## _cr0544 ## Source details **Canonical URL:** [_cr0544](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0544.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0544.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0544.pdf.json) --- ### Macroeconomic outlook and cyclical outlook - A cyclical recovery is underway but pace expected to remain moderate; growth projected to recover only to potential in 2005. - Staff growth forecasts: - 2004: 1.5 percent - 2005: 1.7 percent - Authorities' 2005 growth projection: 2.1 percent. - Growth averaged 1.7 percent over the last decade. - External sector: - Staff expects a positive net external contribution in 2004–05 on the order of ¾ percent (based on results through Q3 2004). - Risks to growth judged on the downside (mainly oil prices and the exchange rate): - Staff estimates a $6 per barrel rise in oil prices would increase the oil import bill by about 0.3 percent of GDP and reduce growth by about half that much. - Inflation and output gap: - Large output gap estimated at about 1½ percent of GDP. - Twelve-month harmonized inflation fell to 2 percent in November. - Consensus forecasts projected inflation at some 2.2 percent in 2005. - Labor costs per worker rose by 2.8 percent year-on-year in Q2 2004. ### Growth trends and productivity - Potential growth estimated at 1¾ percent (authorities and staff). - Italy’s poor growth performance largely attributable to total factor productivity (TFP) developments: - Labor market reforms increased hours worked, but TFP has barely risen. - Scale and duration of decline in TFP growth have eroded much of the gain from increased labor. - Policy implication: - Raising potential growth requires measures to further increase the employment ratio and boost productivity. ### Fiscal stance, composition, and short-term assessment - Fiscal situation described as weak: - Deficit close to the SGP ceiling despite substantial one-off measures. - Debt ratio continues to exceed 100 percent of GDP. - 2004 assessment: - Primary surplus estimated to have fallen to about 2¼ percent of GDP, 3 percent of GDP below the 1995–98 average. - One-off measures likely fell by more than ½ percent of GDP but still amounted to almost 1½ percent of GDP. - Structural deficit net of one-offs estimated to have declined by less than ½ percent of GDP (remaining more than ½ percent of GDP above its 2000 level). - Structural deficit likely actually increased by ¼ percentage point of GDP. - Large gap between public sector borrowing requirement (net of privatization) and the SGP deficit averaged more than 1½ percent of GDP since 1999. - 2005 budget (targets and composition): - Headline and structural deficits targeted to decline by 0.2 percent of GDP (headline deficit at 2.7 percent of GDP). - One-off measures down by 0.4 percentage point of GDP—from 1.4 percent of GDP in 2004 to 1 percent in 2005. - Structural deficit net of one-offs would fall by 0.6 percent of GDP, to 3.0 percent. - Revenue ratio targeted to decline by about 0.8 percent of GDP; staff estimates decline in the tax ratio at about 0.3 percent of GDP. - Corporate tax burden reduction estimated at 0.04 percent of GDP. - Spending ratio targeted to fall by about 1 percent of GDP; nominal spending growth capped at 2 percent (with exclusions). - Staff critique and risk assessment: - Staff judged 2005 adjustment too small; viewed measures likely insufficient—by 0.4 percent of GDP, and possibly more—to achieve the announced deficit target. - Using staff’s lower growth projection, revenues would fall short by about 0.2 percent of GDP. - Budget assumed transfer of ANAS out of the public sector, taking about 0.2 percent of GDP in investment expenditures off-budget; ANAS continued to receive sizable transfers to cover operating deficits (on the order of €0.7 billion annually). - Altogether, deficit at unchanged policies likely to rise to at least 3.1 percent of GDP. - Additional risk: effectiveness of constraints on regional and local governments’ spending, particularly health spending fully devolved to subnational governments. - Authorities’ stance: - Believed risks manageable; did not adopt staff’s call for additional measures of about ½ percent of GDP. - Expected ANAS treatment to be accepted and new controls on subnational spending to prevent overruns; signaled readiness to introduce measures if necessary. ### Medium-term issues: pensions, aging, and required consolidation - Pension reform: - Framework law (August 2004) raises effective retirement age starting in 2008; allows development of fully-funded private pension system by allowing workers to opt out of mandatory severance/retirement payment scheme (TFR). - Statutory retirement age 65 for men; those with 35 years’ contributions eligible at 57. In 2008 minimum age rises to 60 (61 for self-employed), with one additional year added in 2010 and 2014. - For 2004–07, workers eligible at 57 who defer retirement receive employer’s and employee’s social security contributions free of income taxes, raising incomes by about one third. - Authorities estimate long-term financial savings peak at about 0.7 percent of GDP by the middle of the 2010s, decline gradually to zero by 2040, and become moderately negative thereafter. - Age-related spending projections: - Population aging expected to increase annual pension spending by about 2 percent of GDP over the coming decades. - Annual health spending expected to rise by some 3 percent of GDP according to staff estimates. - Staff medium-term recommendations: - Fully implement pension reform measures already legislated (including issuing implementation decrees for the 2004 reform and updating pension replacement rates in line with life expectancy every decade). - Move to a small fiscal surplus in the coming years, with no one-off measures. - Achieving a small surplus by 2009 would imply average annual reductions in the structural deficit net of one-offs of at least ¾ percent of GDP over the next five years. - Combined with major privatization efforts envisaged by government, this would allow the debt ratio to decline and then stabilize below 50 percent over time. ### Fiscal sustainability framework, baseline and scenarios - Baseline projection assumptions (Box 5): - Uses adjustment path in the 2005 budget; thereafter revenue and non-age-related spending ratios kept constant. - Health and pension spending reflect ISTAT demographic projections and pension reforms since mid-1990s, including mid-2004. - Assumes labor productivity growth rises gradually to 1½ percent annually (from 0.8 percent average over last 10 years). - Assumes further gains in the employment ratio (by 5 percentage points over 20 years). - These assumptions result in long-run annual growth of about 1 percent. - Baseline outcomes: - Fiscal deficit would decline through 2010 but rise thereafter due to increased age-related spending and later interest payments. - Debt ratio would bottom out in 2025 at about 65 percent and increase thereafter. - Adjustment scenario: - Spending cuts sufficient to achieve a small surplus would alter the path (details in Box 5). - Stress-test scenarios and outcomes: - (i) Slower long-term productivity growth (1¼ percent): even in the adjustment scenario this leads to a rising debt ratio in the long term. - (ii) Slower population growth (Eurostat projections, with lower immigration rates): leads to upward-trending debt dynamics even in the adjustment scenario. - (iii) Lack of structural fiscal adjustment over the next four years: leads to a debt/GDP ratio above 200 percent. - (iv) More optimistic productivity growth scenario based on authorities’ assumptions: debt stock falls to 20 percent of GDP by 2050. - (v) Failure to implement scheduled adjustments in pension replacement rates in line with life expectancy: adverse fiscal outcomes. - Specific stress-test (Table 6 scenarios, selected outcomes): - Baseline public debt/GDP path: 1999: 115.5; 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004: 105.8; 2005: 104.4; 2006: 104.1; 2007: 103.8; 2008: 104.7; 2009: 105.7. - Scenario: real interest rate shock (avg+2 sd) yields debt/GDP rising to 117.6 by 2011. - Scenario: real GDP growth shock (avg−2 sd) yields debt/GDP rising to 111.6 by 2011. - Combination of shocks (one sd) yields debt/GDP 114.2 by 2011. - Scenario: If debt ratio in 2005 rises by (additional) 10 percent of GDP (others at baseline), reported debt ratio sequence: 106.2 105.8 114.4 114.2 114.0 115.0 116.1. ### Fiscal transparency, accounting gaps, and privatization strategy - Persistent gap: - Over 1999–2003 the annual cash-based borrowing requirement net of privatization receipts (PSBR) exceeded the accrual-based SGP deficit by over 1½ percent of GDP on average. - Box 6 contributors to the gap: - Financial transactions affecting PSBR but not SGP deficit; timing, recording, valuation differences between cash and accrual accounting. - Cash-accrual differences explain most of the 1 percent of GDP increase since 1998. - Specific drivers: accelerated refunds of direct and indirect taxes; payments of health spending arrears; 2003 tax amnesty effects; persistent delay in payment of social security contributions about 0.2 percent of GDP annually. - Privatization and debt-reduction strategy: - Authorities’ plan includes receipts of €100 billion (1.7 percent of cumulative GDP) from below-the-line transactions planned for 2005-08, starting with about €30 billion (2.1 percent of GDP) in 2005. - Above-the-line revenues of €7 billion in 2005 (including from sale of part of the road network; buyer compensated with annual budgetary transfers in lieu of toll payments). - Staff caution: sale-leasebacks, securitizations, and sales with compensating transfers reduce debt ratio but increase future spending or reduce future revenues; need transparent assessment. ### Labor market, product markets, and competitiveness - Labor market developments: - Reforms since the 1990s liberalized part-time and fixed-term contracts, employment agencies, and discouraged early retirement. - Unemployment rate fell to 8.1 percent in 2004:Q3 (seasonally adjusted), about ¾ percentage point below the euro area average. - Employment ratio remained the lowest in the euro area. - South/Center-North relative per capita income rose from about 56 percent in 1995 to 60 percent in 2003. - Product-market and business environment constraints: - Electricity costs 35–40 percent above neighboring countries. - Time to enforce contracts is seven times the average for the rest of the euro area. - Costs of opening and closing businesses well above euro area average. - Transparency International: perception of corruption second-highest in the euro area; 41 countries perceived as less corrupt than Italy. - EC’s 2004 European Summary Innovation Index: Italy ranked fifth lowest among the EU15. - Reform progress: - Progress increasing competition in the energy sector; sale of sizable portion of ENEL; planned privatization/merger activity (Terna/GRTN). - Limited progress in retail trade liberalization due to local government inaction. - Anti-trust authority successes but concerns about enforcement powers and sanctioning capacity. - Bankruptcy law reform delayed; draft law pending to simplify procedures and accelerate firm closure. ### Financial sector assessment and vulnerabilities - Banking sector: - Return on equity expected to rebound to close to 10 percent for the system and to 11 percent for the six largest banking groups. - Capital-adequacy ratio about 11 percent in mid-2004, above the Basel minimum. - Nonperforming loan (NPL) levels remained relatively high despite improvements (nonperforming loans to total gross loans: 2004 H1: 6.7 percent). - Banking system consolidation: number of banks fell by one-third since 1990; number of branches increased about 80 percent. - Six major banks ROE about 13 percent; whole system ROE 11 percent (June 2004). - Accounting and regulatory changes: - Transition to International Financial Reporting Standards in 2005 expected to induce some balance-sheet restatements and possible write-downs of NPLs. - Uncertainty about impact of Basel II: capital requirements may fall for good clients and rise for bad ones; potential implications for lending to smaller enterprises. - FSAP findings: - First FSAP mission gave positive assessment: market regulation and supervision comparable to other G7 countries; securities settlement and clearing systems safe and efficient. - Weaknesses in CONSOB: lack of financial resources, insufficient independence in imposing penalties, limitations on sanctions; draft market abuse law aims to strengthen CONSOB’s powers. - Directors recommended prompt passage of post-Parmalat reforms and measures to strengthen corporate governance (e.g., consider majority independent directors, minority shareholder representation). ### External sector, trade, and ODA - Exports and competitiveness: - Exports of textiles and leather goods (accounting for almost one-sixth of exports in 2003) fell by about 4 percent in volume terms in H1 2004 versus H1 2003. - Italy’s export market shares performed poorly even vis-à-vis other large euro-area countries. - Trade policy and quotas: - Authorities developing program with EC to monitor effects on Italian firms of elimination of textile export quotas under the Multi-Fiber Agreement. - Authorities committed to resist demands for protection and safeguard clauses until data evaluation. - Official development assistance: - ODA rose in 2004 to 0.22 percent of GDP (from 0.19 percent in 2003). - Authorities intend to increase ODA to 0.33 percent of GDP by 2006. ### Judicial system, bankruptcy procedures, and regional issues - Judicial system: - Excessive length and costs of bankruptcy procedures negatively affect firm turnover, resource reallocation, and access to finance. - Draft law on bankruptcy reform under discussion after government maxiemendamento in late December 2004; aims to significantly simplify procedures. - Recent steps: 2003 judicial offices specialized in industrial and property rights litigation; 2004 special procedure for company litigation introduced and reduced settlement time in these matters. - Southern Italy and wage differentiation: - South recorded higher average GDP growth over last eight years on a per capita basis; capital accumulation in South rose relative to Center-North. - Staff suggests wage differentiation could boost growth and employment in the South, with caveats on fiscal federalism and potential wage pressures in the North. - Proposal: public sector to lead by example with regionally differentiated wages, contingent on clarity of fiscal federalism implications. ### Key tables and selected indicators (exact series and values as presented) - Real GDP (change in percent): 1999: 1.7; 2000: 3.0; 2001: 1.8; 2002: 0.4; 2003: 0.3; 2004: 1.5; 1/2005: 1.7 - General government balance (percent of GDP): 1999: -1.7; 2000: -0.6; 2001: -2.6; 2002: -2.3; 2003: -2.4; 2004: -2.9; 2005: -3.1 - Primary balance (percent of GDP): 1999: 5.0; 2000: 4.6; 2001: 3.9; 2002: 3.5; 2003: 2.9; 2004: 2.3; 2005 Est./Proj.: 2.0 - General government debt (percent of GDP): 1999: 115.5; 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004: 105.8; 1/2005: 104.4 - Public debt (in billions of euros): 1999: 1,273; 2000: 1,297; 2001: 1,348; 2002: 1,361; 2003: 1,382; 2004: 1,432; 2005 Est./Proj.: 1,469 - Net imports of crude oil & natural gas (in bln. of U.S. dollars): 1999: 13.6; 2000: 24.4; 2001: 22.7; 2002: 21.7; 2003: 27.7; 2004: 35.5; 1/2005: 36.0 - Nonperforming loans to total gross loans (percent): 1999: 9.8; 2000: 7.8; 2001: 6.7; 2002: 6.5; 2003: 6.6; 2004 H1: 6.7 - Total one-off measures (in percent of GDP): 2000: 0.7; 2001: 0.8; 2002: 1.5; 2003: 2.1; 2004: 1.4; 2005: 1.0 ### IMF staff appraisal and key policy recommendations (timelines where given) - Overall assessment: - Near-term prospects improving but medium-term outlook weak absent credible fiscal consolidation and significant further reforms. - Deficit targets missed for four consecutive years; fiscal pressures to grow with aging. - Priority policy recommendations and timelines: - Move the budget to a small surplus over the coming years; achieving a small surplus by 2009 while eliminating one-off measures judged broadly appropriate. - Enact legislation necessary to implement the pension reform during 2005, and apply in 2005 the first required adjustments to pension replacement rates in line with changes in life expectancy. - Be prepared to adopt structural measures in 2005 to ensure the 2005 target is met; if growth is slower than consensus estimate of 1.7 percent, allow automatic stabilizers to operate. - Focus additional measures on reducing the ratio of primary current spending to GDP; target current spending and incorporate the uniform cap on spending growth into multiyear spending reviews. - Assess privatization and asset-sale transactions (including securitization, sale and lease-back of buildings, sale of part of the road network) transparently because of potential negative implications for future budgets. - Improve fiscal transparency; explore the large gap between deficits and borrowing requirements and monitor operations of public entities outside general government transparently. - Continue reforms to reduce labor market rigidities and unlock stagnant productivity: - Consider basing public sector wage increases in part on regional price indexes once available. - Approve the second stage of the Biagi Reform. - Tackle product market reforms with same resolve as labor market reforms: - Additional regulatory reform and further privatization in key network industries like energy. - Consider strengthening powers of the anti-trust authority. - Reform bankruptcy legislation without further delay and accelerate legal processes. - Passage of post-Parmalat reforms should be a priority to strengthen securities regulation and corporate governance. *Source: _cr0544 (IMF staff report and related documents, February 2005).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Macroeconomic outlook and cyclical outlook - A cyclical recovery is underway but its pace is expected to remain moderate; growth is projected to recover only to potential in 2005. - Staff growth forecasts: - 2004: 1.5 percent - 2005: 1.7 percent - Authorities' 2005 growth projection: 2.1 percent. - Growth has averaged 1.7 percent over the last decade. - External sector: - Improved external sector performance contributed to the recovery. - Based on results through the third quarter of 2004, staff expects a positive net external contribution in 2004–05 on the order of ¾ percent. - Risks to growth are judged to be on the downside (mainly oil prices and the exchange rate). - Staff estimates a $6 per barrel rise in oil prices would lead to an increase in the oil import bill of about 0.3 percent of GDP and reduce growth by about half that much. - Inflation and output gap: - The large output gap is estimated at about 1½ percent of GDP. - Twelve-month harmonized inflation had fallen to 2 percent in November. - Consensus forecasts projected inflation at some 2.2 percent in 2005. - Labor costs per worker rose by 2.8 percent year-on-year in Q2 of 2004. ### Growth trends and productivity - Potential growth is estimated at 1¾ percent (authorities and staff). - Italy’s poor growth performance over the last decade is largely attributable to total factor productivity (TFP) developments: - Labor market reforms increased hours worked, but TFP has barely risen. - The scale and duration of the decline in TFP growth have eroded much of the gain from increased labor. - Policy implication: Raising potential growth will require measures to further increase the employment ratio and boost productivity. ### Fiscal stance and sustainability - The fiscal situation remains weak: - The deficit is close to the SGP ceiling despite substantial one-off measures. - The debt ratio continues to exceed 100 percent of GDP. - Fiscal pressures are likely to rise over the coming years due to population aging. - Staff view a faster pace of fiscal consolidation than planned by the authorities as essential. - On 2005 fiscal strategy: - The fiscal adjustment envisaged by the authorities for 2005 is judged too small, particularly given limited progress in recent years. - Staff and authorities agreed on the need to eliminate the deficit, phase-out one-off measures, and reduce the tax burden in the coming years, but disagreed on relative priorities. - Staff argued that deficit-reduction and elimination of one-off measures should have priority over tax cuts, primarily because tax cuts would have little impact if not seen as sustainable. - There is a significant risk that the fiscal targets will be overshot in 2005; authorities should stand ready to introduce additional measures if necessary. ### Labor market, product market, and competitiveness - Labor force participation rates have risen steadily over the last decade, and labor market reforms have led to a steady increase in hours worked. - Productivity has been stagnant, underscoring the need for structural reforms to enhance product market competition and improve the business environment. - Competitiveness and structural issues: - Real exchange rate indicators have appreciated in recent years; unit labor costs rose particularly rapidly, reflecting poor productivity performance. - Exports of textiles and leather goods (which in 2003 accounted for almost one-sixth of exports) fell by about 4 percent in volume terms during the first half of 2004 compared to the same period of 2003. - Italy’s export market shares performed poorly even vis-à-vis other large euro-area countries. - Product market reform progress: - Progress was being made in increasing competition in the energy sector. - Reform was blocked by vested interests in other areas, notably wholesale and retail trade and professional services. - Efforts to improve the business environment continue; lengthy legal proceedings and high costs of opening and closing businesses are particularly problematic. - Passage of a modern bankruptcy law has been delayed further. ### Financial sector and other policy recommendations - The financial system was found to be resilient: - Banking system profitability is improving. - The first stage of the FSAP assessment of Italy gave a positive assessment of financial sector developments. - Priority recommendations: - Passage of “post-Parmalat” reforms to strengthen securities regulation should be a priority. - The staff urged Italy to increase its level of official development assistance. - The staff called on the authorities to resist pressures for increased trade protection following the elimination of textile export quotas. *Executive Summary — IMF* ### 11. Slow growth was generally attributed to ### _cr0544 - 11. Slow growth was generally attributed to ### Growth constraints: pan-European, Italy-specific, and political obstacles - Pan-European aspects: - High taxation and uncertainty about fiscal sustainability constrained incentives to innovate. - Remaining labor market rigidities slowed firms’ responses to structural changes. - Europe in general—including Italy—had not fully realized the benefits of the technological revolution of the 1990s. - Italy-specific factors: - Small size of Italian firms and associated limited R&D spending. - Concentration in low value-added sectors. - Historical weakness of the South. - Faster aging of Italy’s population. - Labor market rigidities: insufficient wage differentiation, remaining constraints on labor mobility, and the high tax wedge. - Product market rigidities, including inadequate competition, more severe in Italy than elsewhere. - Slow legal system and generally less favorable business climate than other advanced economies. - Obstacles to reform: - Opposition from special interests and lack of consensus for systemic reform. - Trade unions and some academics disputed negative effects of high taxes and public spending, citing Nordic countries. - Some government representatives argued public spending cuts were limited without major downsizing of the welfare state. - Staff noted the absence of consensus for systemic reforms and pointed to disciplinary aspects of Nordic welfare states and rising primary spending in Italy over the past five years. ### Fiscal policy developments and 2004 assessment - Overall assessment for 2004: - Limited progress in strengthening public finances; missed deficit targets, declining primary surpluses, extensive reliance on one-off measures, and little reduction in the debt ratio. - Mid-year corrective package apparently sufficient to keep the deficit below 3 percent of GDP, but 2004 was the fourth consecutive year headline deficit exceeded original budget target. - Key fiscal figures and staff findings: - The primary surplus is estimated to have fallen to about 2¼ percent of GDP, 3 percent of GDP below the 1995–98 average. - One-off measures likely fell by more than ½ percent of GDP, but still amounted to almost 1½ percent of GDP. - Structural deficit net of one-offs is estimated to have declined by less than ½ percent of GDP (remaining more than ½ percent of GDP above its 2000 level). - The structural deficit likely actually increased by ¼ percentage point of GDP. - The large gap between the public sector borrowing requirement (net of privatization) and the SGP deficit has averaged more than 1½ percent of GDP since 1999. - Other observations: - The decline in the debt ratio was muted by the gap between borrowing requirement and the SGP deficit. - Staff regretted limited measures to contain net spending, including raising user fees, cutting transfers to enterprises, and containing the public sector wage bill; public sector wages increased in excess of private sector wages and employment. ### 2005 budget: targets, composition, and staff appraisal - Budget targets and composition: - The 2005 budget targets only modest reductions in the deficit and one-off measures, partly to implement a cut in personal income taxes. - Headline and structural deficits targeted to decline by 0.2 percent of GDP (headline deficit at 2.7 percent of GDP). - One-off measures down by 0.4 percentage point of GDP—from 1.4 percent of GDP in 2004 to 1 percent in 2005. - Structural deficit net of one-offs would fall by 0.6 percent of GDP, to 3.0 percent. - Revenue ratio targeted to decline by about 0.8 percent of GDP; staff estimates the decline in the tax ratio at about 0.3 percent of GDP. - The “solidarity contribution” of 4 percent applies to the highest-income taxpayers; elimination after 2005 as proposed would widen impact. - The reform reduces the number of tax brackets from five to three (with a “solidarity contribution” effectively establishing a fourth bracket) and increases exemption levels; includes corporate tax burden reduction estimated at 0.04 percent of GDP. - Spending ratio targeted to fall by about 1 percent of GDP, largely due to a 2 percent cap on growth of nominal spending (with some exclusions, notably on social transfers); health subject to an even tighter ceiling (from a base in 2004 inflated by payment of wage arrears). - Cuts expected to be achieved primarily by improving spending efficiency, not by cutting entitlements. - Staff critique and risks: - Staff argued a faster improvement than envisaged in the 2005 budget was necessary; fiscal position still far from appropriate for a high-debt country. - Standard and Poor’s had downgraded Italian debt earlier in 2004. - Staff emphasized tax cuts could stimulate supply side only if pursued with sufficient progress in fiscal consolidation and seen as sustainable. - Staff viewed measures taken as likely to be insufficient—by 0.4 percent of GDP, and possibly more—to achieve the announced deficit target: - Using staff’s lower growth projection, revenues would fall short by about 0.2 percent of GDP. - Budget assumed transfer of ANAS out of the public sector, taking about 0.2 percent of GDP in investment expenditures off-budget; ANAS continued to receive sizable transfers to cover operating deficits (on the order of €0.7 billion annually). - Staff skeptical that “shadow tolls” would meet classification requirements or affect underlying fiscal position. - Altogether, deficit at unchanged policies likely to rise to at least 3.1 percent of GDP. - Additional hard-to-quantify risk: effectiveness of constraints on spending by regional and local governments, particularly health spending fully devolved to subnational governments. - Staff recommended prompt action to offset slippage during budget implementation and introduction of measures if needed to ensure compliance with the SGP ceiling. - Authorities’ stance: - Authorities believed risks manageable and did not adopt staff’s call for additional measures of about ½ percent of GDP. - They regarded revenue projections as conservative, expected ANAS treatment to be accepted, and believed new controls on subnational spending would prevent overruns. - Authorities indicated willingness to introduce measures if needed to ensure compliance with the SGP ceiling. ### Medium-term issues: pensions, aging, and required fiscal consolidation - Pension reform and age-related spending: - New pension reform raises effective retirement age starting in 2008; reform expected to have an important effect on medium-term spending trends. - Population aging expected to increase annual pension spending by about 2 percent of GDP over the coming decades. - Annual health spending expected to rise by some 3 percent of GDP according to staff estimates. - Box 4 (Pension Reform) key points: - Framework law (August 2004) offers temporary fiscal incentives to delay retirement and from 2008 raises effective retirement age; furthers development of fully-funded private pension system by allowing workers to opt out of mandatory severance/retirement payment scheme (TFR). - Statutory retirement age 65 for men; those with 35 years’ contributions eligible at 57. In 2008 minimum age rises to 60 (61 for self-employed), with one additional year added in 2010 and 2014. - Women with 35 years’ contributions continue eligible at 57 but with reduced benefits; men and women with at least 40 years’ contributions remain able to retire at any age. - For 2004–07, workers eligible at 57 who defer retirement receive employer’s and employee’s social security contributions free of income taxes, raising incomes by about one third. - Authorities estimate long-term financial savings peak at about 0.7 percent of GDP by the middle of the 2010s, decline gradually to zero by 2040, and become moderately negative thereafter. - Staff medium-term recommendations: - Fully implement pension reform measures already legislated (including issuing implementation decrees for the 2004 reform and updating pension replacement rates in line with life expectancy every decade, as required by the 1995 reform). - Move to a small fiscal surplus in the coming years, with no one-off measures. - Achieving a small surplus by 2009 would imply average annual reductions in the structural deficit net of one-offs of at least ¾ percent of GDP over the next five years. - Combined with major privatization efforts envisaged by government, this would allow the debt ratio to decline and then stabilize below 50 percent over time. ### Fiscal sustainability outlook and scenarios - Budget medium-term targets: - 2005 budget targeted deficit to fall only to 0.9 percent of GDP by 2008; no commitment to achieve balance or surplus within forecast horizon. - Authorities stated commitment to achieving at least overall balance in the longer term and that implementation decrees for the 2004 pension reform would be enacted in 2005. - Box 5 (Fiscal Sustainability) key assumptions and outcomes: - Baseline projection uses adjustment path in the 2005 budget; thereafter revenue and non-age-related spending ratios kept constant. - Health and pension spending reflect ISTAT demographic projections and pension reforms since mid-1990s, including mid-2004. - Assumes labor productivity growth rises gradually to 1½ percent annually (from 0.8 percent on average over the last 10 years). - Assumes further gains in the employment ratio (by 5 percentage points over 20 years). - These assumptions result in long-run annual growth of about 1 percent. - Under baseline, fiscal deficit would decline through 2010 but rise thereafter due to increased age-related spending and later interest payments. - Debt ratio would bottom out in 2025 at about 65 percent and increase thereafter. - Adjustment scenario (spending cuts sufficient to achieve a small surplus) would change this path (details in Box 5). *Source: _cr0544 - 11. Slow growth was generally attributed to* ### 2009. Thereafter, taxes and non aging-related spending are held constant as a percent ### _cr0544 - 2009. Thereafter, taxes and non aging-related spending are held constant as a percent ### Fiscal sustainability and stress-test findings - Baseline path: Savings on the interest bill finance the increase in aging-related spending; debt ratio falls to 45 percent by 2035 and then stabilizes. - Stress-test scenarios and outcomes: - (i) Slower long-term productivity growth (1¼ percent): even in the adjustment scenario this leads to a rising debt ratio in the long term. - (ii) Slower population growth (using Eurostat projections, with lower immigration rates): leads to upward-trending debt dynamics even in the adjustment scenario. - (iii) Lack of structural fiscal adjustment over the next four years: leads to a debt/GDP ratio above 200 percent. - (iv) More optimistic productivity growth scenario based on the authorities’ assumptions: debt stock falls to 20 percent of GDP by 2050. - (v) Failure to implement scheduled adjustments in pension replacement rates in line with life expectancy developments: adverse fiscal outcomes (upward pressure on debt). - Policy implication: results underscore the importance of reforms to increase potential growth, early action to address fiscal problems, and close monitoring given wide uncertainty. ### Fiscal transparency and borrowing requirement gap - Persistent gap: Over 1999–2003 the annual cash-based borrowing requirement net of privatization receipts (PSBR) exceeded the accrual-based SGP deficit by over 1½ percent of GDP on average. - Box 6—identified sources of the gap: - (i) Financial transactions affecting the PSBR but not the SGP deficit. - (ii) Sources of information: PSBR compiled by the Bank of Italy differing from that derived from government agencies. - (iii) Timing, recording, and valuation rules between cash and accrual accounting. - Quantified differences (1994–2003, in percent of GDP; averages reported): - Total Difference (annual series shown in text; averages): 1994-98 average and 1999-2003 average reported in table (values shown in source). - Difference in Sources (annual series shown in text; averages reported). - Impact of Financial Transactions (annual series shown in text; averages reported). - Cash versus Accrual Accounting (annual series shown in text; averages reported). - Explanations for increase since 1998 (cash vs accrual accounting explains most of the 1 percent of GDP increase): - Accelerated refunds of direct and indirect taxes. - Payments of health spending arrears. - 2003 tax amnesty lowered the deficit that year but some cash payments delayed to 2004. - Persistent delay in payment of social security contributions of about 0.2 percent of GDP annually (authorities argued could be structural). - Actions and constraints: - Authorities provided clarifications and data on taxes and health spending flows. - Regional devolution and institutional changes made adherence to ESA95 guidelines time-consuming and economic analysis difficult. - Comprehensive health sector data weaknesses hinder precise deficit accounting; a study group was working to address the issue. - A group was created to examine methodology for social security contributions. ### Privatization and debt-reduction strategy - Authorities’ plan features substantial privatization receipts and above-the-line revenues: - Receipts of €100 billion (1.7 percent of cumulative GDP) from below-the-line transactions planned for 2005-08, starting with about €30 billion (2.1 percent of GDP) in 2005. - Above-the-line revenues of €7 billion in 2005 (including from sale of part of the road network; buyer compensated with annual budgetary transfers in lieu of toll payments). - Transactions included: sales of equity in state-owned enterprises, disposal and possible lease-back of real estate, securitization of income streams, and other transactions. - Authorities assessed total value of public sector assets at well above 100 percent of GDP; significant share controlled by subnational governments—privatization outcomes depend on local/regional commitment. - Staff caution: some transactions (sale-leasebacks, securitization, sale of road network with compensating transfers) reduce the debt ratio but increase future spending or reduce future revenues; potential pressure on future budgets. ### Fiscal devolution and accounting reforms - Constitutional reform (approved late 2001) assigned legislative responsibilities across government levels; progress in implementation has been slow. - Successful implementation requires: transparency and stability of rules, sound monitoring mechanisms, credibility of enforcement. - Need to strengthen coordination of monitoring and enforcement to improve compliance and political ownership. - Pilot program: standardized reporting system for cash transactions of government units (SIOPE) to be implemented in 2005 — a step forward; further unification of accounting standards still needed. ### Labor market and employment developments - Reforms since the 1990s produced benefits: liberalization of part-time and fixed-term contracts, employment agencies, pension reforms to discourage early retirement, tax credits for permanent contracts (expired in 2003), wage moderation. - Employment outcomes: - Unemployment rate fell to 8.1 percent in 2004:Q3 (seasonally adjusted), about ¾ percentage point below the euro area average. - Employment ratio remained the lowest in the euro area. - South/Center-North relative per capita income rose from about 56 percent in 1995 to 60 percent in 2003. - Constraints and recommendations: - Regional disparities in unemployment remain substantial; decentralized wage bargaining could reduce imbalances. - Employers broadly supportive of greater wage differentiation but not a priority due to concerns about higher wages in the North. - Public sector could facilitate decentralization by revising pay scales based on regional cost of living indexes once available. - OECD: overall level of employment protection in Italy slightly below OECD average; further reform (“Biagi Reform” second stage) could yield employment gains. - Over the medium term, and with stronger fiscal accounts, reductions in the tax wedge (which significantly exceeds the OECD average) would contribute to employment gains. ### Product-market competition, innovation, and business environment - Competition problems impede investment, innovation, and efficiency: - Electricity costs 35–40 percent above neighboring countries (lack of competition; higher taxes and absence of lower-cost nuclear generation also contribute). - Barriers to entry by local governments impede competition in wholesale and retail trade. - Restrictions on provision of professional services under consumer-protection rationale increase costs. - Consequences: hampered consolidation, discouraged scale economies, risk-taking, private investment in technology and R&D (among lowest in OECD). - Innovation indicators: - Italy ranked fifth lowest among the EU15 in the EC’s 2004 European Summary Innovation Index. - Private R&D spending and related indicators shown in source charts. - Reform progress and limits: - Greater success in energy sector reform (sale of sizable portion of ENEL; encouragement of private investment in generation). - Limited progress in retail trade liberalization due to local government inaction. - Anti-trust authority had successes but concerns about adequacy of enforcement powers (cannot impose criminal penalties; fines based on turnover for professional associations are negligible). - Business environment diagnostics: - Time to enforce contracts is seven times the average for the rest of the euro area. - Costs of opening and closing a business well above euro area average. - Transparency International: perception of corruption second-highest in the euro area; 41 countries perceived as less corrupt than Italy. - World Economic Forum Global Competitiveness Report ranked Italy forty-seventh in supporting business-environment-driven growth. - Authorities’ view and measures: - Time to open a business reduced from 22 weeks to 6; financial costs for starting a business fallen by two-thirds. - Red-tape reduction and phasing out of “useless” codes are underway. - Legal system reforms: 12 new corporate tribunals created; bankruptcy law reform pending to create a Chapter-11-like process, accelerate firm closure, and strengthen lenders’ rights to stimulate credit to SMEs. Staff encouraged prompt approval. ### Financial sector evolution - Banking system changes over the last 15 years: - Number of banks fell by one-third since 1990 due to consolidation; number of branches increased by some 80 percent. - Banking system now essentially private; new firms entered leasing, factoring, and consumer credit markets. - Heightened competition evidenced by falling operational costs, increased productivity, and declining intermediation spreads. - Further competition potential and constraints: - Competition could be enhanced by increased involvement of foreign banks. - Cross-border mergers and acquisitions limited in continental Europe; analysts attribute this partly to opposition of domestic supervisory authorities. - Authorities concerned Italian banks face restrictions in expanding activities elsewhere. *Source: IMF document excerpt (provided content).* ### 31. Indicators of profitability and ### _cr0544 - 31. Indicators of profitability and ### Profitability and vulnerability of banks - Return on equity was expected to rebound to close to 10 percent for the system and to 11 percent for the six largest banking groups. - The capital-adequacy ratio, about 11 percent in mid-2004, remained comfortably above the Basel minimum. - Despite a significant improvement in loan quality in recent years, nonperforming loan (NPL) levels remained relatively high. ### Accounting standards, Basel II, and balance-sheet adjustments - Market participants expected some restatement of balance sheets with the transition to International Financial Reporting Standards in 2005. - Banks may need to write down the value of nonperforming loans; some banks were therefore already seeking capital injections. - The impact of the introduction of Basel II on bank capital and profits was uncertain: - Capital requirements would fall for good clients and rise for bad ones. - In principle, the new capital standards could induce banks to reduce lending to smaller enterprises. - Some very small firms would qualify for treatment as households under the new rules and thus be subject to more favorable accounting treatment. ### Pension reform, private saving, and corporate costs - Private sector representatives welcomed the stimulus to private retirement savings the recent pension reform would provide. - The scheme had the potential to increase private saving and accelerate the development of financial instruments to manage longevity and related risks. - Expectations were that at least initially few workers would opt to participate in private plans (other than union-managed occupational funds). - The reform would lead to small increases in costs for firms that had until now been using TRF contributions as a form of inexpensive internal financing. - It was expected that the public sector would compensate firms for these costs, although the 2005 budget contained no provision to do so. ### Corporate governance, market regulation, and post-Parmalat/Cirio responses - The authorities prepared a draft law on savings in response to the Parmalat and Cirio scandals, but passage had been delayed by political disagreements over some provisions. - To fast-track elements aimed at enhancing CONSOB’s powers, some measures were included in separate legislation incorporating the EU market abuse directive. - Proposed amendments to the remaining elements of the draft savings law (including transfer of insurance industry regulation to the Bank of Italy and shifting responsibility for banking system competition from the Bank to the anti-trust authority) left timing and final content uncertain. - Ex post analysis suggested financial intermediaries had sometimes marketed products without ensuring customers had full information on their risk profiles, highlighting the need to ensure observance of requirements in this area. - The draft legislation contained no provisions guaranteeing representation of minority shareholders in all listed companies’ corporate boards or requiring a majority of independent directors; the FSAP mission noted these measures could strengthen corporate governance standards. ### FSAP assessment and supervisory issues - The first of two FSAP missions, completed in early November, gave a positive assessment of financial sector developments. - It found standards of market regulation and supervision in Italy comparable with those of other G7 countries. - Compliance of securities regulation with the IMF’s transparency code was high. - Securities settlement and clearing systems were safe, sound and efficient. - Weaknesses identified in CONSOB included a lack of financial resources, insufficient independence from the Ministry of Finance in imposing penalties, and limitations on the sanctions it can impose; these issues were to be addressed by the draft law on market abuse. - The second FSAP mission was scheduled for late summer 2005. ### Other external and policy issues affecting the economy - Changes in EU trade policy and developments in the world trading system may significantly affect Italian agricultural and textile producers. - Authorities supported the recent revision of the EU’s Common Agricultural Policy for so-called Mediterranean products but looked forward to some rebalancing of the treatment of Mediterranean and Continental products. - Authorities were developing a program with the EC to monitor effects on Italian firms of the elimination of export quotas under the Multi-Fiber Agreement. - Authorities stated they would resist demands for protection and for implementing safeguard clauses until data could be evaluated. - Authorities expressed a desire to strengthen protection for intellectual property rights. - They hoped detailed modalities for the Doha Round of trade negotiations could be agreed at the next ministerial meeting in December 2005. ### Official development assistance and anti–money laundering measures - Official development assistance (ODA) rose in 2004—to 0.22 percent of GDP, compared to 0.19 percent in 2003—but remained low. - The authorities intend to increase ODA to 0.33 percent of GDP by 2006, in line with EU commitments. - The authorities supported the UK-sponsored initiative to create an International Finance Facility to increase development assistance. - In February the authorities issued a decree implementing the Second European Directive on Anti-Money Laundering/Combating the Financing of Terrorism. - They were participating in working groups on a third decree to implement additional Financial Action Task Force recommendations. - They were preparing a law to freeze nonfinancial assets of persons related to terrorist groups. ### Statistical and data issues - Only limited progress had been made in addressing statistical issues raised in the 2002 ROSC data module report (Appendix II). - Important steps had been taken to strengthen price collection and raise response rates on enterprise surveys. ### Staff appraisal: fiscal sustainability and reform priorities - Despite improving near-term prospects, Italy’s medium-term outlook remains weak absent a credible commitment to fiscal consolidation and significant further reforms. - The fiscal windfall that accompanied euro adoption was used to finance higher current spending, with the deficit now near the Maastricht ceiling—despite substantial one-off measures—and limited progress in lowering public debt. - Deficit targets had been missed for four consecutive years, and targets going forward had been revised downward. - Fiscal pressures are set to grow as population aging increases spending for health and pensions. - The 2004 pension reform improved the outlook, but much work remained to ensure long-term fiscal solvency. - Deep-seated rigidities in product and labor markets, and the poor business environment, have stifled investment and innovation, and, despite progress, retarded employment growth. Key policy recommendations and timelines: - Move the budget to a small surplus over the coming years; achieving a small surplus by 2009 while eliminating one-off measures was judged to broadly strike the right balance. - Enact legislation necessary to implement the pension reform during 2005, and apply in 2005 the first of the required adjustments to pension replacement rates in line with changes in life expectancy. - The fiscal adjustment envisioned in the 2005 budget fell short of what is needed; additional spending cuts should have been adopted, or the tax cuts deferred. - Be prepared to adopt structural measures in 2005 to at least ensure the 2005 target is met; however, should growth be slower than the consensus estimate of 1.7 percent, automatic stabilizers should be allowed to operate. - Focus additional measures on reducing the ratio of primary current spending to GDP; target current spending and incorporate the uniform cap on spending growth into a system of multiyear spending reviews. - Assess privatization and asset-sale transactions (including securitization of future income flows, sale and lease-back of buildings, and sale of part of the road network) transparently because of potential negative implications for future budgets. - Improve fiscal transparency; explore the large gap between deficits and borrowing requirements and monitor operations of public entities outside general government, notably Infrastrutture S.p.A., transparently. - Continue reforms to reduce labor market rigidities and unlock stagnant productivity: - Consider basing public sector wage increases in part on developments in regional price indexes once available. - Approve the second stage of the Biagi Reform to further reduce labor market rigidities. - Tackle product market reforms with the same resolve as labor market reforms: - Additional regulatory reform and further privatization in key network industries like energy. - Consider strengthening powers of the anti-trust authority. - Reform bankruptcy legislation without further delay; accelerate other legal processes and reduce red tape. - Passage of post-Parmalat reforms should be a priority: - The draft market abuse law gives CONSOB more resources, strengthens independence, and enhances sanctions. - Consider mandating that corporate boards contain a majority of independent directors and include a representative of minority shareholders. - Continue to resist pressures for increased trade protection; address concerns about textile quota expiration and intellectual property rights through existing multilateral and regional institutions. - Faster progress in addressing shortcomings noted in the ROSC data module would be welcome. *Source: _cr0544 - 31. Indicators of profitability and (PDF chapter).* ### 51. It is proposed that the next Article IV consultation take place on the standard ### _cr0544 - 51. It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### Article IV consultation timing - It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### Staff analytical work on Italy, 2000-04 - Fiscal Policy and Entitlement Programs: - Rules-Based Fiscal Policy in France, Germany, Italy and Spain. Occasional Paper No. 225 - Pension Reform Issues. Country Report No. 03/352 - Social Returns to Education: Evidence from Italian Local Labor Market Areas. WP/03/165 - Tax Reform in Italy. Country Report No. 02/232 - Redistribution Through Public Employment: The Case of Italy. IMF Staff Papers, December 2001. - Budgetary Transparency for Public Expenditure Control. WP/01/08 - Health Care and Its Financing in Italy: Issues and Reform Options. WP/00/166 - Italy Fiscal Strategy in a Medium-Term Framework. Country Report No. 00/82 - The Evolving Role of Regions in Italy: The Financing and Management of Health Care Services. Country Report No. 00/82 - Growth and Competitiveness: - Inflation and Competitiveness. Country Report No. 03/352 - Regional Convergence in Italy: 1960-2002. Country Report No. 03/352 - New Estimates of Potential Output. Country Report No. 02/232 - Short-Term Forecasting: Projecting Italian GDP, One Quarter to Two Years Ahead. WP/01/109 - Puzzling Out Italy’s Growth Performance. Country Report No. 00/82 - Seasonality and Capacity—An Application to Italy. WP/00/80 - Labor Markets: - Regional Wage Differentiations and Wage Bargaining Systems: The Case of Italy. Country Report No. 02/232 - Financial and Corporate Sectors: - To Buy or Not to Buy? Uncertainty, Irreversibility and Heterogeneous Investment Dynamics in Italian Company Data. WP/04/104. - Italy: Detailed Assessment of Compliance with the Committee for Payment and Settlement Systems (CPSS) Core Principles for Systemically Important Payment Systems. Country Report No. 04/132 - Italy: Detailed Assessment of Compliance with the Basel Core Principles for Effective Banking Supervision. Country Report No. 04/133 ### Main websites for Italian data (as listed) - National Statistical Office: http://www.istat.it/ - Banca d’Italia: http://www.bancaditalia.it/ - Ministry of Finance: http://www.tesoro.it/welcome.asp - IMF Special Data Dissemination Standard website for Italy: http://www.imf.org/external/country/ITA/index.htm ### Key economic and social indicators (selected, exact series from Table 1) - Real GDP (change in percent): 1999: 1.7; 2000: 3.0; 2001: 1.8; 2002: 0.4; 2003: 0.3; 2004: 1.5; 1/2005: 1.7 - Total domestic demand (change in percent): 1999: 3.2; 2000: 2.3; 2001: 1.4; 2002: 1.3; 2003: 1.2; 2004: 0.9; 1/2005: 1.0 - CPI (average index, change in percent): 1999: 1.7; 2000: 2.6; 2001: 2.3; 2002: 2.6; 2003: 2.8; 2004: 2.2; 1/2005: 2.2 - Unemployment rate (in percent): 1999: 11.4; 2000: 10.6; 2001: 9.5; 2002: 9.0; 2003: 8.7; 2004: 8.3; 1/2005: 8.0 - Gross national saving (percent of GDP): 1999: 20.3; 2000: 19.7; 2001: 19.6; 2002: 19.4; 2003: 18.1; 2004: 18.6; 1/2005: 19.3 - Gross domestic investment (percent of GDP): 1999: 19.0; 2000: 19.8; 2001: 19.7; 2002: 19.8; 2003: 19.1; 2004: 19.7; 1/2005: 20.0 - General government balance (percent of GDP): 1999: -1.7; 2000: -0.6; 2001: -2.6; 2002: -2.3; 2003: -2.4; 2004: -2.9; 2005: -3.1 - General government structural balance (percent of GDP): (Table shows) 2000 onward entries include -2.8; -3.9; -3.8; -4.0; -3.6; -3.5 (presented as in table) - General government debt (percent of GDP): 1999: 115.5; 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004: 105.8; 1/2005: 104.4 - Private sector credit (end of year, percent change): 1999: 10.2; 2000: 13.3; 2001: 7.0; 2002: 6.2; 2003: 7.0; 2004: 7.7; 2004 data refer to end-June - Trade balance (percent of GDP): 1999: 1.9; 2000: 1.0; 2001: 1.6; 2002: 1.5; 2003: 0.6; 2004: 0.7; 1/2005: 1.1 - Current account balance (percent of GDP): 1999: 0.6; 2000: -0.6; 2001: -0.1; 2002: -0.6; 2003: -1.3; 2004: -0.9; 1/2005: -0.1 - Export of goods and services (percent of GDP): 1999: 25.5; 2000: 28.3; 2001: 28.4; 2002: 27.0; 2003: 25.4; 2004: 25.8; 1/2005: 26.2 - Import of goods and services (percent of GDP): 1999: 23.5; 2000: 27.3; 2001: 27.0; 2002: 26.0; 2003: 24.9; 2004: 25.0; 1/2005: 24.7 - Net imports of crude oil & natural gas (in bln. of U.S. dollars): 1999: 13.6; 2000: 24.4; 2001: 22.7; 2002: 21.7; 2003: 27.7; 2004: 35.5; 1/2005: 36.0 - Holdings of currency (percent of quota, Fund position as of November 30, 2004): 65.7 - Quota (millions of SDRs): 7,055.5 - Present exchange rate (January 12, 2005): US$ 1.3122 per euro - Nominal effective rate (1995=100): 1999: 112.4; 2000: 107.9; 2001: 109.4; 2002: 111.9; 2003: 118.0; 2004: 119.4 - Real effective rate (1995=100, based on CPI): 1999: 107.2; 2000: 102.4; 2001: 103.0; 2002: 104.4; 2003: 109.0; 2004: 110.8 ### General government accounts (Table 2, selected series, in percent of GDP) - Total revenues: 1999: 46.6; 2000: 45.8; 2001: 45.7; 2002: 45.3; 2003: 46.3; 2004: 45.4; 2005 Est./Proj.: 44.6 - Total expenditures: 1999: 48.4; 2000: 47.7; 2001: 48.3; 2002: 47.6; 2003: 48.8; 2004: 48.3; 2005 Est./Proj.: 47.7 - Overall balance (percent of GDP): 1999: -1.7; 2000: -1.8; 2001: -2.6; 2002: -2.3; 2003: -2.4; 2004: -2.9; 2005 Est./Proj.: -3.1 - Primary balance (percent of GDP): 1999: 5.0; 2000: 4.6; 2001: 3.9; 2002: 3.5; 2003: 2.9; 2004: 2.3; 2005 Est./Proj.: 2.0 - Public debt (in billions of euros): 1999: 1,273; 2000: 1,297; 2001: 1,348; 2002: 1,361; 2003: 1,382; 2004: 1,432; 2005 Est./Proj.: 1,469 - Public debt (percent of GDP): 1999: 115.5; 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004: 105.8; 2005 Est./Proj.: 104.4 ### Selected vulnerability and financial soundness indicators (Tables 3 & 4, selected) - Current account balance (settlement basis, percent of GDP): 1999: 2.4; 2000: 1.5; 2001: 0.6; 2002: -0.6; 2003: -0.1; 2004: -0.6; 2004 Latest Est. Date: -0.9 - Official reserves (U.S. dollars, billions, end-of-period): 1999: 55.7; 2000: 29.9; 2001: 22.4; 2002: 25.6; 2003: 24.4; 2004: 28.6; Latest Est.Date: 30.4; Oct: 27.7 - Total external debt (percent of GDP): 1999: 59.0; 2000: 71.1; 2001: 72.0; 2002: 82.5; 2003: 81.5; 2004: 91.4; Latest Est.Date: 94.7 - Public sector debt (Maastricht definition, percent): 1999: 120.2; 2000: 116.4; 2001: 115.5; 2002: 111.2; 2003: 110.6; 2004: 108.0; Latest Est.Date: 106.2 - 3-month T-bill yield (percent): 1999: 6.3; 2000: 4.6; 2001: 3.0; 2002: 4.5; 2003: 4.1; 2004: 3.3; Latest Est.Date: 2.2; Oct: 2.1 - Nonperforming loans to total gross loans (percent): 1999: 9.8; 2000: 7.8; 2001: 6.7; 2002: 6.5; 2003: 6.6; 2004 H1: 6.7 - Capital adequacy, regulatory capital to risk-weighted assets (percent): 1999: 10.6; 2000: 10.1; 2001: 10.4; 2002: 11.2; 2003: 11.4 - Household debt to GDP (percent): 1999: 19.5; 2000: 20.4; 2001: 20.7; 2002: 21.9; 2003: 23.4; 2004: 23.8 ### One-off fiscal measures (Table 5, in percent of GDP) - Total one-off measures: 2000: 0.7; 2001: 0.8; 2002: 1.5; 2003: 2.1; 2004: 1.4; 2005: 1.0 - Tax amnesties: 2000: 0.0; 2001: 0.0; 2002: 0.1; 2003: 1.5; 2004: 0.7; 2005: 0.1 - Other temporary measures: 2000: 0.6; 2001: 0.7; 2002: 0.5; 2003: 0.4; 2004: 0.4; 2005: 0.3 - Asset sales: 2000: 0.1; 2001: 0.2; 2002: 0.9; 2003: 0.2; 2004: 0.3; 2005: 0.5 ### Public sector debt sustainability framework and stress tests (Table 6, selected) - Public debt/GDP (baseline): 1999: 115.5; 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004: 105.8; 2005: 104.4; 2006: 104.1; 2007: 103.8; 2008: 104.7; 2009: 105.7 - Change in public debt/GDP (annual): 1999: -0.9; 2000: -4.3; 2001: -0.6; 2002: -2.7; 2003: -1.8; 2004: -0.4; 2005: -1.3; 2006: -0.4; 2007: -0.2; 2008: 0.9; 2009: 1.0 - Net debt-creating flows/GDP (5+6): 1999: -1.9; 2000: -5.1; 2001: -2.1; 2002: -1.4; 2003: -0.9; 2004: -1.2; 2005: -0.9; 2006: -0.2; 2007: -0.3; 2008: -0.4; 2009: -0.6 - Overall deficit excluding net interest payments (= primary deficit, percent of GDP): 1999: -5.0; 2000: -5.8; 2001: -3.9; 2002: -3.5; 2003: -2.9; 2004: -2.3; 2005: -2.0; 2006: -1.1; 2007: -1.3; 2008: -1.4; 2009: -1.7 - Memo macro assumptions (selected): - Real GDP growth (percent per year): 1999: 1.7; 2000: 3.0; 2001: 1.8; 2002: 0.4; 2003: 0.3; 2004: 1.5; 2005: 1.7; 2006: 2.0; 2007: 2.0; 2008: 2.0; 2009: 2.0 - Consumer price index (change, percent per year): 1999: 1.7; 2000: 2.6; 2001: 2.3; 2002: 2.6; 2003: 2.8; 2004: 2.2; 2005: 2.2; 2006: 2.1; 2007: 2.0; 2008: 2.0; 2009: 2.0 - Average interest rate on public debt (percent per year): 1999: 6.0; 2000: 5.9; 2001: 6.1; 2002: 5.4; 2003: 5.1; 2004: 5.1; 2005: 5.0; 2006: 5.0; 2007: 5.0; 2008: 5.1; 2009: 5.2 - Stress tests (public debt/GDP outcomes, selected scenarios): 1. If real interest rate, real GDP growth rate, and primary balance (in percent of GDP) in 2005-2009 are at average of past 10 years: 2005: 106.2; 2006: 105.8; 2007: 104.3; 2008: 103.1; 2009: 102.0; 2010: 102.1; 2011: 102.6 2. If real interest rate in 2005 and 2006 is average plus two standard deviations, others at baseline: 2005: 106.2; 2006: 105.8; 2007: 110.1; 2008: 115.5; 2009: 115.4; 2010: 116.4; 2011: 117.6 3. If real GDP growth rate in 2005 and 2006 is average minus two standard deviations, others at baseline: 2005: 106.2; 2006: 105.8; 2007: 107.1; 2008: 109.7; 2009: 109.5; 2010: 110.5; 2011: 111.6 4. If primary balance (percent of GDP) in 2005 and 2006 is average minus two standard deviations, others at baseline: 2005: 106.2; 2006: 105.8; 2007: 104.9; 2008: 104.1; 2009: 103.9; 2010: 104.8; 2011: 105.8 5. Combination of 2-4 using one standard deviation shocks: 2005: 106.2; 2006: 105.8; 2007: 108.8; 2008: 112.3; 2009: 112.1; 2010: 113.1; 2011: 114.2 *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0544.pdf* ### 6. If debt ratio in 2005 rises by (additional) 10 percent of GDP, others at baseline ### 6. If debt ratio in 2005 rises by (additional) 10 percent of GDP, others at baseline ### Scenario outcome (debt ratio path) - Headline scenario: "If debt ratio in 2005 rises by (additional) 10 percent of GDP, others at baseline" - Reported debt ratio sequence (as presented): 106.2 105.8 114.4 114.2 114.0 115.0 116.1 ### Memorandum items (baseline parameter values; values repeated for each column) - Primary deficit (percent of GDP, average of past 10 years): -4.3 -4.3 -4.3 -4.3 -4.3 -4.3 -4.3 - Primary deficit (percent of GDP, standard deviation of past 10 years): 1.4 1.4 1.4 1.4 1.4 1.4 1.4 - Real interest rate (nominal rate minus change in GDP deflator, average of past 10 years): 4.9 4.9 4.9 4.9 4.9 4.9 4.9 - Real interest rate (nominal rate minus change in GDP deflator, standard deviation of past 10 years): 1.8 1.8 1.8 1.8 1.8 1.8 1.8 - Nominal interest rate (average of past 10 years): 8.1 8.1 8.1 8.1 8.1 8.1 8.1 - Nominal interest rate (standard deviation of past 10 years): 2.4 2.4 2.4 2.4 2.4 2.4 2.4 - Real GDP growth rate (average of past 10 years): 1.7 1.7 1.7 1.7 1.7 1.7 1.7 - Real GDP growth rate (standard deviation of past 10 years): 1.2 1.2 1.2 1.2 1.2 1.2 1.2 - GDP deflator (average of past 10 years): 3.2 3.2 3.2 3.2 3.2 3.2 3.2 - GDP deflator (standard deviation of past 10 years): 1.2 1.2 1.2 1.2 1.2 1.2 1.2 ### Staff findings and policy implications (Statement by the IMF Staff Representative, February 7, 2005) - New information since the Staff Report does not change the thrust of the staff appraisal. - Short-term indicators point to downside risks to the recovery: - Industrial production fell by 0.7 percent in November (month-on-month). - Consumer confidence posted its third consecutive monthly decline in January. - Business Climate Index improved on the strength of rising orders and falling inventories. - Consensus 2005 growth forecast stood at 1.5 percent in January, versus the Staff Report projection of 1.7 percent and the budget projection of 2.1 percent. - Harmonized consumer prices rose 2.1 percent year-on-year in January (preliminary). - European Commission assessment (February 2) raised fiscal concerns and policy advice: - Additional measures could be required to keep the fiscal deficit below 3 percent of GDP in 2005, given downside risks and budget implementation uncertainties. - The Commission found that with full implementation of budgetary targets and the recent pension reform the debt would be sustainable, but noted existence of risks to sustainability. - The Commission called for additional consolidation efforts to bring the budget "close to balance" (consistent with staff advice). ### Fund relations and statistical context (selected points) - Membership status: Joined 3/27/47; Article VIII. - General Resources Account (SDR Million): - Quota: 7,055.50 (100.00 percent) - Fund holdings of currency: 4,637.14 (65.72 percent) - Reserve position in Fund: 2,418.38 (34.28 percent) - SDR Department: - Net cumulative allocation: 702.40 (100.00 percent) - Holdings: 86.79 (12.36 percent) - Outstanding Purchases and Loans: None - Financial Arrangements: None - Projected Obligations to Fund (SDR million, forthcoming): - Charges/Interest: 13.63 13.66 13.66 13.69 - Total: 13.63 13.66 13.66 13.69 - Exchange rate arrangement: Entered the final stage of European Economic and Monetary Union on January 1, 1999, at a rate of 1,936.27 Italian lire per 1 euro. - Exchange system: Free of restrictions on current international payments and transfers, except specified security-related restrictions notified under Executive Board Decision No. 144-(52/51); a list of Council Regulations imposing specific freezes or restrictive measures is noted. - Statistical assessment (ROSC—Data Module, Country Report No. 02/234, 10/18/02): - Italy’s macroeconomic statistics are of generally high quality but shortcomings were identified: - No single statistical agency compiles an integrated, comprehensive statement of government finances; distinct measures of government deficit/financing differ. - Source data and statistical techniques could be strengthened (enterprise survey response rates, CPI price collection efficiency, coverage of cross-border financial transactions not through domestic banks). - Balance of payments and government finance statistics could better conform to international methodological guidelines. - Resource pressures at parts of the National Institute of Statistics given EU and euro-area statistical requirements. - Persistently large gap noted between the SGP-monitored fiscal deficit and the PSBR net of privatization receipts. - Recent data improvements noted: - ISTAT work on regional price levels (expected available in 2005). - Publication of quarterly general government balance, expenditure, and revenue on an accruals basis starting October 2003. - New, more detailed labor survey by professional staff. - Shift to chain-weighted indices for national accounts expected in March 2005. - Remaining weaknesses: - Inventory accumulation in national accounts is derived as a residual and lumped with the statistical discrepancy. - Quality and timeliness of some fiscal data, particularly expenditure by local governments, still fall short of SDDS requirements despite improvements. *Source: _cr0544 - 6. If debt ratio in 2005 rises by (additional) 10 percent of GDP, others at baseline* ### 2008. It also called for close attention to “factors other than net borrowing which contribute ### IMF Concludes 2004 Article IV Consultation with Italy (Public Information Notice No. 05/17, February 9, 2005) ### Background and near-term outlook - Article IV consultation concluded on February 7, 2005. - Cyclical recovery underway: real GDP rose by 1.2 percent in the first three quarters of 2004 relative to the same period of the previous year. - Staff forecasts: growth of 1.5 percent in 2004 and 1.7 percent in 2005 (staff), compared with the official projection of 2.1 percent. - Inflation: expected to average about 2¼ percent in 2004 despite higher international oil prices. - Fiscal stance in 2004: a mid-2004 package of corrective measures likely sufficient to keep the fiscal deficit just below 3 percent of GDP. - 2005 budget: targets a headline deficit of 2.7 percent of GDP, includes a personal income tax cut of about ½ percent of GDP, and relies in part on new measures to control expenditure growth. - Risks to the recovery: high oil prices and appreciation of the euro; growth potential constrained by supply-side weaknesses and uncertainty over fiscal prospects. ### Executive Board assessment — main findings and recommendations - Key challenge: enhance growth potential by securing durable fiscal consolidation and pressing ahead with structural reforms to enhance competition and strengthen the business environment. - Fiscal strategy: - Importance of a strong and credible medium-term fiscal strategy based on durable adjustment measures to ensure long-term sustainability. - Given high public debt, objective of achieving a small structural fiscal surplus before the end of the decade remains appropriate; Directors regretted the authorities dropped a previous explicit commitment to this effect. - Commended pension reform implementation and called for quick finalization of supporting legislation and adjustment of pension replacement rates in line with increases in life expectancy. - Fiscal transparency and composition: - Noted significant reliance on one-off measures; fiscal deficit kept below Stability and Growth Pact ceiling largely due to one-offs. - Urged elimination of one-off measures by 2006 and stronger efforts to clarify the gap between the Stability and Growth Pact deficit and the public sector borrowing requirement net of privatization receipts. - Emphasized that additional adjustment should focus on current spending given Italy’s high tax ratio; welcomed uniform cap on spending growth and recommended multi-year spending reviews. - Supported stepped-up privatization efforts but warned that securitizations, sales and lease-backs, and sale of parts of road networks may have negative implications for future budgets and need careful assessment. - Labor market and wages: - Welcomed positive results from labor market reforms (increases in employment rate and hours worked), but noted employment ratio still low and regional/demographic disparities large. - Recommended approval of the second stage of the “Biagi” labor market reform bill to further reduce rigidities. - Encouraged decentralization of wage bargaining and increased wage flexibility; suggested constructing regional cost-of-living indexes and anchoring public sector wage increases to them. - Advised accompanying reforms to enhance labor force quality through training and education. - Product markets and business environment: - Urged stronger promotion of competition through regulatory reforms and addressing shortcomings in the business environment, including accelerating legal procedures and eliminating red tape. - Emphasized enacting the long-delayed reform of the bankruptcy law. - Financial sector: - Welcomed positive trends from the Financial Sector Assessment Program first round: increased bank profitability and improved vulnerability indicators. - Noted non-performing loans remain relatively high, partly reflecting length of recovery procedures. - Recommended prompt passage of reforms to enhance securities market regulator powers and strengthening corporate governance standards. - External and other policies: - Welcomed commitment to increase overseas development assistance to 0.33 percent of GDP by 2006 and encouraged progress toward the UN target of 0.7 percent of GNP. - Encouraged resistance to pressures for increased trade protection and monitoring domestic impact of the expiration of textile export quotas. - Statistics: - Noted statistics are adequate for surveillance but called to address remaining weaknesses identified in the 2002 Report on the Observance of Standards and Codes and to clarify the persistent discrepancy between the fiscal deficit and the borrowing requirement net of privatization revenues. ### Selected economic indicators (as reported) - Real economy (change in percent) - GDP: 2000: 3.0; 2001: 1.8; 2002: 0.4; 2003: 0.3; 2004 1/: 1.5; 2005 1/: 1.7 - Domestic demand: 2000: 2.3; 2001: 1.4; 2002: 1.3; 2003: 1.2; 2004 1/: 0.9; 2005 1/: 1.0 - CPI: 2000: 2.6; 2001: 2.3; 2002: 2.6; 2003: 2.8; 2004 1/: 2.2; 2005 1/: 2.2 - Unemployment rate (in percent): 2000: 10.6; 2001: 9.5; 2002: 9.0; 2003: 8.7; 2004 1/: 8.3; 2005 1/: 8.0 - Public finances (general government; in percent of GDP) - Overall balance: 2000: -0.6; 2001: -2.6; 2002: -2.3; 2003: -2.4; 2004 1/: -2.9; 2005 1/: -3.1 - Structural balance 2/: 2000: -2.8; 2001: -3.9; 2002: -3.8; 2003: -4.0; 2004 1/: -3.6; 2005 1/: -3.5 - Gross debt: 2000: 111.2; 2001: 110.6; 2002: 108.0; 2003: 106.2; 2004 1/: 105.8; 2005 1/: 104.4 - Money and credit (end of year, percent change) - Private sector credit 3/ 4/: 2000: 13.3; 2001: 7.0; 2002: 6.2; 2003: 7.0; 2004 3/: 7.7 - Contribution to euro-area M3 5/ 6/: 2000: 4.7; 2001: 10.9; 2002: 10.7; 2003: 9.5; 2004 5/: 5.0 - Interest rates (year average) 7/ - Six-month rate on treasury bills: 2000: 4.4; 2001: 4.3; 2002: 3.3; 2003: 2.3; 2004 7/: 2.2 - Government bond rate, ten-year: 2000: 5.2; 2001: 5.2; 2002: 4.3; 2003: 4.4; 2004 7/: 3.7 - Balance of payments (in percent of GDP) - Trade balance: 2000: 1.0; 2001: 1.6; 2002: 1.5; 2003: 0.6; 2004 1/: 0.7; 2005 1/: 1.1 - Current account: 2000: -0.6; 2001: -0.1; 2002: -0.6; 2003: -1.3; 2004 1/: -0.9; 2005 1/: -0.1 - Fund position (as of November 30, 2004) - Holdings of currency (in percent of quota): 65.7 - Holdings of SDRs (in percent of allocation): 12.4 - Quota (in millions of SDRs): 7,055.5 - Exchange rate (present rate as of February 7, 2005): US$1.2857 per euro - Exchange rate indices (change in percent) - Nominal effective 8/: 2000: 109.4; 2001: 111.9; 2002: 118.0; 2003: 119.4 - Real effective (based on unit labor cost) 9/: 2000: 103.0; 2001: 104.4; 2002: 109.0; 2003: 110.8 Notes from the table: - 1/ Staff estimates and projections, unless otherwise noted. - 2/ Structural balances are calculated using the staff’s estimates of potential output and exclude one-off measures. - 3/ Data for 2004 refer to end-June. - 4/ Twelve-month credit growth, adjusted for securitizations. - 5/ Data for 2004 refer to end-October. - 6/ Excludes the currency in circulation held by non-bank private sector. - 7/ Data for 2004 refer to end-November. - 8/ Data for 2004 refer to end-September. - 9/ Based on CPI. ### Structural reforms: pensions, labor markets, product markets, and energy - Pension reform: - 2004 July reform moves toward a contribution-based system; implementation starts in 2008 when tighter eligibility criteria take effect. - Reform projected to produce substantial savings; transition-phase incentives to increase retirement age will be budget-neutral. - DSA taking into account the 2004 pension reform shows the debt to GDP ratio declines steadily over the period 2005-2050. - Labor market reforms: - Phase one of the Biagi reform not fully implemented; further results expected once employment agency system is fully operational. - Second phase covers reorganization of employment incentives, reform of social shock absorber (enlargement of ordinary unemployment benefits), suspension of Article 18 of the Labor Rights Law (experimental), and arbitration in individual labor disputes; bill under discussion in Parliament. - Obstacles to approval: contentious suspension of Article 18 and the budgetary cost of unemployment benefit reform (lengthening benefit duration and increasing its level). - Employment rate improvements: employment rate growth in 1998-03 was 4.1 percent versus 1.7 percent in EU 25; women’s employment increased by 6 percentage points between 1995 and 2003; pension reforms increased participation of over 55 by more than 2 percentage points between 2001 and 2003. - Product market reforms: - Draft laws in Parliament to reform professional services: simplify recognition of new professions; set minimum and maximum fees only for activities bearing on the general interest; allow advertising; improve pre-professional training. - “Simplification law” to be approved in 2005 to liberalize business activities; “decree on competitiveness” to slim down red tape. - Note: product market reforms are potentially more important but more difficult to implement; piecemeal approaches are generally not effective. - Energy sector: - Diversification of supply expected to lower electricity costs; 10000 MW of combined cycle gas turbine power plants foreseen for the next 3-4 years. - Law 55/2003 to introduce a top/down authorization process and compensation mechanisms to speed authorization for new power plants. - Merger of Terna and GRTN to be completed in 2005 with planned privatization of the resulting company. - Energy Authority rules aimed at reducing market power, preventing strategic behavior raising wholesale prices, aligning rules with unification of grid ownership/management, and harmonizing rule sets. - Decrees approved in July 2004 to reduce consumption and enhance energy efficiency; market opened to all non-domestic consumers with wholesale purchases available from January 2005. ### Financial sector and regulatory developments - Banking system in 2004: profitability and vulnerability indicators improved following the Parmalat bankruptcy in December 2003. - Authorities introduced a draft law to strengthen securities regulation; passage delayed. Some elements strengthening Consob’s powers and investor protection incorporated into a draft law implementing the EU market abuse directive under Parliamentary consideration. - Directors recommended prompt passage of reforms to enhance securities regulator powers and strengthening corporate governance standards. - Directors look forward to results of the next round of the Financial Sector Assessment Program. ### Statement by Pier Carlo Padoan (Executive Director for Italy), February 7, 2005 — key points - Italy characterized as a high-debt/low-growth country in a low growth region; authorities committed to fiscal consolidation and structural reforms to raise growth potential. - Structural reforms introduced are beginning to bear fruit: pension reform (2004); labor market improvements from the first segment of Biagi reform; comprehensive school system reform; steps to stimulate R&D (Italian Institute of Technology); measures to foster entrepreneurship and improve business environment (new corporate income tax system, improved access to finance, simplification in judicial procedures for company litigation). - Despite results in labor markets and increased employment, growth remains low due largely to disappointing TFP developments; further complementary reforms and time/political capital required to reap full benefits. - Reiteration that the 2004 pension reform is in the right direction per EU Commission assessment and that its implementation starting in 2008 will produce savings without inducing early retirements. *IMF Public Information Notice No. 05/17, February 9, 2005 — Article IV consultation with Italy.* ### conclusion that improvement in the “judicial system” could significantly boost growth. A ### _cr0544 - conclusion that improvement in the “judicial system” could significantly boost growth. A ### Judicial system and bankruptcy procedures - A costly and inefficient enforcement system may: - generate barriers to entry, reducing competition; - negatively affect the possibility of firms to access financial markets; - indirectly influence the average size of firms. - The excessive length and costs of the Italian bankruptcy procedures have a negative effect on turnover of economic activity and on the re-allocation of resources. - Reform status: - A draft law on bankruptcy reform is under discussion in Parliament, following a major redesign (maxiemendamento) approved by the Government in late December 2004. - The draft law significantly simplifies the existing procedures. - Recent procedural improvements: - In 2003 judicial offices specialized in industrial and property rights litigation were introduced. - A special procedure for company litigation was introduced in 2004 to speed up trials. - Available evidence shows that time needed to settle controversies in these matters has been significantly reduced. - Staff analysis caveats: - Cross-country correlations between quality indicators and GDP do not establish causality from institutions to growth. - Regressions regressing past growth rates (1985-2003) on current institutional variables assume no relevant changes occurred in institutional variables over the 18-year period; the “long term stability” of some institutional factors should be documented. - The analysis and suggested measures focus only on the demand-side and do not fully reflect supply-side issues such as procedural rules and internal organization of courts. ### Competitiveness, productive specialization, and exports - Structural persistence: - One underlying cause of low growth is persistence of Italy’s specialization pattern, exposed to major shifts in world demand and supply. - Long lasting rigidities make resource reallocation towards new, more dynamic sectors more difficult. - Effects of international competition and labor market flexibility: - Recent studies highlight a relationship between increased international competition and increased productivity of exporting sectors beginning in the nineties. - Increased labor market flexibility can help reallocation but may also deepen specialization in traditional sectors (path dependency) rather than in new higher human capital–intensive sectors. - Export performance: - Italy’s export market shares in volume terms have declined since 2001. - Market shares at current prices remained broadly constant (at about 4 percent of world exports), reflecting a higher average unit value of Italian exports—possibly signaling a quality upgrade. - Authorities oppose countering increased international competition in lower quality segments with more protection. ### Growth in Southern Italy and wage differentiation - Southern performance: - In recent weak activity, Southern regions recorded on average a higher rate of GDP growth over the last eight years, a result that holds on per capita terms; first time this occurs in the post-war period. - Growth in the South since the mid-1990s has been driven by increasing fixed gross investment vis-à-vis the Center-North; first time since the Sixties capital accumulation in the South shows a favorable dynamic versus the Center-North. - Performance underpinned by steady increase in the share of public investment out of total capital expenditures; CIPE decisions in 2003 and 2004 expected to strengthen this trend. - Wage differentiation debate: - Staff suggests wage differentiation could boost growth and employment in the South. - Caveats: - Wage differentials between North and South have been rising since the early 1990s. - Two-tier vs. fully decentralized wage systems: two-tier might control overall wage growth; full decentralization might set wages closer to regional equilibrium but could raise pay in the North and hamper competitiveness. - Staff proposes public sector “leading by example” with regionally differentiated wages; authorities note fiscal federalism implications should be carefully spelled out before implementation. ### Debt dynamics, simulations, and debt sustainability - Debt-to-GDP simulation (period 2001-2004) assuming growth at potential (based on Commission estimates): - Higher growth affects debt-to-GDP via smaller nominal deficit for given cyclically-adjusted balance and higher GDP denominator. - Alternative scenario (dotted line) results versus historical level: - 2001: debt-to-GDP would have fallen by 0.3 percentage points more than historical level. - 2002: 2 percent more. - 2003: 1.8 percent more; debt-to-GDP would have been at 102.1 percent, 4.1 percentage points lower than baseline. - 2004: 0.9 percent more; debt-to-GDP would have been at 100.8, 5 percentage points lower than baseline. - Average reduction in the debt-to-GDP ratio in 2001-04 would have been 2.6 percent, against a 2.3 percent average for 1994-2000. - Staff assumptions in DSA (disputed by authorities): - Staff assumes: 1) labor productivity will raise gradually to 1.5 percent annually; 2) limited gains in the participation rate (5 percentage points over 20 years); 3) long-run annual growth of about 1 percent. - Authorities argue staff underestimates interactions between demographic trends and productivity, and underestimates participation rate gains (historically lower in Italy but showing upward trend: a one percentage point increase per year in the last decade). - Italy’s Stability Program (2005) assumptions: - Labor productivity growth stable and slightly below 2 percent; - Participation rate gains by 11 percentage points over the period 2003-2050; - GDP growth rate above 2 percent between 2005 and 2010 and declining to about 1 percent in the following years. - 2005 Stability Program sustainability analysis, including 2004 pension reform, shows debt-to-GDP declines steadily over 2005-2050, drops to below 60 percent in 2018, and turns into a credit in 2042. - Ageing cost projections: - Staff: ageing population expected to increase Italy’s public spending by about 5 percent of GDP in coming decades. - Authorities cite EU Economic Policy Committee Ageing Working Group (2003): projects ageing will increase public spending by 1.4 percent of GDP between 2005 and 2050 (components: pensions, health care, education and unemployment benefits); report notes increases for other EU-15 countries will be much higher, in the range of 3-7 percentage points of GDP. ### Fiscal targets, stock-flow adjustments, and accounting issues - Missing targets and growth-adjusted assessment: - Methodology: production function–based sensitivity analysis as per ECOFIN decision and Commission practice. - Fiscal targets and outcomes table (2001–2004), with average (2001–2004): - 1. Deficit target: -0.8, -0.5, -1.5, -2.2 - 2. Deficit target corrected for growth changes: -1.3, -1.6, -2.9, -2.8 - 3. Outcome: -2.6, -2.3, -2.4, -2.9 - 4. Difference (3-2): -1.3, -0.7, 0.5, -0.1, Average (2001 - 2004) -0.4 - Growth changes significantly affected deficit targets; the “miss” has decreased over time, positive in 2003, expected close to zero in 2004. - Stock-Flow Adjustment (SFA): - Period 1994-2003: average cumulative SFAs for EU countries is 4.2 percent of GDP; Italy at 3.3 percent stands below EU average. - Period 2000-2003: Italy’s cumulative SFAs is 0.3 percent of GDP, the third smallest among EU-15, below EU-15 and EU-25 averages (1.8 and 1.7, respectively). - Breakdown (2000-2003): accumulation of financial assets and valuation effects negligible for Italy; cash-accrual difference in recording of revenue and primary expenditure is 1.2 percent of GDP; another cash-accrual difference related to interest payments is -0.6 percent of GDP; total cash-accrual difference averages 0.5 percent of GDP. - Net borrowing vs. borrowing requirement: - Clarifications requested: Ministry of Economy and Finance’s borrowing requirement is calculated on the formation side for the Public Sector; Bank of Italy’s borrowing requirement is computed on the financing side for the general government sector. - Need to clarify sources/methods used and whether public sector borrowing requirement series include 2004 post-office account revisions; Bank of Italy series includes such revisions while the Ministry does not publish a complete time series. - An ad-hoc committee established to reduce discrepancies. ### Privatizations, specific entities, and public-sector restructurings - Privatization program items: - Possible additional ENEL tranches, Alitalia, and state broadcasting company RAI. - “Second level” privatizations: Terna and Wind by ENEL and SNAM by ENI. - Program to include other assets such as real estate and securitization operations. - ANAS: - ANAS Company privatized in November 2002. - Under ESA 95, to be classified as a full commercial entity operational costs should be progressively financed through market revenues. - Target to reach full commercial classification by the end of 2005; after which EUROSTAT will consider ANAS no longer part of the public sector. - Infrastrutture Spa: - Financial intermediary owned by Cassa Depositi e Prestiti; designed drawing on similar institutions in other large EU member countries. - Mission: co-finance PPP infrastructure projects, including those identified by the European Growth Pact endorsed by the European Council on December 2003. - Activities limited so far due to delays in implementing the European Growth Pact quick-start list of projects. - As a full commercial company, it follows commercial accounting and reporting standards. ### Banking sector and corporate governance - Banking sector performance: - Efficiency improved substantially over the last decade; privatized sector. - Competition increased and cost-income ratio declined. - Six major banks have a ROE of about 13 percent. - Whole system ROE: 11 percent (in June 2004). - Foreign shareholder presence: in the four major Italian banks the share of capital held by foreign banks as members of shareholder agreements is 19.6 percent (statistics based on IBCA data). - Basel II impact: empirical analyses (international and Italian authorities) show the new regime should not have distortional effects on credit conditions of different classes of companies, including SMEs. - Corporate governance strengths and reforms: - Italian legal, regulatory and institutional framework overall adequate. - Assessment that Consob’s insufficient independence in imposing penalties is imprecise: Minister of Finance checks formal legitimacy of sanctions only. - Advanced regulations: financial reporting and disclosure among the most rigorous in Europe; rotation of external auditors is compulsory. - Company Law reform (L.D. 6/2003) allows choice between Anglo-American unitary board and German “supervisory board”. - Preda Code requires adequate independent Non-Executive Directors under “comply or explain” rule. - Imminent legislative package (the “Law on Saving” and implementation of the Market Abuse Directive), possibly by end of February, to address corporate governance problems; major provisions include: - at least one Board of Directors member for listed companies elected by minority shareholders; - Consob staff increase and higher enforcement sanctions; - measures to reduce potential conflicts of interest within the financial industry. ### Fiscal adjustment, health spending controls, and tax relief - Fiscal commitment: - Authorities committed to fiscal consolidation; Minister of the Economy reiterated commitment to maintain deficit below the 3 percent limit in 2005. - Composition and measures: - Composition of adjustment oriented toward reducing one-off measures. - A 2 percent cap imposed on nominal spending with the exclusion of pensions. - Effects already observed: in Q3 2004 general government consumption declined by 4.4 percent. - Preliminary 2004 budget data: interest expenditures declined and lottery revenue increased. - Health spending controls in 2005 financial bill: - a) Regions and public health institutions obliged to define budgets in line with central government fiscal objectives. - b) If expenditure profile deviates, regions obliged within a strict timeframe to take measures to align with projected path; central Government can oblige regional Governor to take measures if region reluctant. - c) Revision of domestic stability pact introduced stricter rules for local authorities to monitor expenditure; all local entities must report quarterly to the Ministry of Economy cash and accrual accounts (with differences based on population size); in case of overruns local government must reduce payments in the following quarter; non-compliance leads to next-year restrictions: a) not allowed to exceed previous year's expenditures; b) not allowed to recruit new staff; c) not allowed to increase debt. - Tax relief measures in 2005 budget: - Impact on revenue side: 4261 million euro in 2005, 7186 million for 2006, and 6564 million for 2007. - Financing: - Fully financed through cuts in expenditures (about 80 percent in 2005, about 50 percent in 2006 and 2007) and increases in revenues, including duties, due to positive impact on disposable income (about 20 percent in 2005 and 50 percent in 2006 and 2007). - Although share of expenditure cuts tends to decrease in 2006 and 2007, overall financing is ensured by structural measures. ### S&P downgrade and market reaction - S&P downgrading: - Other credit rating agencies did not follow S&P's decision; Moody's reiterated stable outlook and raised no budget concerns. - After S&P decision, credit spreads on Italian government bonds showed substantial resilience. - Investors continued robust appetite for Italian bonds and Italy's credit spread continued to improve. ### Fiscal federalism - Fiscal decentralization ongoing: - Concentrated on constraints on the spending side. - Little change on the revenue side. *Source: _cr0544 - conclusion that improvement in the “judicial system” could significantly boost growth. A (PDF).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0544.pdf_