are likely to rise as borrowers’ repayment capacity weakens. - Funding costs expected to increase further, especially for banks with smaller excess reserves relative to maturing TLTRO borrowings and those needing to issue securities to meet MREL requirements. - Risks unevenly distributed; pockets of weakness among less significant banks (LSIs) with weaker credit quality, lower provisioning coverage, and larger holdings of sovereign bonds relative to capital. - Insurance companies face increased surrenders of life insurance policies, declines in premium income, and unrealized losses on securities holdings; solvency remains solid but exposures to Italian sovereign bonds and alternative instruments pose risks. - REIFs mostly closed-end, reducing risk of sharp redemption-driven pressures, but pronounced CRE price downturns could spill over to banks via collateral exposure. - Recommended supervisory and macroprudential actions: - Continue close attention to banks’ funding plans, forward-looking liquidity buffers after TLTRO repayments, and feasibility of using interest rate swaps to bridge duration risk. - Continue tailored stress tests to capture plausible credit, duration, and liquidity risks, including concentrated funding and sovereign exposures. - Calibrate capital and liquidity buffers and challenge dividend and share buyback plans based on stress test results to preserve headroom. - Maintain more comprehensive supervision of LSIs, higher capital requirements and guidance. - Continue close attention to lending to CRE; complete data collection on current price loan-to-value on an individual loan basis. - Consider reinforcing the macroprudential framework by allowing a positive neutral rate for the countercyclical capital buffer. - Avoid windfall taxes on bank profits to prevent unintended consequences for credit availability and resilience. - Limit use of non-standard financial vehicles to mutualize banking sector costs; avoid public-private partnerships using deposit guarantee scheme resources or voluntary contributions to prevent bank failures outside resolution except in cases with strong prospects for successful rehabilitation. - Bar for reintroducing GACS should be high given current low NPL rate; banks should strengthen loan recovery performance. - Cap size of the proposed Guaranteed Loan Action Management (GLAM) scheme at the proposed level of ½ percent of GDP. ### Authorities’ view on financial stability - Authorities’ perspective: - Main risks: geopolitical tensions, high inflation and a worsening economic outlook. - Banking system situation improved significantly over the past decade due to tighter supervision and reductions in NPLs. - Funding and credit risks, including from CRE exposures, are present and being scrutinized. - Banks plan to repay TLTROs by a combination of bond issuance, central bank financing, term deposits and trimming balance sheets. - Sovereign holdings provide high-quality collateral for refinancing; impact on capital of yield changes limited since a large part held at amortized cost. - Harmonization of covered bond framework with EU standards provides additional long-term funding. - For smaller banks, supervisory tools improved through cooperation with SSM, stress-test-guided capital requirements, targeted supervisory actions and orderly exits where needed. - Role for nonstandard vehicles financed by other banks on market terms could be considered if shareholders and managers forfeit their stakes. - Bank of Italy monitors external loan servicers and IT providers to protect continuity of service delivery. - Given the low NPL rate, no need at present for special instruments to support NPL disposals, but tools are readied if needed. ### Structural priorities and growth-enhancing policies - Demographic and structural challenges: - Rapid population aging, low labor force participation, and weak productivity constrain growth. - Working-age population forecast to shrink by nearly 20 percent over the next 25 years. - Underperforming education systems (especially in the South), very low wage premium on tertiary qualifications, prevalence of micro firms and a large informal economy impede productivity. - ISTAT estimates the underground and illegal economy accounts for 11 percent of GDP. - NRRP and implementation challenges: - Post-pandemic NRRP supported by EU grants and concessional loans totaling around 10 percent of GDP; runs during 2021-26. - Implementation ongoing but at a slower-than-envisaged pace, delaying release of the third payment tranche; some revisions expected. - Staff policy priorities to raise potential growth: - Prompt implementation of an ambitious, comprehensive reform agenda to lift productivity. - Complete NRRP reforms aimed at modernizing public administration and the judiciary, simplifying civil procedures, strengthening competition and tax compliance, and improving educational outcomes. - Address public investment bottlenecks caused by labor shortages, rising costs, and many small projects for small municipalities by improving administrative and execution capacity, providing “off-the-shelf” design plans and tender contracts, and reducing the number of projects per municipality. - Address labor shortages and low activity rates by reducing social benefit and tax traps, decreasing informality, providing affordable child- and elder-care, and considering foreign workers to fill domestic skill shortages. - Recognize that tax credits supporting private investment have performed well, partly due to their generosity. *Source: 1itaea2023001 - Box 1. Italy’s Tax System and Reform Needs (Concluded)* ### 27. Ongoing efforts to strengthen the AML/CFT regime, tackle transnational corruption of ### 27. Ongoing efforts to strengthen the AML/CFT regime, tackle transnational corruption of public officials and protect the integrity of public resources should continue ### AML/CFT, beneficial ownership, and integrity of public resources - Continued efforts to strengthen the AML/CFT regime and tackle transnational corruption of public officials are recommended (Annex VIII). - A dedicated AML Supervision and Regulatory Team established within the BdI allows for more efficient handling of complex and cross-border dimensions of financial crimes. - Italy has made considerable progress in fighting foreign bribery. - Risks arising from virtual assets are subject to a new regulation that is yet to be effectively implemented. - Further action is required to operationalize the new beneficial ownership register. - Italy should strengthen coordination efforts between various agencies involved in detection and pursuance of financial crimes. - Administrative and legal measures adopted to speed up NRRP implementation should not erode competition or transparency of contracting, and public officials should be appropriately qualified to assume their legal responsibilities in decision making. ### Authorities’ views on the NRRP and priorities - The authorities will seek to amend the NRRP to better reflect updated priorities. - All targets and milestones for 2022 were successfully met. - The energy crisis and high inflation have created the need for some remodulation and refocusing to accommodate new energy security priorities and account for higher inflation. - Oversight has been shifted to the Prime Minister’s office; the Government is finalizing proposed revisions to the Plan and preparing a new REPowerEU chapter. - Investments and reforms underway are expected to: - improve educational outcomes, particularly at the tertiary level, to increase young people’s employment prospects; - reduce the gender gap in employment; - raise social inclusion and prevent marginalization; - strengthen territorial cohesion. - Italy will continue to make timely progress in further reinforcing its AML/CFT framework. ### Energy security and transition — Background (key facts) - Italy successfully met its energy needs for winter 2022–23, although at high prices. - Contributing factors: mild temperatures, slowdown of energy-intensive production, subsidies for storage, diversification of gas supplies, increased use of coal. - Recently-agreed purchase contracts are expected to allow Italy to meet the EC’s gas storage target of 90 percent capacity by October. - Adverse shocks could produce shortages: full shut-off of Russian gas, more resilient gas demand, continued drought limiting hydro-generated electricity. - Electricity generation from renewables was at a 10-year low in 2022 reflecting drought-induced reduction in hydroelectricity, despite a modest increase in solar and wind capacity. - Italy added 3GW of renewable capacity in 2022, increasing total renewable capacity to 61 GW, almost exclusively through new plants, with 2.5 GW coming from solar plants. - To achieve the target of reducing carbon emissions by 55 percent of 1990 levels by 2030, Italy’s emissions would need to be nearly halved. - The forthcoming 2030 Electricity Plan is expected to target connecting 85 GW of new renewables to the electricity grid and creating 80 GWh of new large-scale storage capacity. - The REPowerEU chapter aims to strengthen energy autonomy and environmental transition by improving the grid, increasing production from renewable sources, supporting decarbonization of companies, and encouraging energy-related production chains. ### Energy security and transition — Staff views and recommendations - Prepare for possible adverse shocks to energy supply in the coming winter, including ensuring timely commencement of operations of new floating storage and regassification facilities. - Full return to market-based energy pricing would encourage efficiency gains, conservation, and faster shift to renewable energy. - Streamline approvals procedures that delay new renewable projects; currently some cases require more than 30 approvals. - Avoid new energy-related contracts that lock Italy into long-term fossil fuel dependence. - Replace excise taxes on electricity with carbon taxes on input fuels to encourage green power generation. - Amend the Superbonus scheme to sharply reduce the subsidy rate and limit eligible investments to those that deliver significant improvements in energy efficiency; embed mandatory green standards in building codes. - Invest in complementary renewable infrastructure, including energy storage and distribution networks. - There is ample scope to reduce industrial emissions by bringing lagging firms to the emissions levels of better-performing sectoral peers. - Taxes on energy should be based on carbon content and carbon taxes should be equalized across fuels and sectors. ### Energy sector implementation challenges noted by authorities - The authorities consider the outlook for energy security much improved from a year ago. - Risk of a sizable gas shortage is low given historically-high storage levels in the spring months. - Competition for gas supplies ahead of next winter could temporarily cause prices to rebound; coordinated EU purchasing could temper the risk. - Recent energy efficiency mandates—minimum cooling and maximum heating settings—have been successful and will remain in place. - The Superbonus scheme will expire at end-2025, and subsidy rates will continue to decline in the interim. - Decisions on carbon pricing will be made in the context of the EU’s pending revision to the Energy Taxation Directive. - An upcoming decree will provide greater autonomy to regions for approvals and encourage better coordination among ministries to tackle authorization bottlenecks. - A structural challenge: solar generation conditions are most favorable in the south while demand is highest in the north; planned electricity grid investments in the next years should address this. ### Staff appraisal — macroeconomic outlook and risks - The Italian economy has demonstrated resilience amid sequential adverse shocks, but major structural challenges remain. - Output and employment recovered strongly in 2021 and 2022. - Private sector financial positions have strengthened; households and firms adapted to the sharp increase in energy prices. - Skillful management of gas supplies avoided energy shortages; extensive compensation cushioned impact of higher energy prices on real purchasing power; generous tax credits boosted construction. - Fiscal deficit widened sharply; the public debt ratio declined but remains very high; core inflation has yet to slow decisively. - The external position in 2022 was weaker than warranted by medium-term fundamentals. - In the absence of deep structural reforms and a large increase in employment, persistent weak productivity compounded by a shrinking working-age population would raise the burden of public debt. - Growth projections and risks: - Growth is expected to moderate to around 1 percent this year and next. - Spending under the NRRP is forecast to increase and temporarily push up growth around the middle of the decade. - Underlying inflation is likely to prove sticky given propagation through the wage settlement system and ongoing fiscal support for the cost of living shock. - A sharply tighter monetary policy could trigger funding tensions; moderate, but borderline, overall risk of sovereign stress and strong sovereign-bank-corporate linkages could disproportionately affect Italy. - Fragmenting economic relations with other regions could impede access to markets and critical inputs. - Modest positive growth surprises are possible, but robust improvement requires comprehensive reforms and investments. ### Fiscal recommendations and quantitative guidance - Reinforcing public finances is essential to decisively lower the debt ratio, create room for critical modernizing spending and prepare for future shocks. - Italy’s overall risk of sovereign stress is moderate, with borderline medium-term and high long-term risk. - Fiscal deficits are forecast to decline only gradually, with initial progress from unwinding remaining crisis support. - Greater frontloading of adjustment is advised to moderate price pressures and mitigate risks of sovereign stress amid slower growth and tighter financial conditions. - Recommendations: - Save revenue windfalls and spend more efficiently to deliver sizable near-term fiscal improvement. - Develop and implement well-defined and efficient measures to underpin consolidation, grounded in a medium-term fiscal framework. - Maintain a 3 percent of GDP primary surplus. - Grow primary current spending—including tax expenditures—by at least 1 to 2 percentage points below nominal GDP growth to deliver steady, decisive debt reduction and carve out room for public investment. - A tax reform should broaden the base, increase efficiency and equity, and strengthen revenue collection. - Public guarantees should be prudently managed and well provisioned, with strict limits on new guarantees. ### Financial stability and banking sector guidance - Preserving financial stability is a priority as monetary policy tightening proceeds, while limiting recourse to public-sector backstops. - Increased capital and liquidity buffers, strengthened supervisory oversight and the sizable share of guaranteed loans will bolster the banking sector’s ability to absorb higher funding costs and anticipated weakening of loan quality. - Risks to monitor: - Strong competition for funding with the public sector could bid up interest rates on bank deposits. - Close attention warranted for banks whose excess reserves do not cover their concessional longer-term funding from the ECB. - Focus on commercial real estate and smaller banks with weaker business models that could be masked by temporarily elevated net interest margins. - Maintain adequate headroom on capital and liquidity from a forward-looking perspective and adopt conforming dividend and share buyback plans. - The need for public-private partnerships in the banking sector has been greatly diminished and should generally be avoided. ### Structural reforms and implementation of NRRP - Reforms and investments to grow productivity and modernize the economy are essential to sustainably raise real incomes and meet demographic, energy, climate, and geo-economic fragmentation challenges. - The NRRP agenda is appropriately ambitious, aimed at addressing long-standing impediments to productivity, investment, and labor force participation. - Reforms should be adopted fully and bottlenecks to implementing critical investments resolved pragmatically, including: - recourse to skilled foreign workers; - providing adequate technical guidance to smaller municipalities. - Measures to accelerate procedures should promote competition and transparency and protect the integrity of financial resources. - To ensure high execution standards, it may be necessary to reduce the number of small-scale projects, especially in smaller municipalities facing large increases in workload. - Accelerating permitting for new renewable electricity capacity would strengthen energy security, support climate targets, and provide more welcoming and predictable conditions for private investors. ### Demographic/scenario note (passive scenario assumptions) - The passive scenario assumes: - zero TFP growth, - no change in labor force participation rates, - the investment rate at 20 percent of GDP. - The passive scenario is somewhat more pessimistic than the baseline scenario because it excludes productivity gains—albeit modest—and public investment brought by the NRRP. *Source: 1itaea2023001 (IMF).* ### 37. It is recommended that the next Article IV consultation take place on the standard 12- ### 1itaea2023001 - 37. It is recommended that the next Article IV consultation take place on the standard 12- ### Real Sector Developments - Real GDP (2019Q4=100) series shown for Germany, France, Spain, Italy (figure). - Industrial Production (Index, SWDA, Jan-2019=100) by energy intensity: High energy intensity; Medium energy intensity; Low energy intensity (figure). - PMI and Consumer Confidence: Manufacturing PMI (50+=expansion); Services PMI (50+=expansion); Consumer confidence (percent balance, RHS) (figure). - Labor shortages and capacity utilization: Capacity utilization and Labor shortages (Labor shortages in percent balance, capacity utilization in percent of capacity) (figure). - Employment and Unemployment Rate: Employed workers (y-o-y percent change); Unemployment rate (percent, RHS) (figure). - PPI and CPI Inflation: CPI (RHS); Domestic PPI; Domestic PPI excl. energy (Year-on-year percent change) (figure). ### Labor Market Developments - Changes in Working Age Population (Thousands of persons, April 2023 relative to end-2019) by age groups: Total; 15-24 Years Old; 25-34 Years Old; 35-49 Years Old; 50-64 Years Old; 64+ Years Old (figure). - Employment and Participation Rate: Employment (millions of people); Participation rate (%, right scale) (figure). - Unemployment Rate: Actual; Net of new employment in construction (Percent) (figure). - Employment by Industry (Percent change): 2021Q4 - 2019Q4 and 2023Q1 - 2021Q4 across Agriculture; Other services; Industry excl. construction; ICT, science & prof. services; Construction (figure). - Employment by Sector (Index, 2019Q1=100): Industry; Construction; Private services; Public services (figure). - Job Positions in Manufacturing (Index, January, 2021=100): Energy intensive sectors; Other sectors (figure). ### Fiscal Developments and Issues - Government Bond Yields: 1-year yield; 10-year yield; 10-year spread over Bunds (basis points, rhs) (figure). - Interest Expense and Bond Yields: Interest expense (percent of GDP); Bond yield: all maturities (percent) (figure). - Central Government Bond Operations, Upcoming Redemptions (Billions of euros): Medium- and long-term; Short-term (figure). - Expenditures by Category (Percent of GDP): Social benefits; Wage bill; Public investment; Other primary spending (2003, 2009, 2022 series) (figure). - Tax Wedge on Low-Wage Earners, 2022: Country comparison including Italy (figure). - Fiscal Balance (Percent of GDP): Structural primary balance; Primary balance (1997–2022) (figure). ### External Developments - Current Account Balance (Percent of GDP, rolling annual): Goods; Services and Primary Income; Secondary income; CA (2011–2023) (figure). - Export and Import Unit Value (Year-on-year percent change) (2010–2023) (figure). - Real Effective Exchange Rate (1999Q1=100): Italy REER (HICP-deflated); Italy REER (ULC-deflated); Germany REER (HICP-deflated); Germany REER (ULC-deflated) (figure). - Export and Import Volume Growth (Percent, year-on-year rolling) (2011–2023) (figure). - Italy Target 2 Balance (Euro billions) (2012–2023) (figure). - Financial Account Composition (Percent of GDP): Other investment; Financial derivatives; Portfolio Investment Liabilities; Portfolio Investment Assets (opposite sign); FDI (2011–2023) (figure). ### Financial Sector Developments - Non-Performing Loans and Coverage Ratio 1/ (Billions of euros): Other NPEs; Bad loans; Coverage ratio (percent, rhs) (figure). 1/ Bank of Italy data starting from 2012. - Common Equity Tier 1 (Fully Loaded) (Percent) — cross-country 2022Q4 comparison including Italy and EU average (figure). - Net Liquidity Position (Average share of total assets): Liquidity indicator - significant groups; Liquidity indicator - less significant groups (figure). - Real Estate Prices (2010Q1=100) (2010–2023) (figure). - Private Sector Credit Growth (Percent): Private credit; Nonfinancial corporates; Households (2008–2023) (figure). - ECB Liquidity Support and Bank Financing (Billions of euros): Deposits; Debt securities; ECB support (right scale) (2008–2022) (figure). ### Financial Sector Assets and Valuation, 2008-23 - General Government Debt by Holding Sector 1/ (Billions of euros and Percent share): Bank of Italy; Monetary Financial Institutions; Financial Institutions; Other Residents; Non Residents (1959–2023; series shown) 1/ Debt recorded at face value (figure). - Foreign Banks’ Exposure to Italy by Sector, 2022Q4 (Percent of own GDP): Listed countries and sectoral composition (Non-bank private sector; Official sector; Banks) (figure). - ISDA CDS Contract Spread and Sentix Euro Break-up Index (Basis points, index): Spread between Italy ISDA 2014 and 2003 CDS contracts; Sentix Euro Break-up Index (rhs) (figure). - Price to Book Value Ratios of Banks: Italian banks; US banks; European banks (2008–2023) (figure). - European Banks' CDS Spreads (Basis points): French banks; German banks; Italian banks; Spanish banks (2011–2023) (figure). ### Banking Sector Indicators, 2015-23 - Banking Sector Loans and Deposits (Year-on-year percent change): Nonfinancial corporation loans; Household loans; Nonfinancial corporation deposits; Household deposits (2015–2023) (figure). - New NPL Rates (Percent): Households; Firms; Total (2010–2022) (figure). - Bank Average Interest Rates to Firms (Percent): New loan up to €1 million; New loan over €1 million; Current account overdraft rate (2012–2023) (figure). - Index of Bank Credit Supply to Firms (Index, greater than zero = tightening) (2011–2022) (figure). - Index of Bank Credit Demand by Firms (Index, greater than zero = expansion) (2011–2022) (figure). - Italian Bank Equities and CDS Spreads: Italian bank equities (1/1/2018=100) and CDS spread (rhs) (2018–2023) (figure). ### Impacts of Monetary Policy Tightening; Private Sector Liquidity and Indebtedness, 2015-23 - Banking Sector Deposits (Billions of euros): Nonfinancial corporates; Households (RHS) (Jan-20–Jan-23) (figure). - Bank Lending Rates (Percent): Mortgage loans; Loans to non-financial corporations; Consumer credit (RHS) (Jan-20–Jan-23) (figure). - Banking Sector Loan (Billions of euros): Nonfinancial corporate loans; Household loans (RHS) (Jan-20–Jan-23) (figure). - Change in Loans Minus Deposits since Dec 2019 (Billions of euros): Nonfinancial corporates; Consumer households; Producer households (Jan-20–Jan-23) (figure). - Non-financial Corporations' Debt (Percent of GDP): Other loans; Securities; Medium- and long-term bank loans; Short-term bank loans (2015Q1–2021Q1) (figure). - Bank Interest Rates on Euro Deposits by Instrument (Percent): Average rate on deposits; Overnight deposits; Deposits with agreed maturity; Deposits redeemable at notice (Jan-20–Dec-22) (figure). ### Table 1. Italy: Summary of Economic Indicators, 2019–28 (selected rows) - Years covered: 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 (Projections) - Real GDP: 0.5-9.07.03.71.10.91.11.11.00.9 - Real domestic demand: -0.2-8.47.24.30.91.01.21.11.11.0 - Final domestic demand: 0.2-8.06.64.71.30.81.11.11.11.0 - Private consumption: 0.2-10.44.74.61.31.21.11.10.80.7 - Public consumption: -0.60.01.50.0-1.1-2.2-1.2-0.91.10.9 - Gross fixed capital formation: 1.2-7.918.69.43.12.23.12.71.81.8 - Stock building 1/: -0.5-0.50.5-0.4-0.30.10.10.00.00.0 - Net exports 1/: 0.7-0.80.0-0.50.2-0.1-0.10.00.0-0.1 - Exports of goods and services 1/: 1.6-13.514.09.42.22.82.72.62.52.3 - Imports of goods and services: -0.7-12.115.211.81.73.23.12.72.62.6 - Savings 2/: 21.621.623.720.522.223.924.625.225.525.9 - Investment 2/: 18.217.720.721.821.522.923.423.623.723.8 - Resource utilization: - Potential GDP: 0.4-4.04.10.00.70.70.90.80.80.9 - Output gap (percent of potential): -1.8-7.0-4.3-0.8-0.4-0.30.00.20.40.5 - Employment: 0.7-3.10.82.40.80.10.00.10.10.0 - Unemployment rate (percent): 9.99.39.58.18.08.18.28.28.28.3 - Prices: - GDP deflator: 0.91.60.63.06.23.62.22.02.02.0 - Consumer prices: 0.6-0.11.98.75.22.52.22.02.02.0 - Consumer prices (core): 0.60.50.84.04.83.22.22.02.02.0 - Fiscal indicators: - General government net lending/borrowing 2/: -1.5-9.7-9.0-8.0-4.5-3.4-2.8-2.3-2.3-2.3 - General government primary balance 2/ 4/: 1.9-6.2-5.5-3.6-0.50.81.42.02.02.0 - Structural overall balance (percent of potential GDP): -0.6-5.4-4.6-1.7-2.1-2.9-3.1-2.5-2.6-2.6 - Structural primary balance (percent of potential GDP) 4/: 2.7-2.2-1.22.71.91.21.11.81.71.7 - General government gross debt 2/: 134.1 154.9 149.9 144.4 140.5 138.8 138.1 137.2 136.3 135.6 - External sector 2/: - Current account balance: 3.33.93.1-1.20.70.91.21.51.82.0 - Trade balance: 3.43.62.3-1.40.50.71.01.31.61.8 Notes: (Annual percentage change, unless noted otherwise). 1/ Contribution to growth. 2/ Percent of GDP. 3/ In industry (including construction). 4/ Primary revenue minus primary expenditure. Member of the EMU. Projections. ### Table 2. Italy: Statement of Operations–General Government (GFSM 2001 format), 2019–28 (selected rows) - Revenue (Billions of euros): 843.8786.3863.4931.4 1,000.6 1,015.9 1,045.7 1,069.8 1,096.0 1,120.4 - Taxes: 517.0478.8529.4568.6609.8625.1642.4659.4678.7697.3 - Social contributions: 242.2229.7246.1261.0277.8293.7302.5309.8316.6321.8 - Grants: 3.04.59.020.022.811.811.84.73.04.0 - Other revenue: 81.673.378.981.890.285.389.095.897.797.2 - Expenditure (Billions of euros): 870.9946.7 1,024.6 1,083.3 1,093.5 1,088.3 1,107.7 1,122.7 1,150.8 1,176.3 - Expense (Billions of euros): 870.4946.1 1,023.8 1,082.4 1,093.4 1,088.2 1,107.6 1,122.6 1,150.7 1,176.2 - Interest (Billions of euros): 60.457.363.783.283.488.893.698.1101.7104.6 - Net lending/borrowing (Billions of euros): -27.1 -160.4-161.2-151.9-92.9-72.4-62.0-52.9-54.9-55.9 - Net lending/borrowing (Percent of GDP): -1.5-9.7-9.0-8.0-4.5-3.4-2.8-2.3-2.3-2.3 - Memorandum items: - Primary balance 1/: 1.9-6.2-5.5-3.6-0.50.81.42.02.02.0 - Structural primary balance 1/: 2.7-2.2-1.22.71.91.21.11.81.71.7 - General government gross debt: 134.1154.9149.9144.4140.5138.8138.1137.2136.3135.6 Notes: 1/ Primary revenue minus primary expenditure. 2/ Percent of potential GDP. (Billions of euros) (Percent of GDP, unless otherwise indicated). ### Table 3. Italy: Summary of Balance of Payments, 2019–28 (selected rows) - Current account balance (Billions of euros): 59.564.054.9-23.313.419.325.934.141.748.6 - Balance of goods and services (Billions of euros): 60.359.940.6-27.610.116.022.430.437.944.5 - Goods balance (Billions of euros): 60.768.349.7-18.112.118.124.632.740.247.0 - Exports (Billions of euros): 459.0414.5496.5591.4611.2646.3678.4708.1732.0754.3 - Imports (Billions of euros): 398.2346.3446.8609.5599.1628.2653.8675.5691.8707.3 - Services balance (Billions of euros): -0.4-8.4-9.1-9.6-2.0-2.1-2.2-2.3-2.4-2.4 - Credit (Billions of euros): 109.474.587.8121.6114.8120.0124.0127.9131.8135.6 - Debit (Billions of euros): 109.882.996.9131.1116.8122.1126.2130.1134.1138.0 - Primary income balance (Billions of euros): 14.820.734.122.321.822.623.424.225.025.8 - Credit: 76.963.781.976.980.383.986.789.592.395.0 - Debit: 62.242.947.954.658.661.263.365.267.369.2 - Secondary income balance (Billions of euros): -15.6-16.6-19.7-17.9-18.5-19.3-19.9-20.6-21.2-21.8 - Capital account balance (Billions of euros): -1.20.91.010.317.417.515.59.51.21.2 - Financial account (Billions of euros): 52.972.255.3-17.630.836.841.443.642.949.8 - Direct investment: 1.518.831.2-20.7-10.2-10.7-11.0-11.2-11.5-11.8 - Portfolio investment: -50.2115.9123.1167.2-23.5-20.6-12.3-9.8-9.7-14.2 - Other investment: 95.7-64.0 -119.7 -177.458.664.962.863.663.475.1 - Gross external debt (Percent of GDP): 124.1139.5137.4129.0126.5125.5124.7123.6122.4121.4 - Public sector: 72.884.382.874.673.773.773.773.573.173.0 - Private sector: 51.355.254.654.452.751.851.050.249.348.5 Notes: Sources: National Authorities; and IMF staff estimates. BPM6 presentation. Projections. (Percent of GDP) (Billions of euros). ### Table 4. Italy: Financial Soundness Indicators, 2017–22 (selected rows) - Regulatory capital to risk-weighted assets: 16.716.117.219.318.819.2 - Regulatory tier 1 capital to risk-weighted assets: 14.313.914.916.916.516.7 - Nonperforming loans net of provisions to capital: 58.040.129.620.216.513.8 - Nonperforming loans to total gross loans: 14.48.46.74.43.32.8 - Growth of bank loans to private non-MFI 2/: 1.82.10.24.72.12.0 - Nonfinancial corporations: 0.21.4-1.98.41.7-0.4 - Households: 2.82.82.62.33.73.3 - Return on assets: 0.60.50.40.10.40.7 - Return on equity: 7.56.15.10.96.07.5 - Interest margin to gross income: 48.249.648.249.546.451.5 - Liquid assets to total assets: 17.316.114.621.323.118.3 - Customer deposits to total (noninterbank) loans: 69.167.975.168.590.678.1 - Foreign-currency-denominated loans to total loans: 8.68.17.86.37.16.9 Notes: 1/ Data from the IMF Financial Soundness Indicators database have been updated, when possible, with Bank of Italy's or ECB's data. 2/ Data are from Bank of Italy. (Percent, unless otherwise noted). ### Table 5. Italy: Monetary Survey, 2017-22 (selected rows) - Net foreign assets (Billions of euros): 162176232240282298 - Claims on Nonresidents: 279298324337388411 - Liabilities to Nonresidents: 1171229296106113 - Net domestic assets: 299129963050326333503342 - Claims on General Govt: 95510101058126113591257 - Claims on Other Sectors: 203619861992200219912085 - Claims on Private Sector: 142713821351140614321450 - Broad money: 164316841781197021182098 - Currency Issued: 181191194218236241 - Demand deposits: 107711321220137315111488 - Other Deposits: 374358360374367366 - Secs Other than Shares: 1136454 Notes: Sources: IMF, Monetary and Financial Statistics; and Bank of Italy. Note: data is based on Euro Area residency reporting format. 1/ 2022Q3 data are latest available. (Billions of euros). *Source: IMF staff estimates and figures/tables as presented in the source content.* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### Global Risks — Key Risks, Impact, and Policy Responses - Intensification of regional conflicts - Relative Likelihood: High - Impact If Realized: High. Negative energy, food and tourism shocks would impede the recovery. A severe output contraction would intensify sovereign-bank-corporate feedback channels, resulting in lower loan quality—including publicly-guaranteed loans—and raising funding costs for banks and the sovereign. - Policy Responses: - Allow the existing means-tested citizenship income program and the short-time work scheme to provide an automatic income backstop for those facing job and income loss. - Provide additional temporary and targeted support to the most vulnerable households and viable firms alongside incentives for conservation if needed. - Continue efforts to diversify energy sources. - Abrupt global slowdown or recession - Relative Likelihood: Medium - Impact If Realized: High. Disruptions will adversely affect the profitability of firms by leading to market share loss, preventing firms from capitalizing on strong market demand due to unavailability of products, and increased costs. Funding will become more expensive. Disruptions can also negatively impact the productivity, utilization of assets, and tourism arrivals. - Policy Responses: - Allow the existing means-tested citizenship income program and the short-time work scheme to provide an automatic income backstop for those facing job and income loss. - Promote high-quality public investment in infrastructure that facilitates global trade, such as ports, and information technology. - Advance structural reforms to maximize efficiency and competitiveness. - Social discontent - Relative Likelihood: High - Impact If Realized: Medium. An inadequate policy response and weak global economy lead to higher unemployment and poverty. - Policy Responses: - Extend targeted social spending and unemployment support according to need. - Facilitate structural reforms to boost future productivity and income growth. - Commodity price volatility - Relative Likelihood: Medium - Impact If Realized: High. Could lead to second-round inflationary effects through wage contract negotiations; negatively impact business confidence, leading to lower investment and damage productivity growth. These effects can increase public discontent and loss in social cohesion, jeopardizing political stability. - Policy Responses: - Provide well-targeted support to avoid excessive volatility in energy prices. - Promote investment in innovative energy systems. - Monetary policy miscalibration - Relative Likelihood: Medium - Impact If Realized: Medium. Pass-through from prices to wages has been limited, as collective agreements exclude import prices. - Policy Responses: - Keep the public debt ratio on a firmly downward path through greater spending efficiency and a comprehensive tax reform to reduce domestic demand pressures and support the ECB in containing inflation. - Support vulnerable households. - Systemic financial instability - Relative Likelihood: Medium - Impact If Realized: High. Sharply higher sovereign borrowing costs and a shift in risk sentiment lead to bond repricing and financial tightening, a reduction of credit growth and further strains on leveraged corporates and households. Insolvencies increase, resulting in rapid deterioration of bank balance sheets and profitability. Tightening of financial conditions lead to housing market corrections. Sovereign spreads increase, raising concerns over fiscal sustainability. - Policy Responses: - Ensure strong coordination between the ECB and the BdI on financial stability risks. - Rely on bank resolution systems to address unsound banks. - Implement a credible medium-term strategy to anchor public debt reduction. - Monitor the quality of publicly guaranteed loans. - Allow automatic stabilizers to operate and provide temporary support to vulnerable households. - Deepening geo-economic fragmentation - Relative Likelihood: High - Impact If Realized: Medium. In the near term, escalating geopolitical tensions could undermine growth both directly and through adverse confidence effects and financial market volatility. In the medium term, deglobalization can give rise to reshoring and less trade, reducing potential growth. - Policy Responses: - Continue support for the multilateral rules-based trading system, and advocate trade liberalization. - Ensure cooperation within EU and avoid retaliatory policies. - Safeguard energy security by accelerating the green transition. - Cyberthreats - Relative Likelihood: Medium - Impact If Realized: Medium. Digitalization of the Italian economy is low but cyberattacks could still impair the functioning of the financial system and the economy. - Policy Responses: - Raise awareness and enhance monitoring of cyberthreats. - Urge businesses/institutions to have robust cyber defenses and business continuity plan. - As per FSAP recommendations, increase the Bank of Italy’s resources and activities on IT and cyber risk. - Extreme climate events - Relative Likelihood: Medium - Impact If Realized: Medium. Climate-related losses could reduce real GDP and increase fiscal costs. EU members may receive migrants from economies facing severe climate disruptions. - Policy Responses: - Leverage EU funds to make infrastructure more resilient to natural disasters. - Work with EU partners on region-wide response to migration. ### Domestic Risks — Key Risks, Impact, and Policy Responses - Inefficient or partial absorption of NextGenerationEU (NGEU) resources and incomplete structural reform - Relative Likelihood: Medium - Impact If Realized: High. High quality public investment together with comprehensive structural reforms in the NRRP would boost medium-term output and potential growth by enhancing the productive capacity of the economy. - Policy Responses: - Promote high-quality public investment in digitization, green infrastructure, and education and innovation. - Adopt comprehensive structural reforms to raise productivity. - Ineffective tax reform - Relative Likelihood: High - Impact If Realized: High. Concerns about Italy’s fiscal sustainability would jump, raising funding costs for the public and private sectors. - Policy Responses: - Ensure reforms are guided by the principles of reducing complexity, broadening the tax base, and lowering marginal tax rates in a revenue-neutral way. - Reduce tax expenditures. - Continue improving tax compliance. - Failure to put public debt firmly on a downward path - Relative Likelihood: Medium - Impact If Realized: High. With already elevated public debt and gross financing needs, any macro-financial shock would increase Italy’s already high borrowing costs, potentially triggering the need for a sharp fiscal adjustment. It could also lead to financing constraints for banks and a credit crunch. - Policy Responses: - Implement a more ambitious fiscal adjustment starting in 2023. - Implement comprehensive fiscal and structural reforms to secure a stable source of revenues and lift potential growth. - Realization of financial sector vulnerabilities - Relative Likelihood: Medium - Impact If Realized: High. Monetary tightening leads to deterioration in asset quality and valuation, and liquidity shortfalls. A shift in market perception undermines Italy’s ability to roll over and service debt, and adversity affecting the banking system. - Policy Responses: - Ensure strong coordination between the ECB and BdI on financial stability risks. - Rely on bank resolution systems to address unsound banks. - Allow automatic stabilizers to operate and provide temporary support to vulnerable households. ### External Sector Assessment — Findings, Metrics, and Policy Responses - Overall assessment - The external position in 2022 was weaker than the level implied by medium-term fundamentals and desirable policies. Uncertainty for the 2022 CA gap assessment is heightened by the lack of clarity about the perceived persistence of the very large negative energy terms of trade shock. - Key drivers in 2022: decline in current account balance largely due to a temporary increase in the gas import bill; decline in private sector saving net of investment while government saving net of investment remained broadly unchanged; household saving net of investment dropped by about 4 percentage points of GDP as the saving rate normalized from its COVID-19-era high. - Potential Policy Responses: - Raise productivity and improve the business climate through structural reforms to encourage higher private investment and normalization of the household saving rate. - Implement high-quality fiscal consolidation measures to ensure the fiscal primary balance returns firmly to surplus. - Upskill the workforce and increase the quality of infrastructure and the effectiveness of the judiciary and public administration. - Improve budget efficiency, contain pension spending, undertake comprehensive and progressive tax reform, and fully implement the National Recovery and Resilience Plan. - Foreign asset and liability position and trajectory (2022) - NIIP: 3.9 percent of GDP - Gross Assets: 174.3 percent of GDP - Debt Assets: 41.3 percent of GDP - Gross Liab.: 170.5 percent of GDP - Debt Liab.: 92.2 percent of GDP - Background and Assessment: - NIIP declined to 3.9 percent of GDP at the end of 2022 due to net valuation losses (3.2 percent of GDP) and the first CA deficit in a decade. - TARGET2 liabilities reached a record high of 36 percent of GDP. - About half of gross external liabilities correspond to the general government and the Bank of Italy. - Further strengthening public balance sheets and undertaking structural reforms would lessen vulnerabilities associated with high public debt and reinvigorate growth. - Current Account (2022) - 2022 (% GDP) CA: –1.2 - Cycl. Adj. CA: 0.6 - EBA Norm: 3.4 - EBA Gap: –2.9 - COVID-19 Adj.: 0.4 - Other Adj.: 0.0 - Staff Gap: –2.5 - Background and Assessment: - The CA averaged 3.0 percent of GDP during 2016–21 and dropped sharply in 2022 by 4.3 percentage points to –1.2 percent of GDP, mainly due to a 3.3 percent of GDP increase in the energy trade deficit as terms of trade worsened by 8.5 percent. - The cyclically adjusted CA is estimated at 0.6 percent of GDP for 2022, 2.9 percentage points below the EBA-estimated CA norm of 3.4 percent of GDP. - Taking adjustments into account, the IMF staff assesses the CA gap to be in the range of –3.2 to –1.8 percent of GDP, with a midpoint of –2.5 percent of GDP. - The fiscal policy gap (–1.5 percent of GDP) contributed substantially to the total policy gap (–1.0 percent of GDP). - Real Exchange Rate (REER) - Background: - During 2016–21, CPI-based REER depreciated by 0.4 percent; ULC-based REER depreciated by 1.8 percent. - During 2022, CPI-based REER depreciated by 2 percent relative to the 2021 average. - As of April 2023, CPI-based REER appreciated by 2.8 percent relative to the 2022 average. - Assessment: - The IMF staff CA gap implies a REER gap of 9.3 percent in 2022 (with an estimated elasticity of 0.27 applied). - The level and index CPI-based REER models suggest an overvaluation in 2022 of 15.4 percent and 12.3 percent, respectively, with an average of 13.9 percent. - Based on the IMF staff CA gap, the staff assesses a REER gap to be in the range of 6.5 to 12.0 percent, with a midpoint of 9.3 percent. - Capital and Financial Accounts; FX Intervention and Reserves - Capital account balance: 0.0 percent of GDP in 2022. - Financial account: net inflows of 0.8 percent of GDP in 2022, reflecting residents’ net acquisition of foreign liabilities. - Large portfolio investment outflows were more than offset by inflows of other investment, including a nearly €60 billion increase in Italy’s TARGET2 liabilities. - Assessment: - Central banks’ monetary policy tightening has pushed up yields in the sovereign debt market. - Large refinancing needs of the sovereign and the banking sector, elevated inflation, and exposures to geopolitical tensions and energy shocks suggest Italy remains vulnerable to market volatility. - FX Intervention and Reserves: - Background: the euro has the status of a global reserve currency. Italy’s reserves remained largely unchanged in 2022. - Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is freely floating. *Source: Annex I. Risk Assessment Matrix (Italy), IMF staff.* ### Annex IV. Progress on Past IMF Recommendations ### Annex IV. Progress on Past IMF Recommendations ### I. Fiscal Policy — Fiscal Adjustment and Quality of Fiscal Policy - Recommendation: Very high public debt and rising borrowing costs call for accelerating potential growth and steadily—but decisively—raising the primary balance, underpinned by structural reforms and rationalizing spending. Carve out room for public investment by growing primary current spending, including tax expenditure, consistently below nominal GDP growth. - Authorities' action: The April 2023 Document on Economy and Finance envisages a gradual path of fiscal consolidation toward achieving a 2 percent primary surplus in 2026. No underlying structural measures have been identified to support adjustment. - Recommendation: Improve the design of the citizenship income program and adapt it to the cost of living in various parts of the country. - Authorities' action: The citizenship income program is being phased out and is being replaced by a dual program: family assistance for low-income families with children and those unable to work, and worker training and temporary benefits for those able to work. - Recommendation: Improve capital spending, the quality of projects, and fully implement the NRRP. - Authorities' action: Capital spending will be raised significantly during 2023–26 under the NRRP and to alleviate bottlenecks, a new procurement code seeks to enhance competition and transparency, including through centralized purchasing. - Recommendation: Lower the subsidy rate on Superbonus tax credits, improve controls on approvals and phase out the scheme. - Authorities' action: The authorities lowered the subsidy rate in 2023 from 110 percent to 90 percent, and a further reduction to 65 percent is expected in 2024. In addition, tax credits are no longer transferable, reducing the attractiveness of the scheme. - Recommendation: Undertake a comprehensive tax reform to broaden the tax base, lower statutory tax rates, and help fight evasion while preserving progressivity and revenue neutrality. - Authorities' action: The government introduced a proposal for a comprehensive reform of the tax system, which is now being prepared. The proposals aim to lower the tax burden and strengthen the economy’s supply side by encouraging investment, innovation, and employment. ### II. Energy Policy - Recommendation: Compensation for high energy bills should be temporary, target vulnerable households and viable firms, and high wholesale prices should be passed through to end users to encourage conservation. - Authorities' action: The energy compensation measures are being phased out given the moderating energy prices. Measures have become more targeted, and with larger passthrough to end-user prices. However there is room to improve targeting of remaining measures. - Recommendation: To accelerate the green transition, energy taxes should be based on their carbon content and equated across energy sources, while incentives for green investments should be made more cost effective. - Authorities' action: The superbonus scheme on energy-efficiency of buildings will expire at end-2025, and subsidy rates will continue to decline in the interim. New guarantees may be used to support investment needs, including those related to the green transition. Energy efficiency mandates, including minimum cooling and maximum heating settings, have been successful in encouraging conservation. ### III. Financial Stability - Recommendation: Maintain bank lending and liquidity support to the real economy; any new guaranteed loan scheme should be selective, and banks should retain a sizable share of the credit risk. Guarantee coverage rates should be reduced. - Authorities' action: The COVID-era public guarantee schemes were phased out; legislative loan moratoria for firms expired. A new targeted public guarantee scheme for energy was introduced but its use has been limited so far. - Recommendation: Enhance banks’ asset quality, credit risk management, and business models; banks should prepare for severe downside scenarios and temporary capital conservation may be required in specific instances. - Authorities' action: The authorities are monitoring banks’ capital and liquidity plans. Recent harmonization of the framework for covered bonds with EU standards provides banks an additional source of long-term funding. - Recommendation: Address distressed banks by continuing to identify weak banks alongside further consolidation of the sector. - Authorities' action: Assessments of banks’ business models have identified a limited number of smaller banks with serious weaknesses. Where needed, early intervention measures and orderly exits from the market were adopted. Consolidation slowed down. ### IV. Structural Reforms - Public administration - Recommendation: Streamline debt resolution procedures to reduce debt overhangs, release trapped capital and attract new investment. Modernize public administration to efficiently execute public investment and reinforce Italy’s governance framework to strengthen the financial integrity of NRRP resources. - Authorities' action: Legislation and implementation frameworks to support the execution of public administration reforms under the NRRP were adopted. Progress has been made with reforms to modernize public administration. To accelerate NRRP implementation, oversight of the Plan has been shifted from the Ministry of Finance to the Prime Minister’s office. - Insolvency and judicial reforms - Recommendation: Integrate the newly introduced out-of-court restructuring procedure into the new Insolvency Code. Additional court resources should help timely resolution of cases. Relax the design of the early warning mechanisms by removing mandatory insolvency triggers. Monitor the effectiveness of the new legal framework for insolvency and debt enforcement, as well as progress with reducing the backlog of court cases. - Authorities' action: Provisions of the new Insolvency Code, including an out-of-court mechanism of negotiated restructuring, are available for creditors and debtors. The revised provisions of the Insolvency Code amended the early warning mechanism, providing for its voluntary use and removing the mandatory nature of the distress triggers. The authorities are monitoring the effectiveness of the new legal frameworks for insolvency and debt enforcement. As part of the NRRP, progress has been made with reforms to modernize judiciary and simplify civil procedures. - Labor markets - Recommendation: Avoid welfare dependence and disincentives to work by offering job suitable openings and training opportunities, and withdrawing benefits gradually as earned income rises. - Authorities' action: The citizenship income program has been split into two parts; for those able to work, a benefit for up to 8 months is available, conditional on participating in training, while benefits are discontinued if a job offer is refused. Those unable to work or with dependent children are eligible for permanent benefits on a means-tested basis. NRRP reforms seek to address some of the labor market’s structural challenges through vocational training, adult learning, and strengthening of work-based training. - Product markets/competition - Recommendation: Strengthen competition to improve the business environment, efficiently execute public investment, as well as building growth-enhancing infrastructure and institutions. - Authorities' action: In the NRRP, the authorities have committed to streamline product market regulation and review the Competition Law annually. *Annex IV. Progress on Past IMF Recommendations (1itaea2023001).* ### Annex V. Implementation of Key 2020 FSAP Recommendations ### Annex V. Implementation of Key 2020 FSAP Recommendations ### Bank Supervision and Regulation and NPL Resolution - Enhance banks’ capital levels to ensure adequate capital ratios under stress scenarios. - In 2022 Pillar 2 Guidance (P2G) continued to increase; over 2020-2022 the P2G more than doubled. - BdI introduced a new approach for determination of the P2G for LSI banks linking buckets of P2G to supervisory stress test results and ICAAP, compliant with CRR/CRD, EBA Guidelines on SREP, and SSM methodology. - The new approach and stress test severity produced a significant increase of the average P2G for LSIs with new capital decisions in 2021; same approach applied in SREP 2022. - Authorities requested a prudent approach for dividend distributions from 2019 to 2021, strengthening capital ratios. - Agency: Bank of Italy (BdI), SSM. Time: ST. - Consider more timely escalation of corrective measures for weak banks (governance, capital, consolidation, orderly wind-downs). - Horizontal analyses post-pandemic updated to prioritize banks by riskiness using central credit register and sample analysis of moratoria exposures, deriving an "adjusted NPL” stock and applying BdI benchmark coverage ratios and stress-test capital impacts. - Third-strand analysis estimated restructuring costs (reduction in extra staff) to reach efficiency of most virtuous banks; aggregated findings used to cluster riskiest banks and better target supervisory interventions. - A limited number of small banks with serious weaknesses identified: in one case early intervention adopted; others resolved or turnaround projects started, some involving third-party investors under assessment. - A dedicated "Sector" created in 2022 within Banking Supervision 2 Directorate to focus supervisory activity on weak banks and turn-around initiatives. - BdI implemented an Early Intervention framework since 2018 supported by an IT tool (periodically back-tested; thresholds annually calibrated and further adjusted post-pandemic) and recently refined to provide a more holistic picture (credit risk, business model sustainability). - BdI achieved compliance with EBA GL 2021/11 on recovery indicators in February 2022 through new provisions on recovery plans to shorten activation time, ensure timely notification of breaches, and increase monitoring frequency. - Agency: BdI. Time: ST. - Perform more periodic deep dives and thematic/targeted inspections on LSI weaknesses (governance, credit risk, business models). - End-2022 requests to LSIs for comprehensive updated strategic and funding plans over a two years’ horizon to assess business model drivers and LTRO reimbursement funding solutions. - Off-site: increased intrusion on governance; thematic review concluded on governance systems of LSIs focusing on Management Board in supervisory functions (MBSF) composition and functioning, leveraging documents and interviews, with benchmarking and recommendations communicated for supervisory follow-up. - On-site: continued inspections driven by risk exposure, size and complexity via SREP; focus on credit risk, internal control, risk management, business model and profitability. Full-scope inspections remain suitable for LSIs; targeted/thematic inspections increased for larger LSIs. - For 2023, five inspections planned: four thematic on liquidity risks and one targeted on internal governance. - BdI calibrated planning selection criteria from 2020 to better focus on supervised institution riskiness. - Agency: BdI. Time: ST. - Continue scrutinizing credit risk, loan classification, provisioning, and NPL reduction plans. - BdI continued scrutiny via horizontal analyses (e.g., NPL plans) and bank-specific off-site/on-site work; credit risk practices remain main area in inspections. - Thematic campaign on servicers and investment firms assessed capacity to manage securitized NPL portfolios; OSI methodology improved in 2022 to reflect IFRS9 and securitization best practices. - Horizontal analysis on unlikely-to-pay exposures identified best practices disclosed on BdI website. - Intensified supervision of entities active in servicing activities with supervisory meetings and planned on-site inspections; communication to banking and financial servicers in November (year not specified) to highlight sector risks and recommendations. - Analyses of funds investing in loans: interviews with active managers, questionnaire, and targeted inspections launched to improve supervision of servicers, specialized asset management companies, and managed funds. - Agency: BdI, SSM. Time: C. - Consider extending SSM bank-specific expectations for gradual provisioning on existing NPL stocks to LSIs and update LSI NPL guidance. - Full compliance with EBA Guidelines on NPE management (EBA/GL/2018/06) attained by replacing national GL issued in 2018; slightly increased number of banks subject to stricter monitoring. - SREP methodology defines supervisory proxies to calculate a P2R and a P2G add-on to cover under-provisioning risk in normal and stressed conditions, considering vintage, IFRS staging, secured/unsecured status. - Updated methodology for P2G and P2R calculation and subsequent supervisory action yielded significant results in coverage and workout of NPL legacies, though ECB calendar approach not extended to existing NPL stock in LSIs’ portfolios. - Agency: BdI. Time: I. - Amend relevant laws to confer BdI and IVASS authority on removal of authorization and winding-up of banks and insurers. - Current framework: Ministry involvement in initiation of resolution/liquidation occurs only based on BdI proposal and is argued not to affect BdI operational independence; Minister’s involvement provides shield from social/political pressures and responsibility-sharing. - Insurance: Art. 240 of Italian Insurance Code requires authorization withdrawal by decree of the Minister of Economic Development upon IVASS proposal; withdrawal for all classes leads to immediate compulsory winding up. - Agencies: MEF, MISE. Time: ST. - Address gaps in governance regulations for banks and insurers by issuing draft MEF and MISE decrees. - Decree setting suitability requirements for banks’ board members and key function holders entered into force on January 30, 2020 (ministerial decree no. 169/2020) and aligns with CRD and ESMA/EBA Joint Guidelines. - BdI adopted an ad hoc Regulation on May 4, 2021, complementing Consolidated Law on Banking for suitability assessment. - IVASS provided technical contribution to MISE for fit and proper regulation under art. 76 of the Italian Insurance Code and proposed coordinated drafting for qualifying shareholders in insurance companies implementing art. 77. - Agencies: MEF, MISE, IVASS, BdI. Time: I. ### Macroprudential Policies and Framework - Establish a national macroprudential policy authority with a leading role for BdI. - Legislative proposal (schema di decreto legislativo) to establish the national macroprudential authority, drafted under Law 127/2022 (Art. 6) in cooperation with Competent Authorities, currently under Government evaluation. - Proposal included in “DDL Delegazione Europea” (DDL 2481) and under evaluation by relevant Parliament Commissions. - Agencies: MEF, IVASS, BdI, CONSOB. Time: ST. - Incorporate the Systemic Risk Buffer (SyRB) and borrower-based tools into the macroprudential toolkit. - February 2022: SyRB and borrower-based measures incorporated into BdI’s macroprudential toolkit via revision of Circular n. 285. - Agencies: MEF, BdI. Time: ST. - Consider implementing prudential policies to moderate the sovereign-bank nexus with an appropriate phase-in period. - No actions planned beyond regular monitoring; view expressed that national-level action in euro area/EU is not advisable and political discussions on completing banking union continue. - Agency: BdI. Time: MT. ### Insolvency Framework - Enhance enforcement and insolvency framework; ensure courts have sufficient resources and specialization for timely handling of insolvency cases. - New Insolvency Code relaxed early warning mechanism (voluntary use; removed mandatory distress triggers) and provides wide range of restructuring tools including “composizione negoziata”. - August 2021 decree law 118/2021 introduced framework to enhance out-of-court workouts (negotiated workout). - Legislative decree 14/2019 (bankruptcy code), as amended to implement EU preventative restructuring directive, will enter into force in July 2022. - Since January 2022, art. 35-ter of law 233/2021 requires judges handling bankruptcy proceedings to undertake professional courses to enhance technical specialization, particularly in smaller courts; new code strengthens bankruptcy professionals’ appointment and training requirements. - Agencies: MoJ, NJC. Time: ST. ### Reinforcing Crisis Management and Safety Nets - Establish additional loss-absorbing capacity to enable greater loss allocation to unsecured and uninsured creditors in resolution/liquidation, notably for LSIs; strictly limit public funds use to exceptional events undermining system-wide stability. - Resolution planning progressed significantly; a resolution plan drafted for all Italian LSIs, updated annually or every 2 years (simplified cases). - Binding MREL targets set according to BRRD2: equal to loss absorption amount where liquidation preferred; may include recapitalization amount and market confidence charge where resolution preferred. BdI assesses whether to limit MREL to loss-absorption considering financial stability and contagion risk; transitional periods envisaged where needed. - For LSIs whose failure could present systemic risks, resolution identified as preferred strategy; resolvability assessments expanded in line with EBA and SRB guidance, with three-year phase-in for completing analyses and necessary steps to ensure full resolvability. - Comprehensive Manual for crisis management and resolution finalized November 2020 and periodically updated; BdI participated in an EU-level dry-run in 2021 testing Resolution College procedures. - BdI view: use of public funds limited to exceptional events per EU regulations, but such events need not be restricted to system-wide impacts and could include regional or multi-regional events with deep financial-stability and real-economy impacts. - Agencies: BdI, MEF. Time: ST. - Reinforce DGS governance, assess adequacy of funding targets, strengthen backstops, and avoid use of public funds where possible. - FITD promoted and BdI approved by-law amendment strengthening independence of FITD Chair and introducing independence of one Board member; further increases of independence to be discussed. - Decree of Italian Minister of Finance n. 169/2020 applies fit and proper requirements to DGS per proportionality principle. - Current funding target: 0.8% of covered deposits (minimum under DGSD); resources collected align with funding path to meet target at end of transitional period; raising target unilaterally could create level-playing-field issues across Europe. - FITD has a funding agreement (€3.5 bn) with a pool of major banks to activate if available financial means (AFM) insufficient; loan repaid with recoveries, AFM, or extraordinary contributions and repaid gradually to avoid adverse effects on banking system profitability. - A credit line agreement is to be finalized for FGDCC with parent companies of two cooperative banking groups and the Institutional Protection Scheme managing institution. - Agencies: DGS, BdI, MEF. Time: ST. - Avoid using DGS resources for failure prevention outside resolution/liquidation except in exceptional cases with strong prospects for successful rehabilitation. - BdI disagrees with blanket avoidance; Italian preventive interventions over last 20 years have been successful and are envisaged by EU legislation and IADI Core Principles. - BdI and FITD agree preventive interventions should be used only with strong prospects for successful rehabilitation and long-term viability; 2021 FITD by-law amendment moved in this direction. - Likelihood of DGS intervention for cooperative banks may be reduced after set-up of two cooperative banking groups and Institutional Protection Scheme. - Agency: BdI. Time: ST. *Prepared based on the inputs from the Italian authorities.* ### Annex VI. The Bank of Italy’s Profits and Consolidated Public ### Annex VI. The Bank of Italy’s Profits and Consolidated Public Sector Considerations ### Balance sheet expansion and drivers - Pandemic-related monetary stimulus programs caused the BdI’s balance sheet to expand significantly. - Drivers of the expansion: - Increase in securities holdings under ECB asset purchase programs. - Subsidized funding-for-lending to banks (TLTROs). - Aggregate change: - Total assets jumped by 50 percent from 2019 to 2021 before retreating slightly at end-2022 owing to partial TLTRO repayments by banks. - Funding composition on the liabilities side: - Asset acquisition was largely funded by an increase in reserves and TARGET 2 liabilities. - Accounting note: - All balance sheet items associated with monetary policy operations are recorded at amortized cost. ### Profit evolution and composition - Profit developments: - BdI net profit declined from €5.9bn in 2021 to €2.1bn in 2022. - The decline reflected mainly write-downs and the increase in interest payments while interest rates on assets were broadly unchanged. - Relevant accounting mechanics: - With securities recorded at amortized cost, no valuation change is recorded if they are held to maturity. - Pooling of net interest payments and receipts on TARGET 2 balances net out and do not impact central bank profit. ### 2023–24 outlook, zero-profit rate, and buffers - Staff estimates and expectations: - The BdI expects further deterioration in net interest income to lead to losses in 2023-24, which can be fully covered by accumulated reserves. - Based on the end-2022 balance sheet, staff estimates a zero-profit policy rate of 2.5 percent, against the current policy rate of 3.5 percent, and with higher rates lowering profits. - Balance sheet dynamics affecting income: - Banks’ repayments of TLTROs will shrink both sides of the BdI’s balance sheet, with little net effect on income as the TLTRO interest rate is indexed to the rate paid on reserves. - Reinvestment of maturing fixed income securities will likely result in higher coupon rates than those on maturing securities, adding to net interest income. - This reinvestment effect could gradually dominate medium-term evolution of BdI net interest income, as three quarters of the securities held for monetary policy purposes have residual maturities beyond 2 years. - Capital and provisions: - The BdI has total equity of €26.3 bn in 2022, equivalent to 1.8 percent to total assets (€1.48 trillion). - Some €35bn in general risk provisions accumulated from past profits is available to cover any future losses. ### Consolidated public sector (CPS) implications - Impact on transfers and consolidated perspective: - Lower profit or a shift to losses could reduce transfers to the government; for 2022, the transfer is announced to decline to €1.7bn. - Round tripping of payments and receipts within the consolidated public sector (general government and central bank; CPS) reduces the fiscal impact: the general government pays interest to the BdI on its sovereign bond portfolio while transferring part of its profit—and also taxes—back to the government, helping reduce the effective interest bill. - Liability maturity and interest-rate sensitivity in CPS: - Netting out government bonds held by the BdI yields a CPS balance sheet where liabilities have a much shorter duration than general government debt. - About 50 percent of GDP in CPS liabilities relate to BdI floating-rate liabilities in the form of bank reserves and TARGET 2 balances. - Nearly 40 percent of government debt outside the BdI has less than one-year residual maturity or is at variable rates. - Consequently, about 100 percent of GDP in CPS liabilities carry interest rates that could reset each year or more frequently. *Source: Annex VI. The Bank of Italy’s Profits and Consolidated Public Sector Considerations.* ### 6. Italy has further taken measures to address the new and emerging risks stemming from ### 1itaea2023001 - 6. Italy has further taken measures to address the new and emerging risks stemming from ### Virtual assets and AML/CFT measures - Pursuant to the MEF Decree from January 13, 2022, all virtual assets service providers (VASPs) need to register with the Organismo Agenti e Mediatori (OAM) to legally operate in Italy. - VASPs operating in Italy are subject to the Italian AML/CTF legislation and must put in place all the arrangements, procedures, and controls necessary to ensure compliance. - Policy recommendation / supervisory priority: - Ensure effective enforcement of the registration requirement. - Put in place effective supervisory mechanisms in terms the applicable AML/CFT controls. ### Fund relations and membership status (key figures) - Membership Status: Joined March 27, 1947; Article VIII. - Quota: 15,070.00 - Fund holdings of currency: 10,849.75 72.00 - Reserve Tranche Position: 4,220.34 28.00 - New arrangements to borrow: 39.89 - SDR Department net cumulative allocation: 21,020.03 100.00 - SDR Department holdings: 21,862.15 104.01 - Projected Obligations to Fund (charges/interest, SDR million; forthcoming years): - 2023: 0.28 - 2024: 0.28 - 2025: 0.28 - 2026: 0.28 - 2027: 0.28 - Exchange rate arrangements: The currency of Italy is the euro. The exchange rate arrangement of the euro area is free floating. Italy participates in a currency union (EMU) with 19 other members of the EU and has no separate legal tender. ### Statistical framework and data adequacy - General assessment: Data provision is adequate for surveillance; economic and financial statistics are comprehensive and of generally high quality. - Standards and reporting: - Italy has adopted the European System of Accounts 2010 (ESA2010). - Italy subscribes to the Special Data Dissemination Standard (SDDS) since 1996 and adhered to SDDS Plus in 2015. - The ECB reporting framework is used for monetary statistics; data are reported to the IMF through a “gateway” arrangement with the ECB. - The Bank of Italy adopted BPM6 standards in the second half of 2014 for BOP and IIP data. - Italy reports IRFCL data and participates in CDIS and CPIS. - Identified improvements needed: - Further consideration for quarterly national accounts treatment of changes in inventories, currently derived as a residual and lumped with the statistical discrepancy. - Component details on stock positions in assets and liabilities by counterparty sector are not available in government finance statistics. - Further progress likely on reporting frequency of Financial Soundness Indicators. ### Financial sector and FSI reporting - Italy participates in IMF Financial Soundness Indicators (FSIs): - Reports all of the 12 core FSIs and 11 of the 13 encouraged FSIs for deposit takers semi-annually to the IMF and quarterly on their National Summary Data Page. - In addition, 12 FSIs for other sectors are compiled and reported. - FSI reporting is timely. ### Table of common indicators (selected entries and dates as of July 06, 2023) - Exchange Rates: Date of latest observation: Jul 06, 2023; Date received: Jun 06, 2023; Frequency: D (Daily) - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation: Apr 2023; Date received: Jun 2023; Frequency: M (Monthly) - Reserve/Base Money: Apr 2023; Jun 2023; M M M - Broad Money: Apr 2023; Jun 2023; M M M - Central Bank Balance Sheet: Apr 2023; Jun 2023; M M M - Consolidated Balance Sheet of the Banking System: Apr 2023; Jun 2023; M M M - Interest Rates: Date of latest observation: Jul 06, 2023; Date received: Jul 06, 2023; Frequency: D D D - Consumer Price Index: Jun 2023; Jul 2022; M M M - Revenue, Expenditure, Balance and Composition of Financing—General Government: Apr 2023; Jun 2023; M M M - GDP/GNP: Q1:2023; May 2023; Q Q Q - Gross External Debt: Q1:2023; Jun 2023; Q Q Q - International Investment Position: Q1:2023; Jun 2023; Q Q Q ### Macroeconomic developments and outlook (authorities’ statement, July 17, 2023) - Authorities’ objectives and priorities: - Continue improving public finances by steadily reducing the public deficit- and debt-to-GDP ratios and phasing out measures adopted in response to the energy crisis. - Increase Italy’s potential growth through effective implementation of the National Recovery and Resilience Plan (NRRP), focusing on decarbonization, digitalization, infrastructure, sustainable mobility, education, health, cohesion, and social inclusion. - The NRRP implementation rate has largely proceeded in line with plans; some fine-tuning is ongoing. - Recent performance and outlook: - The economy continued to grow at a brisk pace in 2022 despite headwinds (energy crisis, high and rising inflation, tightening financial conditions). - GDP growth in 2022 was mainly driven by the recovery in the services sector and the expansion of household consumption. - Even modest growth outturns in the remaining quarters of 2023 would be enough to beat the official growth projection of 1.0 per cent for the whole 2023 set in the 2023 Economic and Financial Document. - Staff’s projection: 1.1 percent (noted as marginally higher than the official one). - Inflation and wages: - Headline inflation peaked in late 2022 but has since come down sizably; core inflation has been more persistent but has shown signs of moderation more recently. - No indication of a wage-price spiral to date because of Italy’s institutional framework that relies on a benchmark for social partners’ wage negotiations based on an independent projection elaborated by ISTAT. - Authorities expect some pick up in wage developments this year followed by a rapid moderation in 2024. *Prepared By European Department (In consultation with other departments); July 6, 2023 / Statement by Mr. Giammusso July 17, 2023.* ### 23.5 million, the number of persons employed is at a historic high, driven notably by the ### 1itaea2023001 - 23.5 million, the number of persons employed is at a historic high, driven notably by the ### Labor market and growth outlook - 23.5 million, the number of persons employed, is at a historic high, driven notably by the robust labor demand from the construction and the services sectors. - The participation rate has exceeded the pre-COVID level while the unemployment rate has continued along a downward trend; productivity also posted moderate gains in 2022. - Authorities view risks to the outlook as somewhat more balanced rather than skewed on the downside as assessed by staff and agree that tourism is an upside risk. - Staff’s trend growth for Italy’s economy has been marginally upgraded to an annual average of 0.9 percent for the 2014-2019 period. - Staff’s growth outlook for Italy has been improved twice since the start of this year. - Authorities underline prudence of official growth and fiscal projections, noting they only marginally incorporate the effects on productivity and labor supply associated with the implementation of the NRRP in the growth estimates. ### Public finances - The pandemic caused a rise in Italy’s public debt ratio of 20 percentage points of GDP; half of that increase has already been reversed in 2021 and 2022. - Authorities are fully committed to: - steadily bringing the public debt-to-GDP ratio back to pre-pandemic levels by 2030 that, in staff’s projections, seems an achievable target already in 2028; - further reducing the deficit-to-GDP ratio; - gradually rebuilding a primary balance surplus of 2 percent of GDP by 2026. - Fiscal support to moderate the impact of energy price shocks has become smaller over time and better focused on vulnerable households, with about a 60 percent rate of closely targeted measures currently. - Public resources allocated to mitigate the energy shock have been more than halved, down from 2.8 per cent of GDP in 2022 to 1.2 percent this year and will be phased out in 2024-2025. - The tax credit “Superbonus” for residential buildings has been markedly reduced this year in consideration of its large impact on public finances; authorities intend to comprehensively review all tax credits that support buildings’ efficiency also considering distributional impacts. - Social policy reform: the citizens’ income has been abolished as of January 1st, 2024, and replaced by two measures: - Inclusion cheques reserved for those who must care for underage, elder, or disabled family members; - Aid to vocational training to provide stronger incentives to job participation, reserved to unemployed people who are both ineligible for Inclusion cheques and actively looking for a job. - Despite tightening financial conditions, the increase in Italy’s public interest bill as a share of GDP is expected to remain contained over the medium term aided by the long average maturity of public debt which stood at 7.7 years at end 2022. - Since last October, the spread of Italy’s government bonds has gradually tightened, moving from 250 bps to around 170 bps. - Italian retail domestic investors have shown a strong appetite for domestic government bonds and there seems to be room to increase the share of public debt held by the household sector. - On new Fund sovereign risk and debt sustainability analysis: authorities agree staff’s assessment that Italy’s overall risk of sovereign stress is “moderate” but disagree with staff’s characterization that it is “on the borderline” and “sensitive to small policy deviations”, arguing these judgments are not adequately corroborated by evidence and that mitigating factors could have been better reflected. ### Banking sector - The financial situation of the Italian banking system is sound overall: banks are well capitalized, liquid, and profitable. - Profitability rose significantly in 2022 and is expected to remain positive in 2023; the ROE for significant institutions was 13.5 percent in March 2023. - Capital adequacy is above pre-pandemic levels (decreased slightly in March 2023 for significant institutions, to 15.4 percent, but still above pre-pandemic levels). - Assets eligible as collateral for Eurosystem refinancing operations continue to be widely available. - The Italian banking system was barely hit by bank failures in some jurisdictions in March-April 2023 owing to limited direct exposures. - Asset quality shows no signs of worsening so far: - In 2022, around €20 billion in NPLs were sold, contributing to a further decline of the NPL ratio, net of loan loss provisions, slightly down to 1.5 per cent (the figure was 1.1 per cent in March 2023 for significant institutions). - Stability reflects a decade-long process of cleaning up balance sheets, improving efficiency, and strengthening corporate governance and internal controls, supported by European regulatory reforms and rigorous supervision. - Reforms for less significant institutions include phased changes to popolari banks and cooperative credit banks; the Bank of Italy raised Pillar 2 capital requirements and is focusing on business model sustainability and risks, including technological innovation impacts. - Main risks to banks: - global geopolitical uncertainty; - cyclical slowdown; - medium-term effects of increased interest rates on customers’ ability to service debts. - Rising interest rates have caused the value of portfolio securities to fall; unrealized losses on securities banks plan to hold until maturity are estimated to have an average impact of 200 basis point on the CET1 ratio, materializing only if banks are forced to sell before maturity. - Less than 2 per cent of these unrealized losses are currently accounted for by banks with a relatively low liquidity coverage ratio. - Eurosystem asset-backed refinancing mechanisms lower the probability that banks will have to liquidate portfolio securities before maturity. - Upward pressures on the cost of funds may arise from replacing funding from TLTRO III and issuing MREL-compliant instruments; expected impact on profitability is assumed manageable. - Repayment to the ECB of TLTRO funds is not expected to be a source of material stress due to large liquidity buffers and a large amount of unencumbered high-quality collateral. - Banks’ market valuations have remained favorable, with declining Credit Default Swaps prices. - Households and non-financial firms have relatively robust financial positions and moderate debt-to-GDP ratios in international comparison. - Italy’s residential sector does not show significant imbalances: house prices have shown only modest gains and recent increases in prices and purchase volumes have come to a halt. - Commercial real estate experienced smaller price increases than in other countries; supervisory authority is monitoring bank exposures closely. ### External sector - Italy’s 2022 current account recorded a deficit of 1.3 percent of GDP, the first in a decade, largely due to a significant deterioration in the energy trade balance (over 5 percent of GDP) following Russia’s war of aggression against Ukraine. - Italy’s export market shares and competitiveness trends have performed well over recent years. - The return of Italy’s current account to a surplus position of about 1 percent of GDP has already materialized in early 2023; official forecasts project sustained improvements towards pre-crisis surplus levels as the energy price shock has reversed and global energy prices are back to 2021 levels. - Authorities disagree with staff’s assessment that Italy’s external position in 2022 was “weaker than the level implied by medium-term fundamentals and desirable policies”, arguing the position is “broadly in line with fundamentals and desirable policies” once adjustments reflect the exceptional and temporary energy crisis. - Fund’s External Sector Assessment model estimates a current account norm at 3.4 percent of GDP for Italy, which authorities consider very high and distant from other methodologies (e.g., European Commission) that evaluate a current account norm for Italy less than half of staff’s norm. - Assessment should consider historically large surpluses in the capital account driven by Next Generation EU (NGEU) transfers in 2022 (0.5 percentage points of GDP based on the most recently available data) and in following years until 2026; these transfers temporarily increase imports via the investment channel but represent additional resources mainly recorded in the capital account and boost productivity in the medium term. ### Conclusions and NRRP implementation - Italy has continued to navigate a series of shocks and difficult policy trade-offs during uncertain times; economic growth has recovered strongly and better than in previous downturn episodes. - The new Government has adopted a prudent and consistent fiscal stance aimed at ensuring public debt sustainability and contributing to keeping inflation on a downward path. - The financial sector is healthy, has sustained the economic recovery, and is in stronger conditions to withstand adverse shocks than in the past. - The NRRP is an opportunity; its effective and timely implementation will contribute to improving medium-term growth, employment, and social inclusion. - Italy is proceeding with NRRP implementation despite unpredictable macroeconomic developments. Dialogue with the European Commission on the third payment request assessment process has continued and is nearing completion. - For the fourth tranche, Italy submitted a request to the European Commission to amend a specific set of milestones and targets to incorporate objective circumstances related to disruptions to global supply chains and high inflation due to Russia’s war; authorities are confident to complete this process shortly. *Source: 1itaea2023001 - 23.5 million, the number of persons employed is at a historic high, driven notably by the (PDF).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1itaea2023001.pdf_