## _cr0660 ## Source details **Canonical URL:** [_cr0660](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0660.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0660.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0660.pdf.json) --- ### Executive Summary - A mild cyclical recovery is underway; medium-term prospects are troubling. - Potential growth estimated at just 1¼ percent annually. - Fiscal deficit exceeded 4 percent of GDP in 2005; public debt ratio increased in 2005, to over 108 percent of GDP. - Significant expenditure-based fiscal adjustment and broad-based structural reforms in product, services, and labor markets are essential to ensure fiscal sustainability and enhance competitiveness and potential growth. - Staff and authorities concurred on need for durable expenditure-based fiscal adjustment; emphasis differed and a broad reform consensus has yet to emerge. ### Cyclical outlook, growth projections, and risks - Growth and projections: - Growth estimated just above zero in 2005; staff forecast growth of about 1½ percent in 2006 (implies average quarterly growth of about 0.3 percent). - Staff central 2006 deficit forecast: 4.0 percent of GDP; staff fiscal uncertainty range for 2006: between 3¾ percent and 4¼ percent of GDP. - Sectoral contributions (2006 projected): - Private consumption: expected to remain resilient. - Net exports: improved external demand but Italy projected to continue to lose market share. - Gross fixed investment: recovery expected with rising business confidence. - Downside risks: - High international oil prices; increase in interest rates; renewed euro strength; policy slippages affecting confidence and ratings; spreads may not remain benign. - Inflation: - Inflation expected to remain moderate; concern about positive inflation differential relative to the euro area despite a sizable output gap. - Output gap: - Staff estimated widening output gap at 2½ percent of GDP in 2005. - External sector drag: - External sector sapped a cumulative 2 percentage points from output growth since 2001. ### Fiscal policy, EDP commitments, and execution (2005–06) - EDP commitments and targets: - Authorities committed under the Excessive Deficit Procedure (EDP) to achieve a deficit of 3.8 percent of GDP in 2006. - Revised deficit target under the EDP for 2005: 4.3 percent of GDP. - Authorities projected the 2006 deficit at 3.5 percent of GDP; staff central forecast 2006 deficit: 4.0 percent of GDP. - 2005 execution: - 2005 deficit target of 4.3 percent of GDP likely achieved but with tight margins. - Budget amendment in October introduced additional spending cuts and revenue measures amounting to just over 0.1 percent of GDP. - Current primary spending projected to rise by about 0.7 percent of GDP in 2005. - Footnote: staff expects a shortfall in yield of the so-called concordato; yields from past similar schemes fell short of expectations. - 2006 budget measures: - Final 2006 budget contains measures officially estimated to yield about 1.9 percent of GDP. - Authorities introduced refinements to the 2005 nominal cap on spending growth; initiatives to contain health care costs (national health card, increased accountability and sanctions). - Authorities investigating mobilization of state asset holdings to reduce public debt (details not available at time of writing). - Staff concerns about expenditure realism: - Deep cuts in central government current spending difficult to enforce and sustain given past rebounds after within-year cuts. - Rigorous expenditure control at local level assumed, particularly for health care, but success only mixed in 2005. - Deep cuts in transfers to state enterprises (ANAS, railways) could prove unrealistic without corporate restructuring and could generate off-budget liabilities. - Final budget raised some revenue estimates which staff viewed as excessive. ### Medium-term fiscal sustainability and scenarios - Staff baseline scenario assumptions: - Current policies maintained through 2010; thereafter revenue and non age-related spending remain constant as percentages of GDP. - Age-related expenditure reflects demographic projections and pension reforms since mid-1990s. - Assumes labor productivity growth increases to 1¼ percent annually and employment ratio increases by 5 percentage points, yielding long-run annual real GDP growth of ¾ percent. - Baseline outcome: - Debt ratio would exceed 300 percent of GDP in 2050. - Staff adjustment scenario: - Annual structural adjustment of 0.7 percent of GDP in 2007–10 through spending cuts, achieving overall structural balance by end of decade. - Productivity growth rises by ¼ percentage point relative to baseline starting from 2011. - Under this scenario, debt-to-GDP ratio falls to around 50 percent by 2030 and then stabilizes. - Stress test scenarios (relative to baseline): - (i) Authorities’ Stability Program update achieving overall fiscal deficit reduced to 1½ percent of GDP by 2009. - (ii) Same fiscal adjustment as (i) with higher productivity growth matching staff adjustment scenario. - (iii) More optimistic productivity growth based on authorities’ assumptions, but with current fiscal policies. - (iv) Failure to implement scheduled adjustments in pension replacement rates in line with life expectancy developments. - Each scenario yields sizable long-run increases in the debt ratio. - Staff quantified required spending cuts: - About ¾ percentage point of GDP annually in structural terms needed to reach overall budgetary balance by 2010 and stabilize debt dynamics. ### Structural reform agenda and competitiveness - Diagnosis: - Protracted slow productivity growth central to poor performance; product and services market rigidities distort incentives and discourage market entry and innovation. - Since 1998 Italy’s ULC-based REER appreciated by a cumulative 18 percent, compared to depreciations in Germany and France; real unit labor cost growth markedly greater than France and especially Germany. - Nominal wage growth moderated but productivity fell over 2001–04, contributing to competitiveness losses. - Employment growth concentrated in sectors less exposed to external competition. - Recent reforms enacted: - Reforms to bankruptcy and civil procedures; “savings law” enhancing corporate governance, disclosure, coordination among regulators; competitiveness decree; bankruptcy law reform approved December 2005. - Pension framework law approved August 2004; second pillar pension scheme approved November 2005 but implementation delayed until 2008. - Product market regulation and barriers: - Italy measured as the strongest product market regulation in the EU-15 on some indicators. - Cumulative cost increases for services, 2001–04 (selected): - Italy: Financial Services 34.5; Insurance Services 28.8; Professional Services 10.0; Total 8.7. - France: Financial Services 6.4; Insurance Services 11.2; Total 5.3. - Germany: Financial Services 20.0; Insurance Services 8.7; Total 4.4. - Specific competition issues: - Professional services: rules inhibit competition (bar nonprofessionals from nontechnical services, establish minimum tariffs, prohibit advertising); many professional services fall outside antitrust jurisdiction. - Retail trade: competition-inhibiting restrictions and protection (pharmacies); competencies devolved to lower levels of government. - State presence in enterprises: state holds controlling shares in many enterprises (energy and transport); local utilities largely public. - Regulatory authorities: Antitrust Authority proactive; other sectoral regulators insufficiently active; political influence and planned termination of budget financing raised concerns. ### Labor market, employment, and pensions - Labor market reforms: - Employment protection indicators improved; Biagi reform package first part approved June 2003; second part pending. - Measures increased flexibility (part-time contracts, staff leasing), and extended unemployment compensation. - Employment protection remains relatively stringent; employment rate remains low. - Statistical work suggested up to three quarters of the rise in employment since start of 2003 came from increases in the working age population rather than employment rate increases. - Pensions: - Pension reform framework law approved August 2004; second pillar scheme approved November 2005 but implementation delayed to 2008. - Directors and staff urged prompt adjustment of pension replacement rates every decade in line with life expectancy as mandated under the 1995 reform. - Longer-term projections show pension spending historically: 2003 14.2; 2004 14.3; 2005 14.4 (percent of GDP); projected ranges to 2050 vary by scenario. ### Financial sector assessment and FSAP findings - Overall assessment: - FSAP found Italy’s financial system generally sound; banking sector resilient to slow growth; stress tests indicate little vulnerability to unfavorable macro shocks. - Key FSAP issues: - Loan classification standards: staff advocated convergence to a 90-day past-due criterion (current transitional path moving from 180-day to 90-day). - Regulation of lending to related parties: insufficient; interministerial guidelines approved paving way for Bank of Italy regulations. - Relatively high operating costs and high fees and commissions; competition and market contestability concerns. - Liquidity buffers decreased; stress tests revealed some vulnerability to liquidity risk. - Governance concerns at the Bank of Italy and potential conflicts between stability and competition mandates; savings law amendments addressed many concerns. - Competition findings: - Four approaches used (Lerner, Panzer-Rosse, net interest margin, costs/switching costs) indicate intensified competition in loans and deposits, increased concentration at national level offset by rise in branches and provincial competition. - Pricing of core services remains high; one study found average price of holding a current account in Italy some 23 percent higher than the unweighted average for surveyed EU countries. - Institutional changes: - Savings law amendments: cap governor’s lifetime mandate; increase transparency via semiannual reports; transfer antitrust functions in banking sector to Antitrust Authority; tighten rules on connected lending; improve corporate bond issuance frameworks. - ECB recommended additional governance enhancements; government enacted changes limiting governor’s tenure to a maximum of two six-year terms and instituting greater collegiality. ### Fiscal transparency, public financial management, and SIOPE - Transparency concerns: - Opacity of budget presentation; “non-current policy” items (real estate sales) initially included in the trend deficit (tendenziale) required amendment. - Key budget documents often available with delay; up-to-date financial data on some state enterprises not widely disseminated. - Recommendations: - Establish an entity to provide independent analysis of fiscal developments or enhance Corte dei Conti powers to include regular ex ante scrutiny of the budget process. - SIOPE: - Planned implementation of SIOPE (integrated data management system to track cash outlays) expected to provide a powerful tool for monitoring spending and facilitating budgeting. - Nationwide rollout should contribute meaningfully to expenditure monitoring. ### Public finance: selected exact figures and projections (as presented) - Real GDP (change in percent): 2001 1.8; 2002 0.4; 2003 0.3; 2004 1.2; 2005 0.1; 2006 (staff proj) 1.5. - General government balance (in percent of GDP): 2001 -3.2; 2002 -2.7; 2003 -3.2; 2004 -3.2; 2005 -4.3; 2006 -4.0 (Table entries show staff/auth. variants). - General government debt (in percent of GDP): 2001 110.9; 2002 108.3; 2003 106.8; 2004 106.5; 2005 108.7; 2006 108.4 (alternate presentations show 108.3). - Public sector debt long-run projections (examples): 2020 123.3 / 89.8 / 69.6; 2030 164.6 / 98.4 / 53.2; 2040 242.0 / 132.2 / 51.1; 2050 339.9 / 178.0 / 50.7. - Key fiscal composition (percent of GDP): Total revenues 2005 44.8; Total expenditures 2005 49.1; Wages and salaries 2005 11.1; Interest payments 2005 5.0. ### External sector and selected indicators - Trade balance (in percent of GDP): 2005 -0.3; 2006 -0.4. - Current account balance (in percent of GDP): 2005 -1.9; 2006 -1.9. - Exports of goods and services (in percent of GDP): 2005 33.2; 2006 32.8. - Imports of goods and services (in percent of GDP): 2005 33.7; 2006 33.4. - Net imports of oil (in bln. of U.S. dollars): 2005 26.3; 2006 29.8. ### Official Development Assistance (ODA) - ODA could reach 0.3 percent of GNI in 2005, about double the 2004 ratio. - Italy committed to “make every effort” to reach a level of 0.5 percent of GNI for ODA in 2010 as intermediate toward 0.7 percent of GNI. ### Policy recommendations (summarized explicit and implied) - Implement significant expenditure-based fiscal consolidation to secure debt sustainability; aim for overall budgetary balance by 2010. - Adopt targeted medium-term budget framework and realize structural spending cuts of about ¾ percentage point of GDP annually (structural terms). - Strengthen expenditure controls (SIOPE rollout, monthly monitoring, strengthened CONSIP procurement, reinforced Internal Stability Pact, stronger Court of Auditors role). - Pursue broad-based structural reforms to reduce product and service market rigidities, liberalize markets, and improve business environment (eliminate restrictive professional rules, implement EU services directive, deregulate network sectors, reduce government presence in enterprises). - Advance labor market reforms and social safety net overhaul (better conditional unemployment support; greater wage variation in line with productivity; enhance human capital). - Implement pension measures (adjust replacement rates in line with life expectancy) and promote private pension savings (second pillar implementation). - Address FSAP-identified financial sector issues: move to 90-day classification rule for nonperforming loans, tighten loan classification standards, regulate lending to related parties, reduce operating costs, and enhance contestability including facilitation of foreign entry. - Enhance fiscal transparency: timely budget documentation, independent fiscal analysis entity or strengthened Corte dei Conti, transparent recording of PPPs and contingent liabilities. - Resist protectionist trade pressures; pursue multilateral trade liberalization. *Source: IMF staff Executive Summary and Staff Report (Italy Article IV consultation) as provided in the supplied content.* ### Executive Summary ...................................................................................................... ### Executive Summary ### Overview and Key Issues - A mild cyclical recovery is underway, but medium-term prospects are troubling. - Potential growth is estimated at just 1¼ percent annually. - The fiscal deficit exceeded 4 percent of GDP in 2005 and the public debt ratio is on the rise again (debt ratio increased in 2005, to over 108 percent of GDP). - Significant expenditure-based fiscal adjustment and broad-based structural reforms are essential to ensure fiscal sustainability and enhance competitiveness and potential growth. - Staff and authorities concurred on the need for durable expenditure-based fiscal adjustment and structural reforms in product, services, and labor markets, though emphases differed and a broad reform consensus has yet to emerge. ### Short-term Outlook and Risks - A cyclical recovery is expected to continue in 2006. - Growth was estimated to have been just above zero in 2005; projected growth of about 1½ percent in 2006. - Sluggish demand should keep inflationary pressures in check. - The widening output gap was estimated by staff at 2½ percent of GDP in 2005. - The external sector had sapped a cumulative 2 percentage points from output growth since 2001. ### Fiscal Policy and EDP Commitments - The authorities committed under the Excessive Deficit Procedure (EDP) to achieve a deficit of 3.8 percent of GDP in 2006. - Authorities introduced measures they believe sufficient to ensure an appreciable overperformance, but staff judged there is a significant risk that envisaged deep expenditure cuts will be difficult to sustain and envisaged some slippage from the EDP target. - The revised deficit target agreed under the EDP was 4.3 percent of GDP for 2005 (reflecting weaker-than-forecast growth, disappointing asset sales, and Eurostat-mandated reclassifications). - Debt dynamics: the debt ratio increased in 2005, to over 108 percent of GDP; deterioration in fiscal prospects led some agencies to downgrade the outlook for Italy’s sovereign debt rating. - Spreads relative to German benchmarks have doubled since Fall 2004, but remain very small in absolute terms. ### Medium-term Fiscal Sustainability - A more ambitious medium-term path of fiscal adjustment is critical for debt sustainability. - Staff simulations indicate reducing non-age related spending to a level consistent with achieving overall budgetary balance by 2010 is necessary for stable debt dynamics. - Realizing the required spending cuts will demand targeted expenditure reduction within a medium-term budget framework. - Required spending cuts quantified: about ¾ percentage point of GDP annually in structural terms. ### Structural Reform Agenda and Competitiveness - A bold structural reform agenda is paramount to boost long-term performance. - Recently-approved reforms include reforms to the codes for bankruptcy and civil procedures and a “savings law” that enhances corporate governance, disclosure and coordination among regulators. - Next steps recommended: measures to promote competition in product, service and labor markets, including through deregulation, liberalization, and an improved business environment. - Rigidities and inefficiencies remain central: measured product market regulation in Italy remains the strongest in the EU-15, distorting incentives and discouraging market entry and innovation. - Firm creation and destruction rates and low private R&D investment indicate limited structural transformation and low rates of knowledge creation and dissemination. - Since 1998 Italy’s ULC-based REER has appreciated by a cumulative 18 percent, compared to depreciations in Germany and France; real unit labor cost growth has been markedly greater than that of France and especially Germany. - Nominal wage growth has moderated but productivity fell over 2001–04, contributing to competitiveness losses. - Employment growth has been concentrated in sectors less exposed to external competition. ### Pension and Other Structural Reforms (Box 1 highlights) - Pension reform: a “framework law” on pension reform was approved in August 2004; a measure establishing a second pillar pension scheme for private sector workers was approved in November 2005 but implementation delayed until 2008. - Fund assessment: Fund had supported pension reform and measures to promote private savings. - Competition and business environment: a “competitiveness decree” approved in 2005 and a long-pending bankruptcy law reform were approved by Parliament in December 2005. - Labor market reforms: employment protection indicators have improved; first part of a framework law on employment and the labor market approved in June 2003, second part remains to go forward. - Corporate governance: legislation strengthening corporate governance, corporate bond issuance, and coordination among regulatory agencies was passed by Parliament in December 2005. ### Financial Sector and FSAP Findings - The Financial Sector Assessment Program (FSAP) found that Italy’s financial system is generally sound. - The banking sector has proven resilient to slow growth; stress tests revealed little vulnerability going forward. - FSAP-identified issues include loan classification standards, regulation of lending to related parties, and relatively high operating costs. - The mission raised concerns about the Bank of Italy’s governance structure and potential conflicts of interest arising from the Bank’s joint mandates for banking sector stability and competition; these have been substantially addressed by amendments to the savings law approved in late-December. ### Policy Recommendations (implied and explicit) - Implement significant expenditure-based fiscal consolidation to secure debt sustainability. - Adopt a targeted medium-term budget framework to realize structural spending cuts of about ¾ percentage point of GDP annually. - Pursue broad-based structural reforms to reduce product and service market rigidities, liberalize markets, and improve the business environment to raise potential growth above the estimated 1¼ percent annual rate. - Implement measures to strengthen corporate governance, disclosure, and regulator coordination. - Address FSAP-identified financial sector issues: tighten loan classification standards, regulate lending to related parties, and reduce operating costs in the banking sector. - Continue reforms to enhance competition and labor market flexibility; implement remaining elements of the employment and labor market framework law. *Source: IMF staff Executive Summary (Italy Article IV consultation).* ### 9. A mild cyclical recovery appears at hand. The strength—and breadth across ### _cr0660 - 9. A mild cyclical recovery appears at hand. The strength—and breadth across ### Cyclical outlook and growth projections - A mild cyclical recovery appears at hand after four years of disappointing economic performance; the strength—and breadth across demand components—of the 2005:Q2 outturn had surprised most analysts. - At the time of the mission, most forecasters projected annual output growth of about ¼ percent for 2005; subsequent weaker-than-expected 2005:Q3 outcomes led most forecasters—and the staff—to reduce estimates to barely above zero. - Staff forecast for 2006: - Growth of about 1½ percent, in line with the budget projection and slightly above the consensus forecast of 1.3 percent. - Implies average quarterly growth of about 0.3 percent, equal to the 2005:Q3 outturn. - Sectoral contributions projected for 2006: - Private consumption: expected to remain resilient, accelerating slightly relative to 2005 but staying within the narrow range posted since 2003. - Net exports: strong global demand projected to lead to an improved contribution from net exports; gains in external competitiveness are not expected as firms likely to take advantage of somewhat slower ULC growth to restore margins. Italy is projected to continue to lose market share. - Gross fixed investment: with rising business confidence and healthy corporate balance sheets, an improved external contribution is forecast to encourage a recovery of productive investment, which has been languishing. ### Downside risks to the recovery - Nascent cyclical recoveries have turned into false starts; downside risks are appreciable. - Main risks identified: - High international oil prices seen as the main risk to growth. - Impact of an increase in interest rates. - Possible renewed euro strength. - Policy slippages negatively affecting confidence and ratings agencies’ evaluations. - Continued benign behavior of spreads cannot be assumed indefinitely in the absence of adjustment and reform. ### Inflation outlook - Inflation expected to remain moderate. - Little evidence that high oil prices have generated significant second-round effects on prices. - Large flow of low-priced imports from emerging markets has helped contain inflation, even against some euro weakness. - Concern: positive inflation differential relative to the euro area despite Italy’s sizable output gap raises concerns about possible underlying inflationary pressures. ### Fiscal policy 2005–06: achievement of EDP commitments - 2005: - The 2005 deficit target of 4.3 percent of GDP is likely to have been achieved, but margins were expected to be tight. - Tax revenues performed relatively well despite unfavorable economic conditions. - Indications that spending discipline had weakened later in the year. - A budget amendment in October introduced additional spending cuts and revenue measures amounting to just over 0.1 percent of GDP. - Delays in renewing some public sector wage contracts would push fiscal impact into 2006. - Achievement of the deficit target would entail a small improvement in the underlying fiscal position (about ¼ percent of GDP as measured by the change in the cyclically-adjusted primary balance net of one-off measures). - Current primary spending was projected to rise by about 0.7 percent of GDP in 2005. - 2006: - Authorities repeatedly strengthened the 2006 budget to secure the EDP deficit target of 3.8 percent of GDP. - The final 2006 budget contains measures officially estimated to yield about 1.9 percent of GDP. - Authorities now project the 2006 deficit at 3.5 percent of GDP. - Staff concerns: underlying expenditure dynamics underpin doubts about achieving the 3.8 percent of GDP target in 2006. - Staff central forecast: deficit of 4.0 percent of GDP in 2006. - Staff fiscal uncertainty range: between 3¾ percent and 4¼ percent of GDP, depending on details of 2005 outcome. - Specific staff concerns about expenditure realism in 2006 budget: - Deep cuts in central government current spending envisaged, but difficult to enforce and sustain without changes in underlying determinants, especially after within-year cuts in 2004 and 2005 which typically resulted in spending rebounds. - Rigorous expenditure control at the local level assumed, particularly for health care; success in curbing health care costs was elusive and only mixed progress was made in 2005. - Deep cuts in current and capital transfers to some state enterprises (notably ANAS and the railways) could prove unrealistic without meaningful corporate restructuring and could generate off-budget liabilities. - Final budget raised revenue estimates—in some cases excessively, in the staff’s view. - Authorities’ response and measures: - Argued original revenue forecasts were conservative. - Introduced refinements to the 2005 nominal cap on spending growth to allow greater differentiation across spending categories. - Implemented initiatives to contain health care costs, including introduction of a national health card (tessera sanitaria) to improve controls and reduce fraud, and mechanisms to increase accountability among local governments for health spending overruns; sanctions for such overruns strengthened. - Expected limited risk associated with cuts in transfers to state enterprises, anticipating enterprises would adjust spending or that cuts could spur asset sales not incorporated in budget projections. - Noted corrective measures could be introduced over the course of 2006 if necessary. - Authorities investigating mobilization of state asset holdings to reduce public debt (details not available at time of writing). - Notes: - Footnote: staff expects a shortfall in yield of the so-called concordato (a tax assessment and settlement procedure covering pending tax liabilities 2003-04 and those for future years 2006-08), which is partly one-off in nature; yields from past similar schemes fell short of expectations. - In February 2006, the European Commission is to adopt a recommendation as to whether “effective action” has been taken to resolve Italy’s excessive deficit. ### Fiscal sustainability and long-term projections (Box 2) - Staff baseline scenario assumptions: - Current policies maintained through 2010; thereafter revenue and non age-related spending remain constant as percentages of GDP. - Age-related (health and pension) expenditure reflects recent demographic projections and pension reforms since mid-1990s. - Assumes increases in labor productivity growth to 1¼ percent annually and an increase in the employment ratio by 5 percentage points. - Together these result in long-run annual real GDP growth of ¾ percent. - Baseline scenario noted as less optimistic than official projections (officials assume annual productivity growth of 1¾ percent and cumulative employment ratio increase of more than 10 percentage points). - Baseline assumption on health care spending links age-adjusted per capita consumption of health services to growth of GDP per capita. - Baseline outcome: - Fiscal deficit would decline marginally next few years but rise thereafter due to aging-related spending and later interest payments. - The debt ratio would exceed 300 percent of GDP in 2050. - Staff adjustment scenario: - Annual structural adjustment of 0.7 percent of GDP in 2007–10 through spending cuts, leading to overall structural balance by end of decade. - Assuming current and future reforms, productivity growth rises by ¼ percentage point relative to baseline starting from 2011. - Under this scenario, savings on interest bill finance increases in aging-related spending, debt-to-GDP ratio falling to around 50 percent by 2030 and then stabilizing. - Stress test scenarios relative to baseline include: - (i) Implementation of authorities’ Stability Program update achieving overall fiscal deficit reduced to 1½ percent of GDP by 2009. - (ii) Same fiscal adjustment path as (i), but with higher productivity growth matching staff’s adjustment scenario. - (iii) More optimistic productivity growth based on authorities’ assumptions, but with current fiscal policies. - (iv) Failure to implement scheduled adjustments in pension replacement rates in line with life expectancy developments. - Each scenario yields sizable increase in the debt ratio in the long run. - Conclusion: results underscore dual importance of reforms to increase potential growth and early action to address fiscal problems. ### Fiscal consolidation strategy and risks from devolution - Authorities agreed consolidation needs to be based on expenditure containment given trend growth of spending since late 1990s. - Primary current spending rose at an average annual rate of 2 percent in real terms over last several years. - Italy largely squandered fiscal dividend associated with euro participation. - Staff recommendation: better-targeted approach focused on expenditure reduction within a medium-term budget framework; suggested areas of savings: - Cuts in subsidies to firms. - Rationalization of public employment. - Further steps to control health care costs. - Reforms to enhance efficiency of public procurement. - Planned implementation of SIOPE (integrated data management system to track cash outlays) expected to provide a powerful tool for monitoring spending and facilitating budgeting. - Devolution risks: - Ongoing devolution of functions from central government remains a source of risk in absence of a properly-designed system of fiscal federalism. - High Commission on fiscal federalism completed mandate and issued a report, but no major changes planned ahead of elections. - Internal stability pact governing local government fiscal policies was changed in the 2006 budget, negatively affecting predictability and ownership by local authorities. - Staff observed fiscal federalism arrangements incomplete until increased spending responsibilities are paired with mechanisms allowing local governments to raise own taxes and create incentives for fiscal responsibility. ### Structural reform agenda and competition - Diagnosis: protracted slow productivity growth at heart of Italy’s poor economic performance; sustained reforms to stimulate competition and facilitate market entry essential to accelerate potential growth. - Medium-term national action plan submitted in line with reformed Lisbon agenda, grouping priority initiatives into five areas: (i) liberalization of individual and enterprise activity; (ii) research and development; (iii) human capital; (iv) infrastructure; and (v) environment. - Mission suggested emphasis on low-cost, high-benefit initiatives (e.g., liberalization and implementation of the EU services directive) ahead of high-budget items (research and infrastructure). - Product market regulation and barriers to competition: - Italy’s poor showing on indicators of product market regulation suggests substantial scope to eliminate barriers discouraging market entry and innovation. - Cumulative cost increases for services in Italy have outstripped those in France and Germany, despite Italy’s lower productivity growth (table: Cumulative Cost Increases for Services, 2001-04: Italy: Financial Services 34.5, Insurance Services 28.8, Professional Services 10.0, Total 8.7; France: Financial Services 6.4, Insurance Services 11.2, Professional Services n/a, Total 5.3; Germany: Financial Services 20.0, Insurance Services 8.7, Professional Services n/a, Total 4.4). - Specific competition issues and staff recommendations: - Professional services: rules inhibit competition (bar nonprofessionals from performing nontechnical services, establish minimum tariffs for certain activities, prohibit advertising). Closed associations (ordini) constitute formidable barriers; most professional services fall outside antitrust jurisdiction. Staff called to eliminate these restrictions. - Retail trade: competition-inhibiting restrictions and protection for certain sectors (e.g., pharmacies). Competencies largely devolved to lower levels of government; staff urged central government to proactively use remaining responsibilities to promote competition. - State presence in enterprises: despite divestment, state holds controlling shares in many enterprises (notably energy and transport); most local utilities remain public. Authorities plan to abandon “golden shares” in some enterprises but intend to replace them with “poison pill” arrangements. Staff noted continued public presence reduces incentives to resist cost pressures and innovate. - Regulatory authorities: Antitrust Authority proactive and well-regarded, but regulatory authorities in certain key sectors play insufficient role in promoting competition. Staff advocated enhanced powers and expressed concern about political influence in nomination procedures and plans to terminate their financing from the budget. - Financial sector: greater market contestability—including by foreign entrants—would make the sector more dynamic, yielding significant efficiency gains and helping reorient a predominantly relationship-based system that tended to favor incumbents over new entrants. Authorities thought staff overstated benefits of foreign presence, though they agreed on desirability of increased competition and efficiency. *Italic: IMF staff report content provided in the supplied source excerpt.* ### 23. Cross-country indicators point to a need to improve the business environment, ### _cr0660 - 23. Cross-country indicators point to a need to improve the business environment, ### Cross-country indicators and business environment - World Bank and other international data indicate significant problems including slow legal processes and substantial bureaucratic requirements; authorities expressed reservations about applying cross-country data. - Legislative measures in final stages (passed by Parliament in December 2005) include: - Overhaul of the bankruptcy law to simplify procedures and provide debtors with a fresh start. - Reform of civil procedures to accelerate legal processes. - Selected World Bank Doing Business Indicators (as presented): - Cost of Starting a Business (in pct per capita GDP)15.76.8 - Rigidity of Employment Index 1/57.036.1 - Legal Framework to Facilitate Lending 2/3.06.3 - Time Needed to Enforce Contracts (days)139019.5 - Cost of Foreclosing a Business (pct of estate value)22.07.4 - Staff work highlights the importance of differences in institutional quality, product market regulation, and tax rates in explaining national and regional growth rates in the EU. ### Labor market and employment - Recent reforms have brought Italy’s level of employment protection close to the advanced economy average; more fundamental reform of labor market institutions is only in initial stages. - Historical effects of strong employment protection legislation: - Substituted for an adequate social safety net; benefited insiders. - Resulted in low participation rates, employment precariousness for outsiders, and disincentives to mobility and risk-taking. - Recent measures: - Enhanced unemployment compensation, including extending benefit collection periods. - Biagi reform package recognized; mission stressed need to complement with broader overhaul of employment-related social safety net and further liberalization of employment protection legislation. - Persistent issues: - EPL remains relatively stringent, contributing to still-low employment rates. - Labor unions argued that reducing employment protection would not create high value-added jobs without substantial increases in funding for education and worker training. - Italy falls short of the EU average in many measures of human capital. - New forms of contracting and employment growth: - Authorities noted beneficial impact of promoting part-time contracts and temporary agencies (“staff leasing”). - Statistical agency work suggested up to three quarters of the rise in employment since the start of 2003 came from increases in the working age population (likely from regularization of immigrants already in Italy) rather than from growth in the employment rate. - Other measures: - Steps to link regional databases of job openings to improve transparency and national labor market efficiency and to reduce regional disparities in unemployment rates. - Staff continued to call for greater regional wage variation in line with productivity differences; resistance remained. ### Financial sector: soundness, issues, and competition - Overall assessment: - The 2005 Financial Sector Assessment Program (FSAP) found Italy’s financial system generally sound; banking sector resilient to slow growth; stress tests indicate little vulnerability to unfavorable macroeconomic shocks. - Specific FSAP issues to address: - Relatively lenient loan classification standards complicating assessment of banks’ financial health; Bank of Italy undertaking measures to align the definition of impaired loans with the standard 90-day past due criterion (moving to 180-day and ultimately to 90-day). - Insufficient regulation of lending to related parties; interministerial committee approved broad guidelines, paving way for Bank of Italy regulations. - Stress tests suggested some vulnerability to liquidity risk; liquidity indicators broadly in line with other European countries but liquidity buffers have decreased. - Revelations of financial improprieties in recent takeover attempts point to need for greater vigilance in enforcement. - Competition and efficiency: - Views diverged on market contestability; several indicators suggest competition similar to other large European economies but core banking service prices remain high and efficiency gains from the common currency have been small. - European Commission surveys show higher dissatisfaction with quality of banking services than elsewhere in Europe. - Bank of Italy cautioned individual country circumstances matter when evaluating cross-country indicators (e.g., high fees weighed against large number of interest-bearing and joint accounts; share of system owned by foreign entities comparatively high but mostly minority positions). - Box 3 FSAP specific findings (excerpted): - Market contestability in banking is limited and foreign entry has proven difficult; further consolidation with strong foreign partners could enhance competition and lower pricing. - Italian banks exhibit structurally higher nonperforming loans compared to other leading European countries despite more lenient loan classification standards; accelerate convergence to 90-day past due criterion. - Limited regulation of lending to related parties creates uncertainty; staff supports plans for enhanced regulation. - Liquidity buffers decreased; stress tests revealed some vulnerability to liquidity risk. - Box 4 on competition (methods and findings summary): - Four approaches used to assess competition: profitability-based indicators (Lerner), revenue elasticity (Panzer-Rosse), price (net interest margin), and costs of services/switching costs. - Findings: - Competition intensified in loan and deposit markets; banks do not seem to face markedly less competition than in other large European countries. - Concentration increased at national level (83 bank groups), but sharp rise in branches since 1990 increased provincial/regional competition. - Cross-country indicators suggest monopolistic competition; degree of competition not dissimilar to comparable euro area countries. - Competition not reflected in pricing of core services; international surveys show average price of basic banking services among highest in Europe. - One study found average price of holding a current account in Italy some 23 percent higher than the unweighted average for the EU countries surveyed. - Authorities concerned about high switching costs; Bank of Italy investigating in cooperation with the anti-trust authority. ### Institutional arrangements, governance, and legislative changes - Controversy over Bank of Italy conduct in response to two cross-border takeover bids revived debate on potential conflicts among mandates to maintain financial stability, enforce antitrust laws, and promote efficiency/competitiveness. - Staff suggested consideration of shifting responsibility for competition to another authority; government amended savings law giving Bank of Italy and the antitrust authority joint responsibility for bank mergers and acquisitions and transferring responsibility for other anticompetitive behavior fully to the antitrust authority (mid-December). - Savings law governance changes: - Caps the governor’s lifetime mandate. - Increases transparency via semiannual reports to Parliament and Government. - ECB Governing Council reviewed reforms favorably and recommended additional enhancements: extend fixed term to all directorate members, increase collegiality, safeguard central bank independence in planned transfer of ownership to public sector. - Government amendments reflected ECB recommendations: limit governor’s tenure to a maximum of two six-year terms, change nomination and dismissal procedures, institute collegiality in decision-making; planned ownership transfer shelved for three years. - Savings law also includes provisions to enhance non-bank financing: - Advances in corporate governance, marketing and issuance of corporate bonds, and coordination among regulatory agencies. ### Pensions, household savings, and financial instruments - Major reform to encourage private pension savings effectively delayed until 2008. - Reform allows workers to redirect firm-based severance payment fund contributions toward privately-managed retirement schemes. - Measure passed in late November but will take effect only in 2008; further modifications possible. - Delay due to concerns over fiscal costs and level playing field among private pension providers. - Rationale: - Italian household sector has high housing wealth and low debt; creation of more flexible financial instruments/products could help meet savings and investment needs, including retirement. - Increased private pension saving seen as essential over the medium term given impact of recent public pension reforms on benefits. - Staff analysis suggests household sector likely to smooth future impact of pension reforms through greater asset accumulation. - Large number of self-employed remain without private pension coverage; future reforms needed to encourage retirement savings among this population. ### Fiscal transparency and public financial management - Staff repeatedly pointed to opacity of Italy’s budget presentation; issues acute in 2005 when “non-current policy” items (notably real estate sales) were initially included in the trend deficit (tendenziale), necessitating amendment and complementary measures to substitute for asset sales. - Key concerns: - Key budget documents available only with considerable delay. - Up-to-date financial data on some important state enterprises not widely disseminated. - Authorities noted issues often relate to timely availability of data rather than transparency per se. - Joint work by the Ministry of Economy, the Bank of Italy, and the statistical authority narrowed unexplained gaps between cash and accrual deficits. - Staff recommendations: - Need for improved fiscal governance mechanisms, including establishing an entity to provide independent analysis of fiscal developments, building on work by the Court of Auditors (Corte dei Conti) and other bodies. - Authorities reluctant to create another independent authority; saw scope for enhancing powers of the Corte dei Conti. - Staff considered extending the Court’s mandate to include regular ex ante scrutiny of the budget process and developments (not solely ex post auditing) and strengthening staffing accordingly. - Public-Private Partnerships (PPPs): - Recent initiatives to promote PPPs in infrastructure could increase efficiency of public spending. - Mission emphasized care to ensure transparency in recording these operations and associated contingent liabilities in budget documents. - PPPs should be implemented only when they result in higher spending efficiency and balanced allocation of risks, not to evade budgetary restrictions. ### Other issues - Authorities committed to reducing barriers to international trade through a multilateral approach. - Impact on sectors: - Italian textile firms severely affected by elimination of export quotas under the Multi-Fiber Agreement; authorities welcomed accords providing breathing space for adjustment. - Losses to Italian firms from counterfeiting were sizable. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0660.pdf* ### 35. Official development assistance remains low, but was projected to rise in 2005. ### _cr0660 - 35. Official development assistance remains low, but was projected to rise in 2005. ### Official development assistance (ODA) - ODA could reach 0.3 percent of GNI in 2005, about double the 2004 ratio. - Italy has committed to “make every effort” to reach a level of 0.5 percent of GNI for ODA in 2010, as an intermediate objective toward the medium- to long-term goal of 0.7 percent of GNI. - The authorities’ commitment to raise relatively low ODA is welcomed. ### Macroeconomic context and near-term outlook - Past policy failings (repeated fiscal slippages and reliance on one-off measures) have produced a deficit appreciably above the 3 percent of GDP ceiling under the SGP, inhibiting rapid reduction of public debt, which is rising again. - Short-term outlook: growth expected to rise to about 1½ percent in 2006. - Staff view: early, decisive progress on medium-term challenges must be the next government’s key economic priority. ### Fiscal performance, targets, and execution - The package of expenditure cuts and revenue measures for 2005 gives reasonable confidence that the deficit target of 4.3 percent of GDP was achieved, although with tight margins. - The 2006 budget has been appreciably strengthened since its initial presentation and is based on a realistic macroeconomic scenario; it calls for adjustment mainly via expenditure containment rather than tax increases or significant one-off measures. - Current-year EDP deficit target: 3.8 percent of GDP — underlying expenditure dynamics could compromise achievement of this target. - Targeted reduction of the deficit to below 3 percent of GDP by 2007 is judged insufficient to ensure sustainability of the public debt. - Recommendation: establish a path of medium-term deficit reduction sufficient to achieve overall balance by 2010, before the end of the next legislature. - Adjustment credibility: should be centered on expenditure containment, addressing the steady rise of primary current spending. - Pension policy: adjust pension replacement rates every decade in line with developments in life expectancy, as mandated under the 1995 reform; current delays are of concern. - If developments indicate slippages from targets, corrective measures should be taken in a timely manner, notwithstanding the electoral calendar. ### Expenditure control and public-sector reforms - Deep cuts in spending at the central and local government levels could prove difficult to implement, especially for health care. - Reductions in transfers to state enterprises will be unsustainable absent credible corporate restructuring. - Firm execution of spending and careful monitoring of outcomes are essential. - Nationwide rollout of SIOPE should contribute meaningfully to expenditure monitoring and should continue to be fully supported. - Fiscal planning practice concern: use of a non-transparent tendenziale as the budget baseline undermines clarity of fiscal plans. - Recommendation: seek an institutional mechanism able to provide regular, independent evaluations of budget proposals and trends at the behest of Parliament, via a new entity or reinforcement of existing institutions. ### Structural reforms and competitiveness - Diagnosis: failure to liberalize product and services markets contributed to economic stagnation and a rigid productive structure; long-standing advantage in relatively low-tech products eroded by emerging market competition and steady domestic cost increases. - Imperative: broad-based structural reforms and medium-term fiscal consolidation to create a more robust, flexible, and dynamic economy. - Recent reforms passed before end of legislative session include: overhaul of the bankruptcy code; new and accelerated civil procedures; a savings law with advances in corporate governance, marketing and issuance of corporate bonds, coordination among regulatory agencies, and changes to Bank of Italy governance and accountability. - Recommendations for the next government: - Make an unequivocal commitment to reforms that enhance competition, reduce price mark-ups, and promote freedom of choice for consumers. - Focus on product and services markets to complement labor market reforms. - Eliminate rules in the professions that inhibit competition. - Rapidly implement the EU services directive, when finalized. - In retail trade, use remaining state competencies to promote consumer welfare through greater competition. - Further deregulate network sectors, move away from “golden shares” and “poison pills,” and enhance powers for antitrust and sectoral authorities. - Pursue reforms to improve the business environment; many such reforms have low budgetary costs and can be pursued despite tight fiscal positions. - Product market reforms that increase domestic competition can help shield the impact of continued wage moderation on workers’ real incomes. ### Labor market and human capital - Commendable progress: labor market reforms reduced employment protection and introduced more flexible contracting, supporting employment growth. - Recent initiatives to improve the unemployment compensation system are positive and should be the first step toward a more thorough overhaul. - Recommendations: - Offer better and properly conditional unemployment support in concert with a further relaxation of employment protection legislation. - Facilitate movement of labor to more productive uses. - Allow greater variation of wages in line with productivity differences to redress competitiveness losses in the short term. - Advance progress in enhancing human capital. ### Financial sector and institutional arrangements - FSAP assessment: Italy’s financial system is generally sound but exhibits structural weaknesses that constrain growth promotion, including limited market contestability (notably for foreign contenders); high operational costs, fees and commissions; undersized corporate bond and equity markets; and a relationship-based orientation favoring incumbents. - Authorities have taken steps on some FSAP issues and should move promptly on the others. - Institutional reform: assign banking competition issues to the antitrust authority to address potential conflicts between stability and competition in the previous arrangement. - Preparatory efforts to transfer expertise and resources to the antitrust authority are essential. - Maintain a high level of independence for the antitrust authority and establish clear division of responsibilities and distinct accountability between it and the Bank of Italy. - Envisaged changes to the Bank of Italy’s governance structure, in line with ECB recommendations, are welcome. ### Trade policy and statistics - Authorities should resist pressures for increased trade protection, particularly for textiles, apparel and footwear. - Economic statistics: broadly adequate for surveillance, but there is a glaring need to improve transparency and timeliness of fiscal data and documentation. *Source: IMF staff appraisal text (excerpt provided).* ### 49. It is proposed that the next Article IV consultation take place on the standard 12- ### _cr0660 - 49. It is proposed that the next Article IV consultation take place on the standard 12- ### Article IV timing - It is proposed that the next Article IV consultation take place on the standard 12-month cycle. - Italy is on the standard 12-month consultation cycle; previous discussions took place during October 27–November 10, 2004, and the staff report (Country Report No. 05/44, 02/10/05) was discussed on February 7, 2005. ### Macroeconomic overview (selected indicators) - Real GDP (change in percent): 2001: 1.8; 2002: 0.4; 2003: 0.3; 2004: 1.2; 2005: 0.1; 2006 (staff proj): 1.5 - Total domestic demand (change in percent): 2001: 1.4; 2002: 1.2; 2003: 1.2; 2004: 1.0; 2005: 0.7; 2006: 1.3 - CPI (average): 2001: 2.3; 2002: 2.6; 2003: 2.8; 2004: 2.3; 2005: 2.3; 2006: 2.3 - Unemployment rate (in percent): 2001: 9.5; 2002: 9.0; 2003: 8.7; 2004: 8.5; 2005: 8.1; 2006: 7.8 - Gross national saving (in percent of GDP): 2001: 19.6; 2002: 19.2; 2003: 18.1; 2004: 18.9; 2005: 18.5; 2006: 19.2 - Gross domestic investment (in percent of GDP): 2001: 19.7; 2002: 20.0; 2003: 19.5; 2004: 19.8; 2005: 20.4; 2006: 21.1 ### Public finance and fiscal stance - General government balance (in percent of GDP): 2001: -3.2; 2002: -2.7; 2003: -3.2; 2004: -3.2; 2005: -4.3; 2006: -4.0 - General government debt (in percent of GDP): 2001: 110.9; 2002: 108.3; 2003: 106.8; 2004: 106.5; 2005: 108.7; 2006: 108.4 - Table 2 fiscal composition (selected items, percent of GDP): - Total revenues (staff/auth. lines): 2001: 45.7; 2002: 45.3; 2003: 46.0; 2004: 45.2; 2005: 44.8; 2006: 44.8 - Total expenditures: 2001: 48.8; 2002: 48.1; 2003: 49.2; 2004: 48.5; 2005: 49.1; 2006: 48.6 - Wages and salaries: 2001: 10.8; 2002: 10.8; 2003: 11.1; 2004: 11.0; 2005: 11.1; 2006: 11.2 - Interest payments: 2001: 6.5; 2002: 5.8; 2003: 5.3; 2004: 5.1; 2005: 5.0; 2006: 5.0 - Overall balance (Table 2): 2001: -3.2; 2002: -2.7; 2003: -3.2; 2004: -3.2; 2005: -4.3; 2006: -4.3 (staff/auth. variants shown) ### Debt sustainability projections (Table 5 summaries) - Public sector debt (baseline paths shown): - Historical: 2003: 106.8; 2004: 106.5; 2005: 108.7; 2006: 108.4 - Long-run projections (baseline variants by scenario): 2020: 123.3 / 89.8 / 69.6 (different scenarios); 2030: 164.6 / 98.4 / 53.2; 2040: 242.0 / 132.2 / 51.1; 2050: 339.9 / 178.0 / 50.7 - Overall balance (in percent of GDP) projection snapshots: - Historical/near term: 2003: -3.2; 2004: -3.2; 2005: -4.3; 2006: -4.0 - Long-run examples: 2020: -6.0 / -2.2 / 0.1 (across scenarios); 2030: -9.9 / -4.5 / -0.7; 2040: -14.8 / -7.4 / -1.5; 2050: -19.4 / -9.4 / -1.1 - Pension spending (in percent of GDP): historical 2003: 14.2; 2004: 14.3; 2005: 14.4; projected ranges to 2050 include 15.4, 16.9, 17.8, 17.3 depending on scenario. - Health care spending (in percent of GDP): historical 2003: 6.2; 2004: 6.5; 2005: 6.7; projected to 2050: 7.1, 7.6, 8.0, 8.3 across scenarios. ### Key macroeconomic and fiscal assumptions used in projections - Real GDP growth (in percent): historical/proj sequence includes: 2003: 0.3; 2004: 1.2; 2005: 0.1; 2006 onward baseline: 1.5, then 1.7 (several years), then long-run values ranging 1.0 to 0.5 to 0.8 depending on horizon and scenario. - Real GDP per capita growth (in percent): 2003: -0.3; 2004: 0.3; 2005: -0.5; 2006 onward baseline: 1.4, 1.6, 1.6, ... long-run values 1.0, 0.7, 0.5, 0.8 etc. (scenario-specific listings provided in Table 5). - Employment rate (in percent): 2003: 57.5; 2004: 57.5; 2005: 58.2; projections gradually rise to 63.3 by 2050 in some scenarios. - Average nominal interest rate on public debt (in percent): 2003: 5.1; 2004: 5.0; 2005: 4.8; projected around 4.5–4.7 in near term and 5.1 in long run scenarios. - Average real interest rate (in percent): 2003: 2.1; 2004: 2.3; 2005: 2.2; projected around 2.0–2.6 and 3.0 in long run. ### Financial sector soundness (Table 3 highlights) - Capital adequacy (regulatory capital to risk-weighted assets): 2001: 10.4; 2002: 11.2; 2003: 11.4; 2004: 11.6; 2005: 11.6 - Nonperforming loans (share of total gross loans): 2001: 6.7; 2002: 6.5; 2003: 6.6; 2004: 6.5; 2005: 6.3 - Return on assets: 2001: 0.59; 2002: 0.50; 2003: 0.51; 2004: 0.65; 2005: 0.70 - Return on equity: 2001: 8.6; 2002: 7.1; 2003: 7.4; 2004: 9.4 - Liquidity: Liquid assets to total assets: 2001: 8.7; 2002: 7.8; 2003: 8.6; 2004: 8.4; 2005: 7.9 - Household debt to GDP - Italy: 2001: 22.9; 2002: 24.3; 2003: 26.0; 2004: 28.1 - Residential real estate prices (1990=100, deflated by CPI): 2001: 104.6; 2002: 114.6; 2003: 124.1; 2004: 131.9 - Residential real estate loans to total loans: 2001: 10.3; 2002: 12.0; 2003: 13.8; 2004: 15.7 ### External sector and balance of payments (selected indicators) - Trade balance (in percent of GDP): 2001: 1.4; 2002: 1.1; 2003: 0.8; 2004: 0.7; 2005: -0.3; 2006: -0.4 - Current account balance (in percent of GDP): 2001: -0.1; 2002: -0.8; 2003: -1.3; 2004: -0.9; 2005: -1.9; 2006: -1.9 - Exports of goods and services (in percent of GDP): 2001: 24.8; 2002: 24.8; 2003: 28.4; 2004: 32.3; 2005: 33.2; 2006: 32.8 - Imports of goods and services (in percent of GDP): 2001: 23.6; 2002: 24.0; 2003: 27.8; 2004: 31.3; 2005: 33.7; 2006: 33.4 - Net imports of oil (in bln. of U.S. dollars): 2001: 11.9; 2002: 12.4; 2003: 14.8; 2004: 19.1; 2005: 26.3; 2006: 29.8 - Foreign Direct Investment (net, in percent of GDP): 2001: -0.6; 2002: -0.2; 2003: 0.5; 2004: -0.1; 2005: 0.0; 2006: 0.1 ### Vulnerability and financial market indicators (selected) - Official reserves (U.S. dollars, billions, end-of-period): 2001: 24.4; 2002: 28.6; 2003: 30.4; 2004: 27.9; 2005: 26.6 (Nov) - Total external debt (in percent of GDP): 2001: 80.9; 2002: 90.7; 2003: 94.0; 2004: 93.1 - Total external debt to exports (ratio): 2001: 2.9; 2002: 3.5; 2003: 3.7; 2004: 3.6 - Public sector debt (Maastricht definition): 2001: 110.9; 2002: 108.3; 2003: 106.8; 2004: 106.5; 2005: 108.7 - 3-month T-bill yield: 2001: 4.1; 2002: 3.3; 2003: 2.2; 2004: 2.1; 2005: 2.2 (Nov) - Spread of 3-month T-bills with Germany (percentage points, period average): 2001: 0.4; 2002: 0.3; 2003: 0.2; 2004: 0.1; 2005: 0.0 (Nov) ### Data quality, statistical issues, and ROSCs - Italy subscribes to the Special Data Dissemination Standard (SDDS) and has posted metadata on the DSBB. - ROSC assessments and follow-ups: - Fiscal Transparency ROSC: October 9, 2002 (Country Report No. 02/231) - Data ROSC: October 18, 2002 (Country Report No. 02/234) - FSAP: February, 2006 (expected) - Identified data shortcomings (ROSC findings include): - No single statistical agency with responsibility to compile and disseminate a comprehensive statement of government finances; persistent difference between SGP-monitored fiscal deficit and PSBR net of privatization receipts. - Need to raise response rates on enterprise surveys used in national accounts and producer price index; improve CPI price collection efficiency; improve coverage of cross-border financial transactions. - Balance of payments and government finance statistics could be closer aligned with international methodological guidelines. - Resource pressures at the National Institute of Statistics given EU and Euro area statistical requirements. - Recent improvements noted: - Introduction in 2005 of regional price indices by Istat. - Publication of quarterly general government balance, expenditure, and revenue on an accruals basis starting in October 2003. - More detailed labor survey conducted by professional staff. - Progress in reconciling cash-based net borrowing requirement and accrual budget deficit through working groups (Bank of Italy, Ministry of Economy and Finance, Istat). - Remaining weaknesses: - Inventory accumulation in national accounts is derived as a residual and combined with statistical discrepancy, hampering business cycle analysis. - Quality and timeliness of some fiscal data, particularly local government expenditure, need improvement. - Shift to chain-weighted indices for national accounts was postponed until December (originally scheduled for March 2005). ### Fund relations and administrative details (as of November 30, 2005) - Membership status: Joined 3/27/47; Article VIII. - Quota (SDR million): 7,055.50 (100.00 percent). Fund holdings of currency: 5,512.50 (78.13 percent). Reserve position in Fund: 1,543.01 (21.87 percent). - SDR Department: Net cumulative allocation: 702.40 (100.00 percent). Holdings: 152.95 (21.77 percent). - Outstanding purchases and loans: None. Financial arrangements: None. - Projected obligations to Fund (SDR million; forthcoming totals): Principal: (not shown as positive entries); Charges/Interest: 16.47 16.53 16.58 16.53 (2006–2009); Total: 16.47 16.53 16.58 16.53 - Exchange rate arrangement: Italy entered the final stage of EMU on January 1, 1999, at a rate of 1,936.27 Italian lire per 1 euro. Exchange system free of restrictions on current international transactions except specified security-related restrictions notified to the Fund (listed Council Regulations, as provided). *Staff Report for the 2005 Article IV Consultation, February 1, 2006.* ### 1. This Supplement provides information that has become available since the issuance of ### _cr0660 - 1. This Supplement provides information that has become available since the issuance of ### Recent macroeconomic developments - Short-term indicators have been, on balance, disappointing: industrial production rose by 0.1 percent in November (month-on-month), and the October outturn was revised downward. - As a result, a number of forecasters downgraded their growth estimates for 2005; downside risks to the staff’s 2005-06 forecast have risen. - Positive signals: - Index of business confidence experienced its eighth consecutive monthly increase in January, reaching its highest level in nearly four years. - Harmonized consumer price inflation declined to 2.0 percent (year-on-year) in December, despite the rebound in oil prices. - On the basis of slightly stronger-than-expected preliminary revenue performance in 2005 and assuming downside risks to growth do not materialize, staff revised its central 2006 deficit forecast marginally to 3.9 percent of GDP, maintaining the range of uncertainty (+/- ¼ percent of GDP). ### Budget execution, enforcement measures, and risks - Authorities introduced steps to strengthen execution of the 2006 budget: - Enhanced monitoring systems, enforcement mechanisms, and sanctions—including for health spending. - Increased role of the Court of Auditors in evaluating subnational governments’ budget preparation and execution. - Effectiveness caveat: measures’ impact will depend on rigorous enforcement given past leniency vis-à-vis non-compliance with spending norms. - First enforcement test at end-March 2006: - Regions exceeding 2005 health spending limits to receive formal Prime Ministerial warnings to undertake corrective measures. - Failure to comply could lead to regional healthcare administration commissariamento (central government receivership). - Rates on some regional taxes would increase automatically with effect from end-May 2006, if steps prove necessary. - Implementation of the new savings law is progressing: - Antitrust authority opened an investigation into costs of banking services. - Revision of the Bank of Italy’s statute is underway to ensure compliance with the savings law. - Note: 2006 EDP deficit target mentioned in staff concerns is 3.8 percent of GDP (staff revised central forecast to 3.9 percent of GDP). ### IMF Executive Board assessment and policy recommendations - Growth outlook and inflation: - Consolidation of cyclical recovery expected; growth rising to about 1½ percent in 2006 from close to zero in 2005. - Inflationary pressures expected modest at just over 2 percent in 2006. - Medium-term potential growth estimated at 1¼ percent annually. - Fiscal stance: - 2005 fiscal deficit target of 4.3 percent of GDP is estimated to have been met. - Authorities committed to a deficit target of 3.5 percent of GDP for 2006. - Directors stressed credibility of fiscal adjustment under the EDP, cautious execution of spending plans, timely monitoring, and strict implementation of strengthened control and sanction mechanisms. - Directors urged discontinuation of amnesties and one-off measures. - Medium-term recommendation: commit to a path of medium-term deficit reduction sufficient to achieve overall balance by 2010. - Suggested focus on ambitious and targeted expenditure containment, particularly subsidies, public employment, and health care. - Directors noted sales of public assets could help reduce public debt and enhance efficiency. - Urged prompt adjustment of pension replacement rates as mandated. - Stressed need for a properly designed system of fiscal federalism to maintain budget discipline with devolution. - Called for enhanced transparency of budget presentation and timely availability of key budget documents and financial data on state enterprises. - Structural reforms and competitiveness: - Urged liberalization and deregulation to enhance competition, eliminate economic rents, and promote consumer choice; main focus on product and services markets. - Recommended freeing professional services from rules inhibiting competition, rapid implementation of the EU services directive when finalized, using central government role in retail trade to promote consumer welfare, further deregulation of network sectors, reduction of government predominant interest in privatized firms, and enhanced powers for antitrust and sectoral authorities. - Recommended improving business environment by reducing bureaucratic burdens and accelerating legal processes. - Welcomed the National Action Plan for Innovation, Growth, and Employment and urged timely implementation. - Labor market and social policy: - Welcomed strong employment growth from past labor market reforms but noted employment ratio remains very low. - Suggested further overhaul of unemployment compensation to provide better conditional support and more flexible labor legislation. - Recommended greater wage variation in line with productivity and greater regional wage flexibility to address regional employment disparities. - Encouraged strengthening education and training. - Financial sector: - FSSA: Italy’s financial system generally sound and well regulated; banking sector resilient to slow growth. - Identified issues: limited market contestability, high fees and commissions, loan classification standards, lending to related parties. - Directors recommended moving to a 90-day classification rule for non-performing loans. - Supported changes in Bank of Italy governance and transfer of anticompetitive responsibility to antitrust authority; stressed preserving independence and clear division of responsibilities. - Development and multilateral trade: - Welcomed Italy’s commitment to raise development assistance and promote trade liberalization through multilateral approaches. - Statistics and transparency: - Noted statistics adequate for surveillance; welcomed steps to address weaknesses from the 2002 ROSC. - Urged addressing remaining issues regarding transparency and timeliness of some fiscal data and documentation. ### Key statistics and projections (selected exact figures as presented) - Growth and real economy: - Real GDP: 2001 1.8; 2002 0.4; 2003 0.3; 2004 1.2; 2005 0.1; 2006 1.5 (staff estimate/projection). - Total domestic demand: 2001 1.4; 2002 1.2; 2003 1.2; 2004 1.0; 2005 0.7; 2006 1.3. - CPI (average): 2001 2.3; 2002 2.6; 2003 2.8; 2004 2.3; 2005 2.3; 2006 2.3. - Unemployment rate (in percent): 2001 9.5; 2002 9.0; 2003 8.7; 2004 8.5; 2005 8.1; 2006 7.8. - Public finance (in percent of GDP): - General government balance: 2001 -3.2; 2002 -2.7; 2003 -3.2; 2004 -3.2; 2005 -4.3; 2006 -3.9. - General government debt: 2001 110.9; 2002 108.3; 2003 106.8; 2004 106.5; 2005 108.7; 2006 108.3. - Money and credit (end of year, percent change): - Private sector credit (Twelve-month credit growth, adjusted for securitizations): 2001 7.0; 2002 6.2; 2003 7.0; 2004 5.9; 2005 8.8 (2005 data refer to July). - National contribution to euro area M3: 2001 6.0; 2002 8.1; 2003 6.7; 2004 8.1; 2005 8.7 (2005 data refer to October). - Interest rates: - 6-month interbank rate: 2001 4.3; 2002 3.3; 2003 2.3; 2004 2.1; 2005 2.5 (2005 data refer to November). - Government bond rate, 10-year: 2001 5.2; 2002 5.0; 2003 4.2; 2004 4.3; 2005 3.6 (2005 data refer to December). - Balance of payments (in percent of GDP): - Trade balance: 2001 1.4; 2002 1.1; 2003 0.8; 2004 0.7; 2005 -0.4. - Current account balance: 2001 -0.1; 2002 -0.8; 2003 -1.3; 2004 -0.9; 2005 -1.9. - External and Fund position: - Net imports of oil (in bln. of U.S. dollars): 2001 11.9; 2002 12.4; 2003 14.8; 2004 19.1; 2005 26.3; 2006 29.8. - Foreign Direct Investment (net, in percent of GDP): 2001 -0.6; 2002 -0.2; 2003 0.5; 2004 -0.1; 2005 0.0; 2006 0.1. - Fund position (as of December 31, 2005): - Holdings of currency (percent of quota) 82.6 - Holdings of SDRs (percent of allocation) 22.8 - Quota (millions of SDRs) 7,055.5 - Exchange rates: - Exchange rate regime: Member of EMU - Euro per U.S. dollar (January 30, 2006) 0.85 - Nominal effective rate (2000=100): 2001 100.4; 2002 101.6; 2003 105.8; 2004 107.2; 2005 106.5 (2005 data refer to November). - Real effective rate (2000=100): 2001 101.1; 2002 104.2; 2003 111.4; 2004 113.7; 2005 110.1 (2005 data refer to November). - Social and other indicators (selected): - GDP per capita, in U.S. dollars 2004 29,014 - Population density, inhabitants per square kilometer 2002 196.2 - Income distribution, ratio of income received by top relative to bottom quintiles 2001 5.1 - At-risk-of-poverty rate, persons (in percent) 2001 19.0 - Life expectancy (years at birth): males 2002 75.0; females 2002 81.9 - Illiteracy, percent of persons aged 15 and above 2002 1.5 - Gender pay gap, share of female versus male pay, in percent 1995 81; 2000 72.4; 2000 7.4 (as presented) *Summary based solely on the Supplement to the Staff Report and the IMF Public Information Notice and Executive Board conclusions contained in the provided content.* ### 1. Introduction ### 1. Introduction ### Introduction - Staff produced a very comprehensive report and conducted a successful mission. - Following the Art. IV consultation and extensive discussions with the European Commission (EC), the Italian authorities introduced additional measures to strengthen the 2006 Budget. - The deficit target for 2006 has been reduced to 3.5 percent of GDP, facilitating efforts to bring the deficit well below the 3 percent reference value by 2007. ### Economic Outlook - Slow growth in recent years has hampered fiscal adjustment. - Authorities committed to fiscal consolidation and completion of the structural reforms agenda. - A gradual recovery is under way and is expected to strengthen in 2006. - Main growth drivers: - Private consumption, fuelled by rising employment and gains in disposable income. - Investment rebound, particularly machinery and equipment. - Improvement in the foreign sector. - Inflation around 2 percent; the differential relative to the euro area average has been narrowing. - Macroeconomic scenario broadly in line with staff projections. ### The reform strategy - Faster economic growth will facilitate fiscal consolidation, but cyclical upturns will not resolve fundamental problems: low productivity and substantial loss of competitiveness. - Solution hinges on successful implementation of the reform agenda along the lines of the Lisbon Strategy. - Building on measures in labor market, pension system, and education, the agenda aims to foster greater competition and productivity in services and product markets. ### Fiscal Policy - Italy committed to respect the July 2005 EU Council recommendations: reduce the deficit below 3 percent of GDP by 2007. - Required correction: 1.6 percentage points in the cyclically-adjusted deficit (net of one-offs) over 2006-2007, with at least half of the correction to be achieved in 2006. - For 2005: - Authorities confident the deficit target of 4.3 percent of GDP will be achieved. - Preliminary data indicate the central government cash deficit was EUR 60 billion, 5 billion below original projections. - 2006 Budget: - Aims to reduce the deficit to 3.5 percent of GDP (0.3 percentage points below figure discussed with staff at time of mission). - Fiscal adjustment equals 1.4 percent of GDP: two-thirds expenditure cuts and one-third additional revenues. - Measures represent a correction of the cyclically-adjusted deficit, net of one-offs, of 0.9 percent of GDP. - Preliminary reactions from EU authorities are positive; formal assessment to be approved in a few weeks. - Stability Program for 2006-09: - Confirms target of reducing deficit to 2.8 percent of GDP in 2007. - Implies a further correction of 0.8 percent in the cyclically-adjusted deficit, net of one-offs. - Envisages reduction of the cyclically-adjusted deficit of 1.1 percent of GDP by the end of this decade. - This target is lower than the "minimum benchmark" necessary to respect the 3 percent reference value during normal cyclical fluctuations. - Debt-to-GDP ratio expected to decline to 101.7 in 2009. ### Strengthening the expenditure controls - Final 2006 Budget includes measures tightening administrative controls on expenditures of central administrations, local governments, and healthcare agencies. - Central Government measures: - Monthly monitoring of spending by each administration. - In the event of spending overruns, the head of the agency will be personally responsible for taking immediate corrective actions. - Procurement of goods and services for all administrations to be channeled through central agency CONSIP; CONSIP’s power strengthened to evaluate competitive bids and the merit of requests. - Local Government measures: - Internal Stability Pact reinforced by imposing strict ceilings for spending other than personnel costs and social outlays. - Compliance with budgetary guidelines by regional authorities monitored on a quarterly basis. - In event of healthcare expenditure overruns, the President of the Region has thirty days to take corrective measures; failing this, there will be a mandatory increase in regional taxation. - Health Care Agencies measures: - Ministry of Health launched a new system to closely track healthcare expenditures. - An electronic “health card” introduced to monitor individuals' expenditures and prevent fraud and waste. - Role of the Pharmaceutical Agency expanded to monitor spending on drugs and to contain related prices. - Court of Auditors (Corte dei Conti): - Role and capabilities strengthened. - Mandate extended to monitor finances of local governments and healthcare agencies. ### Ageing-related costs and fiscal sustainability - Authorities consider staff macroeconomic assumptions for long-term fiscal sustainability overly pessimistic. - Staff assumptions criticized: - For 2005-2050, staff assumes real GDP growth averaging 0.75 percent and productivity expected to average just above one percent. - Increase in public debt attributed to pessimistic macro assumptions rather than growth in age-related expenditures. - Authorities’ Stability Program assumptions (shared by EC): - Average real GDP growth of 1.3 percent. - Productivity rate increases gradually from current 0.7 percent to 1.7 percent in 2030 and thereafter. - Participation rate raises by 8 percentage points by 2050 (largely due to contribution of women). - Unemployment rate declines from current 8 percent to 6.4 percent by end of the period. - EC report "Age-related public expenditure for the EU25 Member States up to 2050": - Public pension spending in Italy expected to increase by 0.3-0.4 percent of GDP from 2005 to 2050. - Healthcare expenditures expected to increase by 1.4 percent over the same period, less than the EU average. ### Structural Reforms - Labor market performance during prolonged slow growth confirms effectiveness of past reforms. - Some improvement reflects regularization of illegal immigrants; past reforms increased labor market flexibility and facilitated women's participation. - Authorities agree on need to shift balance from employment protection to enhancing social safety net. - Pending approval by Parliament of second wave of labor market reforms, measures adopted in 2005 include increase in unemployment benefits and introduction of active labor market policies. - The Renewed Lisbon Agenda and PICO: - First national Plan for Innovation, Growth, and Employment (PICO) developed in accordance with the Renewed Lisbon Agenda. - Plan aims to streamline administrative procedures, liberalize services markets, and stimulate human capital accumulation. - Privatization: - 2005 privatization measures included additional 10 percent sale of ENEL capital stock, reducing government holdings to 31 percent. - Further asset sales amounting to 0.7 percent of GDP planned in 2006. - The ‘Poison pill’ provision introduced in 2006 Budget Law is stated as not a substitute for golden shares. - Law Reforming Bankruptcy Procedures: - Parliament approved reforms streamlining bankruptcy and civil procedures. - New Law on Bankruptcy: streamlines procedures; favors early access by reducing sanctions for bankrupt debtor; reinforces role of reorganization procedures; introduces possibility for debtors to negotiate out-of-court restructuring agreements to be submitted to bankruptcy judge. - Law on Savings: - Addresses corporate governance; role and capabilities of Supervisory Authorities; governance of the Bank of Italy including ownership structure, role of Board of Directors, and Governor’s term of office. - Objectives: improve corporate governance of listed companies, increase transparency, enhance consumer protection. - Consob’s resources and sanctioning powers increased; minority shareholders' rights enhanced; more stringent rules on external auditors introduced; compliance with Corporate Governance Codes reinforced. - Banks obliged to publish a full prospectus for unlisted bonds, approved by Consob. - Antitrust functions in banking sector transferred from Bank of Italy to Antitrust Authority. - Tighter rules introduced for prevention of conflicts of interest in connected lending. ### The Financial Sector - Both the Article IV staff paper and the FSSA conclude the Italian banking and financial sector is generally sound and well regulated. - Staff characterization of the banking system as fragmented, with small foreign bank presence in retail markets, weaker competition, and relatively high operating expenses and costs of services is disputed by authorities. - Consolidation: - In last decade, M&A involved target banks accounting for half of system’s total assets. - Value of banks’ M&A in 1996-2005 was higher in Italy than in other large continental countries. - Herfindahl-Hirschman concentration index increased by 40 percent between 1998 and 2004 (contrasted with 11 percent reported in IMF selected issues paper). - Consolidated market share of top five banking groups about 50 percent, in line with European average. - Foreign banks: - Foreign branches and subsidiaries account for 8 percent of banking system’s total assets, "similar to the share in other western European countries." - Foreign banks and other foreign investors are important members of shareholders' agreements controlling main Italian banking groups. - Foreigners hold an average of 16 percent of the capital of the four largest banking groups, a share higher than in other large continental countries. - Contestability and Competition: - Privatization in financial sector largely complete; all large and almost all medium-sized banks listed. - Indicators (number of banks in local markets, turnover in market shares, interest rate spreads) show competition has greatly increased and is comparable to other large European banking systems. - IMF empirical evidence and cited literature confirm increased competition; final staff appraisal appears to diverge from results of their own analysis. - Bank performance: - Operating costs relative to bank assets are relatively high in Italy but biased because Italian banks offer labor-intensive retail asset management services often provided by non-bank financial intermediaries elsewhere. - Interbank claims relatively low due to efficiency of screen-based markets. - Cost-income ratio comparison: 2004 Italian banks’ cost-income ratio almost 6 percentage points lower than euro-area average (per official ECB data). - Asset quality: flow of new bad debts averaged 1 percent of loans outstanding at beginning of year between 2001 and 2004. - By comparison, new bad debts were about 4 percent in early 1990s recession and remained above 2 percent until 1996. - Relatively high stock of non-performing loans partly due to length of bankruptcy procedures. - Authorities committed to implement the standard 90-day past-due classification before the transitory period allowed by the Basel committee (i.e. 2012). ### ODA - Italy fully shares EU commitment to reach an ODA-to-GDP ratio of 0.56 percent by 2010. - Authorities will make all efforts to meet, by the end of 2006, the target of 0.33 percent; this doubles the 2004 results and serves as an intermediate goal to achieving the target of 0.5 percent in 2010, as agreed in Barcelona and Monterrey. *Source: _cr0660 - 1. Introduction* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0660.pdf_