## _cr12167

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### Overview and recent developments
- Economy in recession since middle of 2011; GDP contracted for a third straight quarter, by 0.8 percent (q/q, s.a.) in Q1 2012.
- Contraction led by sharp falls in consumption and investment as concerns about the fiscal outlook and the euro area crisis depressed confidence and tightened credit conditions.
- Exports fell, but net exports contributed positively to growth due to sharp import compression.
- Household real disposable income continued to decline in 2011; consumer sentiment fell below levels in 2008–09.
- Unemployment rose to 10.2 percent in April 2012, with youth unemployment at 35 percent.
- Household sales are 25 percent below 2007 levels.

### Fiscal measures, consolidation and risks
- Government announced a third fiscal consolidation plan in December, bringing total adjustment for 2012–14 to around 5 percent of GDP.
- Fiscal targets and staff projections:
  - General government met its 2011 deficit target of 3.9 percent of GDP.
  - 2012 overall deficit projected to decline to 2.6 percent of GDP.
  - Staff macro assumptions: Primary balance would improve from 3.0 percent of GDP in 2012 to 4.2 percent of GDP in 2013; overall deficit would shrink to 1.5 percent of GDP.
  - Gross debt ratio projected to peak in 2013 at 126.4 percent of GDP and decline to around 119 percent by 2017 (staff estimates).
- Financing and investor base:
  - Nonresident investors’ share of sovereign bonds declined from 52 percent in 2010 to an estimated 36 percent in March.
  - Government issued €237 billion through mid June, completing more than half of its financing for the year; annual rollover needs during 2012–13 around €415 billion (25 percent of GDP).
  - Average maturity of public debt remains at 6.8 years.
- Staff recommendations:
  - Adjustment in 2012–13 appropriate but identify medium-term measures; shift composition toward expenditure cuts and lower taxes.
  - Cut government expenditure (e.g., public sector wage bill) via spending review.
  - Reduce sizeable tax expenditures (estimated at around 8 percent of GDP).
  - Step up efforts against tax evasion and use savings to finance growth-supporting measures (reduce labor tax wedge, raise allowance for corporate equity, modest targeted public investment).
  - Example: a 2 percent of GDP shift from social security contributions to the VAT could raise the level of GDP by at least 1 percent over the long term (Box 6 reference).

### Medium-term fiscal anchor and composition (recommended)
- Recommendation: Target a 1 percent of GDP structural surplus from 2014 onwards as medium-term anchor.
- Implementation options: use spending reviews to identify cuts, legislate medium-term expenditure cuts, enshrine target in fiscal-rule legislation, pursue structural reforms.
- Estimated fiscal impact over 5 years (figures as presented):
  - Public expenditure based savings 2/: 0.6, 0.6, 1.1, 1.6
  - Reduction in tax expenditures 3/: 2.0
  - Growth supportive measures:
    - Avoid increase in top VAT rate from 21 to 23.5: -0.6
    - Reducing the labor tax wedge to boost employment: -1.5
    - Lowering CIT (incl. cutting rates and raising allowance for corporate equity): -0.5
    - Well targeted increase in public investment: -0.5
  - Net savings from rebalancing fiscal composition: 0.0, 0.0, 0.0, 0.5
- Debt management recommendations: maintain current maturity structure; diversify investor base; consider syndications/private placements; mobilize public assets via privatization.

### Debt-sustainability scenarios and sensitivity
- Baseline: debt-to-GDP ratio peaks at about 126.4 percent in 2013, declines to about 119 percent in 2017; effective interest rate forecast rises from 4.2 percent in 2011 to 4.6 percent in 2012.
- Alternative scenarios (summarized):
  - Structural surplus scenario: target a structural overall surplus of 1 percent from 2014; structural primary balance would improve to 6.7 percent of GDP; debt-to-GDP drops to about 116 percent by 2017; spreads assumed to tighten.
  - Slow recovery scenario: medium-term real annual growth stagnates at 0.25 percent; primary surplus reaches only 4.2 percent of GDP by 2017; debt-ratio reaches 128 percent in 2017.
  - High interest rate scenario: spreads rise to about 580 bps from 2013; government interest bill reaches 8 percent of GDP by 2017; implicit average interest rate of 6.5 percent; debt-to-GDP approaches 130 percent by 2017.
  - Policy slippage scenario: starting in 2012 only 25 percent of planned adjustment undertaken; debt-to-GDP around 131 percent in 2017.
  - Deep recession and interest rate shock: annual GDP growth 1 percentage point lower than baseline plus 100 bps rise in interest rates pushes debt-ratio above 140 percent of GDP.
  - Structural reform scenario: comprehensive product and labor market reforms could raise real GDP by 5¾ percent after 5 years; debt-to-GDP improves to about 108 percent by 2017.
- Sensitivity: a 1 percentage point reduction in growth combined with a 100 bps increase in interest rates would push the debt ratio above 140 percent of GDP and keep it on a rising path.

### Outlook and macro projections (selected)
- Staff GDP projection: -1.9 percent in 2012 and -0.3 percent in 2013.
- Main contraction drivers:
  - Fiscal consolidation estimated to reduce growth by 1½ percentage points in both 2012 and 2013.
  - Tight financial conditions: IMF April 2012 GFSR estimates a 2¾ percent contraction in private credit during 2012–13, lowering growth by 0.8 and 0.2 percentage points in 2012 and 2013.
  - Slowing exports: trading partners’ real import growth expected to slow to 2 percent in 2012 from over 5 percent in 2011.
- Economy expected to emerge from recession in early 2013, led by modest export pickup; recovery will lag region by nearly two quarters.
- Construction investment likely to continue contracting.
- Unemployment projected to reach 11 percent in 2013.
- Inflation: Annual HICP inflation 3.5 percent (y/y) in May; core inflation 1.4 percent (y/y) in May; inflation projected to remain above euro area average in 2012–13 due to VAT and indirect tax hikes.
- Key real-side projections (selected, annual percent change):
  - Real GDP: 2008 -1.2; 2009 -5.5; 2010 1.8; 2011 0.4; 2012 -1.9; 2013 -0.3; 2014 0.5; 2015 1.0; 2016 1.2; 2017 1.2.
  - Private consumption: 2008 -0.8; 2009 -1.6; 2010 1.2; 2011 0.2; 2012 -2.6; 2013 -1.1; 2014 0.5; 2015 0.8; 2016 0.9; 2017 1.0.
  - Gross fixed capital formation: 2008 -3.7; 2009 -11.7; 2010 2.1; 2011 -1.9; 2012 -6.5; 2013 1.5; 2014 0.3; 2015 1.6; 2016 1.4; 2017 1.4.
  - Exports of goods and services: 2008 -2.8; 2009 -17.5; 2010 11.6; 2011 5.6; 2012 0.6; 2013 1.9; 2014 2.5; 2015 3.3; 2016 4.1; 2017 4.1.
  - Unemployment rate: 2008 6.8; 2009 7.8; 2010 8.4; 2011 8.4; 2012 10.3; 2013 11.1; 2014 11.3; 2015 11.0; 2016 9.6; 2017 8.8.
  - Consumer prices (annual percent change): 2008 3.5; 2009 0.8; 2010 1.6; 2011 2.9; 2012 3.0; 2013 2.1; 2014 1.0; 2015 1.2; 2016 1.3; 2017 1.4.

### Financial sector: banks, credit, and stability
- Banking stress and funding:
  - Credit ratings for several banks cut in late 2011 and May 2012; banks rely heavily on Eurosystem support (nearly one-quarter of total financing).
  - Italian banks borrowed net €140 billion from two LTROs; Eurosystem refinancing stabilized at around €273 billion in May (25 percent of total ECB financing).
  - Available collateral net of haircuts around €200 billion.
  - Total bank deposits increased 0.4 percent from December 2011 to April 2012; non-resident deposits declined -20 percent (y/y) in April; resident deposits increased 2 percent (y/y).
  - Banks need to roll over estimated €140 billion in maturing debt in 2013.
- Capital and asset quality:
  - To meet EBA targets, four of the five large banks need to raise €15½ billion by end-June; UniCredit secured €7.5 billion in common equity in January.
  - Average core tier 1 ratios: five largest banks 9½ percent at end-March (euro area average: 10.3 percent); other 9 listed groups 8.4 percent; remaining groups around 12.2 percent at end-2011.
  - Gross impaired loans rose to 11 percent in 2011, from less than 6 percent before the crisis.
  - Banks’ loan loss provision averaged around 0.8 percent of total loans; bankruptcy procedures on average take more than 8 years.
  - Banks’ holdings of government bonds increased to over 7 percent of assets.
- Corporate sector vulnerabilities:
  - Corporate debt with maturity less than one year around 40 percent.
  - Corporate leverage (debt-to-equity) rose; profitability stagnant; bankruptcies increased since end-2007.
- Staff policy recommendations for financial sector:
  - Maintain adequate capital and liquidity buffers; encourage raising equity, converting hybrids into core capital, or disposing noncore assets rather than cutting loans.
  - Extend stress tests to a larger set of institutions and publish results in Financial Stability Reports.
  - Encourage strategies to sell, restructure or write down impaired loans; align tax deductibility of loan loss provisioning and write-offs to facilitate development of distressed-asset market.
  - Streamline bankruptcy procedures and promote out-of-court workouts; improve banks’ capacity to post eligible collateral at the Bank of Italy.

### Deleveraging and credit dynamics (Box 1 findings)
- Credit growth to the non-financial private sector dropped from 3.5 percent (y/y) in November to 1.6 percent (y/y) in April, mostly reflecting declines in non-financial corporate loans.
- Lending to small firms fell from 0.4 percent (y/y) in November to -4 percent (y/y) in March.
- Surveys at end-2011 showed significant tightening of lending conditions similar to those after the Lehman bankruptcy.
- For three quarters since start of recession, annual private credit growth fell by 3.3 percentage points (compared to 6.5 and 4.7 percentage points in earlier recessions).
- Q4 2011 analysis suggests loan demand exceeded supply by 0.5 percentage point; in 2012 weak demand appears to be main factor driving decline after LTRO.

### Structural reforms: product markets, services, SMEs and labor
- Product-market reforms:
  - Parliament passed comprehensive liberalization covering network industries, fuel distribution, local public services, transport, professional services, infrastructure; strengthened competition enforcement and administrative simplification.
  - Priority actions: complete ownership separation of gas distribution and production in 2012; accelerate opening of professional orders; push privatization especially for local public utilities.
  - Authorities estimate recent liberalization and simplification measures could increase GDP level by 2.4 percentage points in 2020 (on average 0.3 percentage points annually).
- Services and SMEs:
  - Services account for over 70 percent of total value added.
  - Italian SMEs account for 71 percent of value added versus 58 percent EU average; SMEs concentrated among micro firms with less than 10 workers.
  - SMEs suffer excess leverage, with debt-to-equity ratios above 200 percent in 2010.
  - Measures to help firms grow: improve access to financing via risk-based lending; develop venture capital/private equity; allowance for corporate equity to foster recapitalization; promote inward FDI; simplify regulations.
- Labor market reform (parliament approved June 27):
  - Extension of tax incentives for firm-level bargaining; minimum remuneration for some temporary contracts; increased flexibility for temporary and apprenticeship contracts.
  - Objective: create a more inclusive, dynamic labor market; introduce faster out-of-court procedures for labor disputes; extend unemployment benefits coverage; strengthen active labor market policies.
  - Authorities’ labor reform proposals: limit compensation for economic dismissals; preference for apprenticeship contracts; policies to raise female participation via financial incentives and improved child/elderly care; promote wage decentralization via tax allowances for firm-level bargaining.
- Judicial efficiency constraint:
  - Reducing civil trial duration (1,200 days on average in Italy versus 331 days in France) would improve contract enforcement and restructuring.

### External sector, oil price risk and competitiveness
- Current account and external balances:
  - External current account deficit narrowed from 3½ percent of GDP in 2010 to around 2¾ percent of GDP in year to Q1 2012.
  - Current account balance (percent of GDP): 2009 -2.0; 2010 -3.5; 2011 -3.3; 2012 -2.2; 2013 -2.0.
  - Gross external debt (percent of GDP): 2009 116.5; 2010 117.3; 2011 114.7; 2012 119.2; 2013 121.0.
- Oil prices and macro impact:
  - Low-probability, high-impact event: geopolitical instability could trigger a large and sustained oil price shock.
  - Exact sensitivity: "A $10 increase in the oil price could reduce growth―via compression of domestic as well as external demand―by up to 0.4 percentage points in the first year."
  - An oil price shock combined with protracted low growth could intensify the crisis, raising sovereign yields, declining activity, and rising public debt—reinforcing other downside risks.
- Competitiveness:
  - Producer prices (excl. construction) increased by 10½ percent since 2009; nominal wages increased by 3¼ percent (relative to higher increases in Germany and euro area).
  - Staff assesses Italy’s real effective exchange rate to be modestly overvalued by around 5–10 percent.
  - EBA approach finds structural current account deficit around 1–1½ percent of GDP above level justified by fundamentals and policies; full implementation of reform agenda should close competitiveness gap.

### Impaired loans, legal framework and recommendations
- Impaired loans:
  - Gross impaired loans rose to 11 percent in 2011 from less than 6 percent pre-crisis.
  - Bankruptcy procedures average more than 8 years; banks limited to deducting loan loss provisions equivalent to 0.3–0.5 percent of total loan portfolios, excess carried over 9–18 years.
  - Scenario: doubling default rates in 2012–13 and increasing coverage ratio by 1 percentage point would lower average core tier 1 ratio for 10 largest banking groups to 7.1 percent from 8.7 percent at end-March 2012; five banks below 7 percent, one below 6 percent.
- Policy recommendations:
  - Encourage banks to sell, restructure or write down impaired loans; ensure adequate provisioning; align tax deductibility of provisioning and write-offs.
  - Streamline bankruptcy procedures and promote out-of-court workouts.
  - Encourage supervisors to take early action on loans benefiting from SME moratorium and improve banks’ capacity to post eligible collateral at Bank of Italy.
  - Broaden resolution tool kit under forthcoming EU Directive; consider pan-European backup funding and direct capital injections to strengthen credibility.

### Risks and Executive Board priorities
- Risks tilted to the downside, mainly from intensification of the euro area crisis.
- Key risk channels (Relative Likelihood; Expected Impact):
  1. Euro area crisis intensifies strongly — Medium likelihood; High impact.
  2. Banks’ asset quality deteriorates and/or funding pressures rise — Medium likelihood; High impact.
  3. Fiscal consolidation goes off track — Medium likelihood; High impact.
  4. Structural reforms stall — Medium likelihood; Medium impact.
- Executive Board emphasized priorities: raise productivity and labor participation; pursue growth-friendly fiscal consolidation; promote a more dynamic and resilient banking system; sustain reform momentum and progress at European level.

*Source: IMF staff summary from the Italy 2012 Article IV Report (excerpts provided).*

### 1.    Summary of Economic Indicators, 2008–17 __________________________________________________ 35

### 1. Summary of Economic Indicators, 2008–17

### Overview and Recent Developments
- The economy has been in recession since the middle of 2011; GDP contracted for a third straight quarter, by 0.8 percent (q/q, s.a.) in Q1 2012.
- Contraction led by sharp falls in consumption and investment as concerns about the fiscal outlook and the euro area crisis depressed confidence and tightened credit conditions.
- Exports also fell, but net exports contributed positively to growth due to sharp import compression.
- Household real disposable income continued to decline in 2011; consumer sentiment fell below levels in 2008–09.
- Unemployment rose to 10.2 percent in April 2012, with youth unemployment at 35 percent.
- Household sales are 25 percent below 2007 levels.

### Fiscal Measures and Structural Reforms
- The new government in December announced a third fiscal consolidation plan, bringing the total adjustment for 2012–14 to around 5 percent of GDP.
- A comprehensive package of structural reforms to liberalize services and plans for key labor reforms were approved.
- The broad public and parliamentary support for Prime Minister Monti’s technocratic government weakened; general elections scheduled for April 2013 and Prime Minister Monti declared he will not run.

### Financial Markets and Sovereign Financing
- In late 2011, 10-year government bond yields rose above 7 percent; subsequent policy actions and ECB LTRO liquidity injections drove yields down, with spreads dropping below those of Spain by early March.
- Following a brief respite, 10-year Italian sovereign spreads rose by almost 150 bps since early March.
- The government through mid June issued €237 billion in sovereign debt, completing more than half of its financing for the year, but faces sizeable funding needs in coming months.
- Italian equity prices were down 17 percent for the year through May.
- Around 37 percent of public debt is held by non-residents.
- Net foreign liabilities have been stable at around 20 percent of GDP.

### Banking and Credit Developments
- Turmoil has put banks under stress; credit ratings for several Italian banks were cut in late 2011 and again in May, and remain on a negative outlook.
- With limited access to wholesale markets and soaring funding costs, Italian banks have relied heavily on Eurosystem support, accounting for nearly one-quarter of their total financing.
- Banks have made progress in raising private capital to meet EBA targets, but at a steep discount.
- Private sector credit contracted by 0.8 percent from December through April.
- Corporate borrowing rates rose for smaller firms; lending standards tightened especially for smaller firms.
- Bank deleveraging and higher interest rates are expected to weigh on business investment.

Box 1 findings (What are the Factors Behind Deleveraging in Italy?)
- Credit growth to the non-financial private sector dropped from 3.5 percent (y/y) in November to 1.6 percent (y/y) in April, mostly reflecting declines in non-financial corporate loans.
- Lending to small firms fell from 0.4 percent (y/y) in November to -4 percent (y/y) in March.
- Surveys at end-2011 showed significant tightening of lending conditions similar to those after the Lehman bankruptcy.
- Three quarters since the start of the recession, annual private credit growth has fallen by 3.3 percentage points, compared to declines of 6.5 and 4.7 percentage points in earlier recessions.
- Q4 2011 analysis suggests loan demand exceeded supply by 0.5 percentage point; in 2012 the situation reversed with weak demand appearing to be the main factor driving the decline in credit after LTRO.

### External Sector
- The external current account deficit narrowed from 3½ percent of GDP in 2010 to around 2¾ percent of GDP in the year to Q1 2012, as weak imports improved the trade balance.
- Imbalances with the euro area payment system (Target 2) widened over the past year; external outflows from the sovereign and banks have been offset by ECB support.
- Energy prices contributed to a deteriorating current account over 2010–11; recent import compression has helped offset slowing export growth.

### Outlook and Projections
- Staff projects GDP will decline by 1.9 percent in 2012 and another 0.3 percent in 2013.
- Main factors driving contraction:
  - Fiscal consolidation: government’s fiscal adjustment program is estimated to reduce growth by 1½ percentage points in both 2012 and 2013. With revenue increases making up the bulk of the adjustment, growth in disposable income and household spending is expected to remain sluggish.
  - Tight financial conditions: IMF’s April 2012 GFSR sees higher funding costs and capital pressures on banks contributing to a 2¾ percent contraction in private credit during 2012–13 (compared to positive growth of 3½ percent during 2008–10). This is estimated to lower growth by 0.8 and 0.2 percentage points in 2012 and 2013, respectively.
  - Slowing exports: real import growth in Italy’s trading partners is expected to slow sharply to 2 percent in 2012, from over 5 percent in 2011.
- Economy expected to emerge from recession in early 2013, led by a modest pickup in exports; recovery will lag the rest of the region by nearly two quarters.
- Construction investment likely to continue contracting.
- Unemployment projected to reach 11 percent in 2013.
- Inflation: Annual HICP inflation was 3.5 percent (y/y) in May and is projected to remain above the euro area average in 2012–13 due to VAT and indirect tax hikes. Core inflation was 1.4 percent (y/y) in May.
- Wages likely to increase more slowly than inflation, producing a moderate real wage adjustment.

### Risks and Vulnerabilities
- Risks are tilted to the downside, mainly from an intensification of the euro area crisis.
- Key risk channels and assessments (Relative Likelihood; Expected Impact):
  1. The euro area crisis intensifies strongly — Medium likelihood; High impact
     - Potential outcomes: loss of investor confidence, higher funding costs, negative feedback loop between sovereign and banks, jeopardized export-led recovery.
  2. Banks’ asset quality deteriorates with the slowdown and/or funding pressures rise — Medium likelihood; High impact
     - Potential outcomes: increasing NPLs, erosion of banks’ capital, funding pressures, bank deleveraging leading to credit crunch and contingent fiscal liabilities.
  3. Fiscal consolidation goes off track — Medium likelihood; High impact
     - Potential outcomes: weakened implementation, higher-than-expected fiscal multipliers, intensified market concerns, increased interest rates, and higher outstanding public payments.
  4. Structural reforms stall — Medium likelihood; Medium impact
     - Potential outcomes: stalled reform implementation, lower long-term growth, undermined fiscal consolidation, and lasting consequences from high youth and long-term unemployment.

*Source: IMF staff summary from the Italy 2012 Article IV Report (excerpts provided).*

### 5. Oil prices

### 5. Oil prices

### Scenario description
- Low-probability, high-impact event: "Geopolitical instability could trigger a large and sustained oil price shock."
- The RAM (Risk Assessment Matrix) shows events that could materially alter the baseline path—the scenario most likely to materialize in staff’s view.

### Macroeconomic impact
- "Higher oil prices would damage economic activity."
- Exact sensitivity cited: "A $10 increase in the oil price could reduce growth―via compression of domestic as well as external demand―by up to 0.4 percentage points in the first year."

### Interaction with broader risks and implications
- An oil price shock occurring "combined with a protracted period of low growth in the area as a whole could lead to an intensification of the crisis, pushing Italy back into a bad equilibrium, with higher sovereign yields, declining activity, and rising public debt reinforcing each other."
- Such an intensification would likely correlate with other downside risks noted in the RAM, including a larger contractionary impact from fiscal adjustment, a faster pace of deleveraging, and a sharp fall in partner demand outside the euro area.

*Source: _cr12167 - 5. Oil prices (Italy 2012 Article IV Report).*

### 23.      Important progress is being made in overdue product market reforms. Parliament in

### _cr12167 - 23.      Important progress is being made in overdue product market reforms. Parliament in

### Product-market reforms and priorities
- Parliament in March passed a comprehensive liberalization package covering network industries, fuel distribution, local public services, transport, professional services, and infrastructure, and strengthened enforcement of competition rules.
- Administrative simplification reforms were approved to lower the cost of doing business.
- Expected long-term effect: help close Italy’s competitiveness gaps and boost growth potential.
- Priority reform actions in product markets:
  - Complete the planned ownership separation of gas distribution and production in 2012 to improve competition and eventually help drive down energy prices (noting electricity prices in Italy are 50 percent higher than the European average, per footnote).
  - Accelerate the opening of professional orders to strengthen competition and lower excessive rents and costs for businesses and households.
  - Push forward on privatization, especially for local public utilities, to enhance efficiency and quality of public services and lower their cost.
- Complementary EU-wide initiatives that would amplify benefits:
  - Develop a broader internal energy market.
  - Remove barriers to infrastructure investment.
  - Develop a single European transport area.
  - Reduce the number of regulated professions in Europe.
- Simulation results (accompanying Selected Issues Paper) suggest combining Italy’s product and labor market reforms with wider euro area structural reforms increases gains for Italy.

### Services sector and SME constraints
- Services account for over 70 percent of total value added in Italy.
- Services productivity has lagged peers; product market reforms to increase competition can raise productivity by reducing business costs and improving resource reallocation.
- SMEs:
  - Italian SMEs account for 71 percent of value added versus 58 percent for the EU average.
  - SMEs are concentrated among micro firms with less than 10 workers; small size and low productivity particularly evident in trade and tourism-related sectors.
  - SMEs suffer from excess leverage, with debt-to-equity ratios above 200 percent in 2010.
  - Business startup and exit rates are low, limiting flexibility and innovative capacity.
- Measures to help firms grow:
  - Improve access to financing by expanding risk-based (rather than collateral-based) lending.
  - Develop venture capital and private equity to expand risk capital.
  - Recent initiatives: allowance for corporate equity to foster firm recapitalization.
  - Promote greater inward FDI to allow SMEs to benefit from global supply chains and technology transfer.
  - Simplify regulations and administrative requirements to reduce burdens on firms.
  - Government measures (June growth agenda): tax incentives for infrastructure and construction investment; expand debt instruments for non-listed firms; simplify procedures for business startups.
  - Authorities' SME financing measures: government credit guarantees, allowances for corporate equity, and tax incentives for venture capital.

### Authorities’ views on reforms and labor market
- Authorities estimate recent liberalization and simplification measures could increase the level of GDP by 2.4 percentage points in 2020 (on average by 0.3 percentage points annually).
- Judicial efficiency remains a key constraint; reducing the lengthy period for civil trials (1,200 days on average in Italy versus 331 days in France) would improve contract enforcement.
- Labor reform objectives:
  - Create a more inclusive and dynamic labor market balancing firms’ flexibility and the social safety net.
  - Proposed limits on compensation for economic dismissals expected to reduce hiring uncertainty and judicial incentives.
  - Preference by authorities for apprenticeship contracts as the main entry point for young workers, encouraging firms to invest in training while maintaining hiring flexibility.
- Policies to raise female participation and better match wages to productivity:
  - Government intends to provide more financial incentives for hiring women and youth (budget constrained).
  - Improve welfare for child and elderly care to facilitate women’s entry to the labor force.
  - Promote wage decentralization via extended tax allowances for firm-level wage bargaining.
  - Consider greater regional differentiation of public sector wages as part of broader public sector reform (politically challenging).
- Implementation status:
  - Government issued a decree on separating ownership in the gas sector and will issue parameters for setting professional fees by end-July.
  - Creation of independent Transport Authorities highlighted as important to promote competition at the local level.
  - Authorities committed to privatization where feasible, completing inventory of public assets and exploring ways to improve efficiency and revenue generation capacity.

### Fiscal consolidation: measures, outcomes, and risks
- Recent fiscal packages (2011) feature significant and front-loaded consolidation; pension reforms for long-term sustainability; modest shift from direct to indirect taxes; higher taxes on wealth, especially property; and measures against tax evasion.
- Pension reforms: expected to generate savings of around 1.2 percent of GDP annually during 2020–30.
- Fiscal targets and projections:
  - The general government met its 2011 deficit target of 3.9 percent of GDP.
  - In 2012, the overall deficit is projected to decline to 2.6 percent of GDP.
  - Based on staff macro assumptions:
    - Primary balance would improve from 3.0 percent of GDP in 2012 to 4.2 percent of GDP in 2013.
    - Overall deficit would shrink to 1.5 percent of GDP.
    - The gross debt ratio would peak in 2013 at 126.4 percent of GDP.
  - Debt ratio projected to decline to around 119 percent by 2017 (staff estimates), but vulnerable:
    - Example adverse shock: a combined 1 percentage point reduction in growth and a 100 bps increase in interest rates would push the debt ratio above 140 percent of GDP and keep it on a rising path.
- Financing and investor base developments:
  - Nonresident investors’ share of Italian sovereign bonds declined from 52 percent in 2010 to an estimated 36 percent in March.
  - Italian banks purchased more than €80 billion between November 2011 and April 2012, financed partly from LTRO support.
  - Authorities sold €7.3 billion of inflation-linked bonds to domestic retail investors in February and €1.7 billion in June.
  - Average maturity of public debt remains at 6.8 years.
  - Annual rollover needs during 2012–13: around €415 billion (25 percent of GDP).
- Policy issues and staff recommendations:
  - The fiscal adjustment in 2012–13 is appropriate to restore sustainability, but more medium-term measures are needed.
  - Government should identify and implement expenditure cuts to avoid raising VAT rates later in the year.
  - Shifting composition of adjustment toward expenditure cuts and lower taxes would better distribute the burden and support growth.
  - Suggested expenditure and revenue actions:
    - Cut government expenditure (e.g., public sector wage bill) via the spending review.
    - Reduce sizeable tax expenditures (estimated at around 8 percent of GDP).
    - Step up efforts against tax evasion (including measures to strengthen compliance).
    - Use savings to finance growth-supporting measures such as reducing the labor tax wedge, raising the allowance for corporate equity to encourage investment, or financing modest, well-targeted increases in public infrastructure investment.
  - Staff example: a 2 percent of GDP shift from social security contributions to the VAT could raise the level of GDP by at least 1 percent over the long term (Box 6 reference).

*International Monetary Fund — 2012 Article IV Report: Italy (content unit _cr12167).*

### 40.      Locking in prudent fiscal policies over the medium term would improve confidence

### 40.      Locking in prudent fiscal policies over the medium term would improve confidence

### Medium-term fiscal anchor and consolidation strategy
- Recommendation: Target a 1 percent of GDP structural surplus from 2014 onwards as the medium-term anchor for the fiscal rule to create a buffer against shocks and put the debt ratio on a more robust downward path, even under adverse conditions.
- Implementation options:
  - Use ongoing spending reviews to identify further cuts to less productive expenditure, with some savings used to reduce debt.
  - Legislate medium-term expenditure cuts with next year’s budget to lock in gains.
  - Enshrine the structural surplus target in supportive legislation for the fiscal rule.
  - Pursue comprehensive structural reforms to boost growth and improve debt dynamics.
- Credibility effects:
  - Faster pace of debt reduction could lower borrowing costs significantly, especially once market conditions stabilize.

### Estimated fiscal impact over 5 years (figures as presented)
- Public expenditure based savings 2/: 0.6, 0.6, 1.1, 1.6
- Reduction in tax expenditures 3/: 2.0
- Growth supportive measures:
  - Avoid increase in top VAT rate from 21 to 23.5: -0.6
  - Reducing the labor tax wedge to boost employment: -1.5
  - Lower CIT (incl. cutting rates and raising allowance for corporate equity): -0.5
  - Well targeted increase in public investment: -0.5
- Net savings from rebalancing fiscal composition: 0.0, 0.0, 0.0, 0.5
- Notes on figures:
  - 1/ Against baseline, which already assumes some modest adjustment in 2016/17 to comply with the structural balance rule.
  - 2/ Annualized savings from the Spending Review, plus potential reductions in public wage bill.
  - 3/ OECD estimates tax expenditures at 8 percent of GDP.

### Debt dynamics scenarios
- Baseline vs policy scenario charting debt-to-GDP shows:
  - Policy advice assumes targeting a structural fiscal surplus of 1 percent from 2014.
  - Interest rate shock scenario: spreads are 180 bps higher than baseline or policy scenario from 2013 (1.5 standard deviations).

### Fiscal institutions, outstanding payments, and debt management
- Fiscal institutions and rules:
  - The new constitutional fiscal rule can strengthen fiscal discipline if backed by sound institutions.
  - The legislated fiscal council should be fully independent in staffing, funding, and work agenda.
  - Adopt a binding multi-year expenditure framework and merge various spending reviews, giving them a central role in the budget process.
- Outstanding public payments:
  - Estimates of outstanding public payments are around 5 percent of GDP and are likely concentrated at the subnational level.
  - Recommended actions: complete stocktaking at central and sub-national levels; enhance public expenditure control; improve reporting and timeliness of public payments; coordinate across government levels; maintain incentives for sub-national fiscal prudence.
- Debt management recommendations:
  - Maintain current maturity structure of debt and diversify the investor base.
  - Recent placement of inflation-linked bonds with retail investors shows potential for new demand.
  - Consider syndications or private placements to ease pressures on primary dealers.
  - Provide collateral for sovereign swap transactions and report such transactions regularly in government accounts to enhance transparency.
  - Assess scope to mobilize public assets, including through privatization, to reduce rollover pressures and debt.

### Authorities’ views and plans (as reported)
- Authorities project the overall deficit to decline further in 2012–13 but to fall short of a balanced budget due to the weaker outlook.
- Structural terms: budget is estimated to be in surplus by 0.6 percent of GDP in 2013 before gradually converging to overall balance by 2016.
- Authorities remain committed to maintaining a structural balance as the anchor under their fiscal rule and prioritize enacting needed spending cuts to avoid raising the VAT rate in October.
- On a 1 percent of GDP structural surplus target from 2014, authorities:
  - Did not see a strong case for changing to that target versus the current structural balance.
  - Project debt ratio declining to 114½ percent of GDP by 2015 and remaining robust to various shocks.
  - Note that structural overall balance through 2015 would exceed medium-term objectives and debt reduction target under the Fiscal Compact.
  - See risks in changing the rule now and confusing the public about fiscal plans.
- Measures to mobilize assets:
  - In June, government announced plans to sell shares in three state-owned companies to Cassa Depositi e Prestiti for around €10 billion to reduce debt and accelerate delayed payments to suppliers.
  - A real estate fund will be created to manage public asset disposal at all levels of government.

### Box: Would a Fiscal Devaluation Work in Italy? — key findings
- Definition: A “fiscal devaluation” (FD) is a revenue-neutral shift from employer’s social contributions toward value-added tax, intended to promote growth, employment, and exports by reducing tax distortions and labor costs and by improving the trade balance via terms-of-trade effects.
- Simulation and empirical evidence:
  - A shift on the order of two percent of GDP from social security contributions (SSC) towards VAT would raise GDP and employment by 0.5–1.5 percent above baseline after ten years (impact may be stronger if both labor and capital taxes are cut).
  - The revenue shift could increase net exports by at least 0.4 percent of GDP in the short-run.
- Italy-specific considerations enhancing FD effectiveness:
  - (i) a high tax wedge; (ii) strong wage rigidities; (iii) a moderate competitiveness gap; (iv) a fixed nominal exchange rate for much of its trade.
- Design recommendations:
  - Increase VAT revenues by reducing tax expenditures rather than by raising the standard VAT rate.
  - Raising 2 percent of GDP from broadening the base would increase Italy’s VAT efficiency to the OECD average.
  - Use savings to lower taxes on labor, targeting SSC cuts at lower wage levels to focus benefits on low earners, women, and young workers.
- Empirical/table snapshot (Table 1 summary):
  - Many modeled or econometric studies show small-to-moderate positive effects of a 1 percent of GDP SSC-to-VAT revenue shift on GDP, employment, and the trade balance over short and long terms, with variation across countries and methods.
  - Italy (IMF 2012, model-based): GDP effect 0 to 0.2; Employment 0.5; Trade balance 0.1 to 0.2 (figures as presented).

### Banking sector and financial stability (key indicators and policy recommendations)
- LTRO and bank funding:
  - Italian banks borrowed net €140 billion from the two LTROs, more than sufficient to cover the €115 billion in maturing medium-and long-term retail and wholesale debt for the 32 largest banking groups in 2012.
  - Italian banks’ use of Eurosystem refinancing stabilized at around €273 billion in May (25 percent of total ECB financing).
  - Available collateral net of haircuts was around €200 billion.
  - Total bank deposits increased by 0.4 percent from December 2011 to April 2012.
  - Non-resident deposits declined -20 percent (y/y) in April; resident deposits increased 2 percent (y/y).
  - Looking ahead, Italian banks will need to roll over an estimated €140 billion in maturing debt in 2013 and may continue relying on ECB liquidity support absent improved wholesale funding markets.
- Capital positions and provisioning:
  - To meet EBA capital ratio targets, four of the five large banks need to raise €15½ billion by end-June; UniCredit secured €7.5 billion in common equity in January.
  - Other banks plan to meet targets by converting hybrid instruments into core capital, adjusting risk models, or buying back long-term debt at a discount.
  - Average core tier 1 ratios:
    - Five largest banks (covering 68 percent of system consolidated assets): 9½ percent at end-March (euro area average: 10.3 percent).
    - Other 9 listed banking groups (12 percent of system): 8.4 percent (only a couple below 7 percent).
    - Remaining banking groups: around 12.2 percent at end-2011.
- Asset quality and vulnerabilities:
  - Gross impaired loans rose to 11 percent in 2011, from less than 6 percent before the crisis.
  - Declining provisioning rates (below pre-crisis levels) increase vulnerability, especially in SME and construction sectors.
  - A moratorium on SME loan repayments was reintroduced in February, which may mask credit risks and delay restructuring.
  - Banks’ holdings of government bonds increased to over 7 percent of assets, compared to 4 percent average for other euro area banking systems.
- Insurance sector:
  - Life and non-life insurers hold about €200 billion of Italian government debt.
  - In 2011 insurers experienced a 12½ percent decline in premiums and an increase in surrenders.
  - Recent legislation allowing insurers to forgo booking unrealized losses on securities held as long-term investments has shielded insurers from price fluctuations.
  - Market sentiment remains weak: insurer share prices declined 28 percent for the year through May.
- Corporate sector vulnerabilities:
  - Corporate leverage measured by debt to equity has risen steadily since the onset of the crisis.
  - About 40 percent of corporate debt has maturity less than one year.
  - Firms are heavily reliant on bank funding; profitability stagnant and bankruptcies have grown steadily since end-2007.
- Policy issues and staff views for the financial sector:
  - Banks should maintain adequate capital and liquidity buffers; BoI should encourage raising equity, converting hybrids into core capital, or disposing noncore assets rather than cutting loans.
  - BoI should consider extending stress tests to a larger set of institutions, including mid-sized banks, and publish results in Financial Stability Reports to enhance transparency and market discipline.
  - Encourage banks to improve capacity to post eligible collateral at the BoI to facilitate access to Eurosystem liquidity facilities.

*Source: ITALY 2012 ARTICLE IV REPORT — International Monetary Fund.*

### 55.      Reducing impaired loans would free up resources for new lending.

### _cr12167 - 55.      Reducing impaired loans would free up resources for new lending.

### Impaired loans: scale, causes, and effects
- Banks’ buildup of impaired loans reflects both an inefficient legal process that delays loan write-offs and the flow of new bad loans arising from the slowdown.
- The growing stock and slow pace of disposal have constrained core profitability and tied up funding and capital.
- Bankruptcy procedures on average take more than 8 years.
- Banks are limited to deducting loan loss provisions equivalent to 0.3–0.5 percent of their total loan portfolios, with any excess carried over 9–18 years.
- Banks’ loan loss provision has averaged around 0.8 percent of total loans and would rise during a recession.
- Using publicly available data, a staff scenario analysis that assumes a doubling in default rates on outstanding loans in 2012–13 compared to staff’s baseline projections and an average increase in the coverage ratio by 1 percentage point compared to 2011 would lower the average core tier 1 ratio for the 10 largest banking groups to 7.1 percent from 8.7 percent at end-March 2012.
  - Five banks would have a ratio below 7 percent, with one below 6 percent.

### Policy recommendations to address impaired loans and free up lending
- Supervisors should encourage banks to develop strategies for selling, restructuring or writing down impaired loans to free up resources for lending.
- Ensure adequate bank provisioning and align more closely tax deductibility of loan loss provisioning and write-offs to facilitate development of a market for restructuring distressed assets.
- Streamline bankruptcy procedures and promote more out-of-court workouts to provide stronger tools to address impaired loans.
- Supervisors should encourage banks to provision appropriately against loans benefiting from the moratorium agreement on SMEs and take early action toward problem borrowers.
- Improve banks’ capacity to evaluate and post eligible collateral at the Bank of Italy to facilitate access to Eurosystem financing.

### Financial-stability and crisis-management framework
- The plan to broaden the resolution tool kit under the forthcoming EU Directive, including the introduction of an ex-ante deposit insurance fund, is welcome.
- Broader backup funding via pan-European mechanisms, including direct capital injections from EU institutions, could make the resolution framework more robust.
- Pan-European financial support for public capital or deposit insurance could strengthen the resolution framework but its credibility would depend on the size of resources available.
- Since 2009, 35 financial institutions have been placed under special administration procedures, up from 9 in the previous three-year period; two-thirds of the cases returned to normal operations, including after merging.

### Authorities’ views on impaired loans and market development
- Italian banks benefit from a large and stable retail funding base, low leverage, and a traditional lending model with limited exposures to risky assets; resilience supported by firm supervision and regulation.
- Authorities cautioned against comparing impaired loan ratios across Europe, noting wide variation in definition and coverage of NPLs and that disclosure in Italy is in some respects more stringent and transparent.
- The more relevant figure, they argued, is the flow of new impaired loans which has risen but remains within historical averages.
- Authorities emphasize that provisioning rates do not include coverage from real estate and other guarantee collateral which provides an important additional buffer.
- The stock of “legacy” NPLs is seen by authorities as a structural feature reflecting a slow and inefficient legal system that hinders disposals of bad loans.
- Supervisory authorities recognized that the tax treatment for loan loss provisions may serve as a disincentive for more aggressive write-downs, but not for provisions, which they regulate closely; tax authorities saw scope to clarify rules on loan write-offs but valued smoothing tax revenue volatility.
- A market for distressed assets could support corporate restructuring; authorities warn against forcing “fire sale” disposals that would drive down asset prices and prefer improving judicial efficiency to enable proactive restructuring.

### Staff appraisal: macro outlook, reforms, and banking measures
- Italy’s economy is expected to contract this year owing to tight financial conditions, the global slowdown, and the needed fiscal consolidation; absent shocks, recovery will take hold in early 2013 led by a modest pickup in exports but will lag the rest of the region.
- Risks to the outlook are on the downside, mainly from an intensification of the euro area crisis.
- Progress at the European level in strengthening the currency union is crucial for securing stability.
- Maintaining momentum for comprehensive structural reforms is important to address weak productivity, fragmented labor market, and limited competition in services; without reforms, medium-term potential growth would remain low.
- Labor reform priorities include: bridging the gap between permanent and temporary workers, reducing the tax wedge, decentralizing wage setting, passing the labor market reform bill quickly, allowing a more flexible open-ended contract that increases protection with tenure, and reducing marginal tax rates for married second-earners to raise female labor participation.
- Product market reforms to accelerate: ownership separation in the gas sector, opening professional orders, greater privatization, and increasing judicial efficiency.
- Fiscal strategy: the sizeable adjustment in 2012–13 is critical for fiscal sustainability; shifting composition toward lower taxes supported by expenditure cuts would be more growth-friendly.
- Locking in prudent medium-term fiscal policies: target a 1 percent of GDP structural surplus from 2014 onwards as the medium-term anchor for the fiscal rule to put the debt ratio on a more robust downward path.
- Banks need to maintain adequate capital and liquidity buffers; the Bank of Italy should continue encouraging large banks to meet capital needs by raising equity or disposing of noncore assets rather than cutting loans.
- The Bank of Italy should extend stress tests to a larger set of institutions and publish the results regularly to enhance transparency and discipline.
- Reducing impaired loans would free up resources for new lending through: adequate provisioning, aligning tax deductibility of loan loss provisioning and write-offs, and improving bankruptcy proceedings and out-of-court workouts.

*Source: _cr12167 - 55.      Reducing impaired loans would free up resources for new lending.*

### 73.      It is recommended that the next Article IV Consultation take place on the standard 12-

### 73. It is recommended that the next Article IV Consultation take place on the standard 12-month cycle.

### Recommendation
- It is recommended that the next Article IV Consultation take place on the standard 12-month cycle.

### Macroeconomic projections and key real-side indicators (selected)
- Real GDP (annual percent change): 2008 -1.2; 2009 -5.5; 2010 1.8; 2011 0.4; 2012 -1.9; 2013 -0.3; 2014 0.5; 2015 1.0; 2016 1.2; 2017 1.2.
- Real domestic demand components (annual percent change):
  - Public consumption: 2008 0.6; 2009 0.8; 2010 -0.6; 2011 -0.9; 2012 -0.9; 2013 -1.5; 2014 -0.9; 2015 0.1; 2016 0.9; 2017 0.9.
  - Private consumption: 2008 -0.8; 2009 -1.6; 2010 1.2; 2011 0.2; 2012 -2.6; 2013 -1.1; 2014 0.5; 2015 0.8; 2016 0.9; 2017 1.0.
  - Gross fixed capital formation: 2008 -3.7; 2009 -11.7; 2010 2.1; 2011 -1.9; 2012 -6.5; 2013 1.5; 2014 0.3; 2015 1.6; 2016 1.4; 2017 1.4.
- Net exports contribution to growth (percent): 2008 0.0; 2009 -1.2; 2010 -0.4; 2011 1.4; 2012 1.9; 2013 0.2; 2014 0.3; 2015 0.2; 2016 0.2; 2017 0.2.
- Exports of goods and services (annual percent change): 2008 -2.8; 2009 -17.5; 2010 11.6; 2011 5.6; 2012 0.6; 2013 1.9; 2014 2.5; 2015 3.3; 2016 4.1; 2017 4.1.
- Imports of goods and services (annual percent change): 2008 -3.0; 2009 -13.4; 2010 12.7; 2011 0.4; 2012 -6.3; 2013 1.2; 2014 1.5; 2015 2.9; 2016 3.8; 2017 3.8.
- Output gap (percent of potential): 2008 1.0; 2009 -4.5; 2010 -2.9; 2011 -2.3; 2012 -3.9; 2013 -4.1; 2014 -3.7; 2015 -2.9; 2016 -2.0; 2017 -1.2.
- Unemployment rate (percent): 2008 6.8; 2009 7.8; 2010 8.4; 2011 8.4; 2012 10.3; 2013 11.1; 2014 11.3; 2015 11.0; 2016 9.6; 2017 8.8.
- Consumer prices (annual percent change): 2008 3.5; 2009 0.8; 2010 1.6; 2011 2.9; 2012 3.0; 2013 2.1; 2014 1.0; 2015 1.2; 2016 1.3; 2017 1.4.

### Fiscal accounts and public finances (selected, percent of GDP)
- General government net lending/borrowing: 2008 -2.7; 2009 -5.4; 2010 -4.5; 2011 -3.9; 2012 -2.6; 2013 -1.5; 2014 -1.4; 2015 -1.3; 2016 -1.0; 2017 -0.6.
- General government primary balance: 2008 2.5; 2009 -0.8; 2010 0.0; 2011 1.0; 2012 3.0; 2013 3.6; 2014 4.2; 2015 4.9; 2016 4.5; 2017 5.6.
- Structural overall balance (percent of potential GDP): 2008 -3.5; 2009 -3.6; 2010 -3.3; 2011 -3.4; 2012 -0.7; 2013 0.5; 2014 0.4; 2015 0.2; 2016 0.0; 2017 0.0.
- Structural primary balance (percent of potential GDP): 2008 1.7; 2009 0.8; 2010 1.2; 2011 1.4; 2012 4.7; 2013 4.9; 2014 6.0; 2015 6.1; 2016 6.1; 2017 6.2.
- General government gross debt (percent of GDP): 2008 105.8; 2009 116.1; 2010 118.7; 2011 120.1; 2012 125.8; 2013 126.4; 2014 125.6; 2015 124.1; 2016 122.0; 2017 119.4.
- Detailed General Government (National Presentation) selected ratios (percent of GDP):
  - Total revenues: 2008 46.5; 2009 47.1; 2010 46.6; 2011 46.6; 2012 48.9; 2013 49.2; 2014 49.6; 2015 49.5; 2016 49.7; 2017 49.4.
  - Total expenditures: 2008 49.2; 2009 52.5; 2010 51.2; 2011 50.5; 2012 51.5; 2013 50.9; 2014 51.1; 2015 50.0; 2016 51.1; 2017 49.6.
  - Interest payments: 2008 5.2; 2009 4.7; 2010 4.6; 2011 4.9; 2012 5.6; 2013 5.3; 2014 5.7; 2015 5.4; 2016 5.9; 2017 5.6.
  - Primary balance (memorandum): 2008 2.5; 2009 -0.8; 2010 0.0; 2011 1.0; 2012 3.0; 2013 3.6; 2014 4.2; 2015 4.9; 2016 4.5; 2017 5.6.
  - Structural overall balance (memorandum): 2008 -3.5; 2009 -3.6; 2010 -3.3; 2011 -3.4; 2012 -0.7; 2013 -0.4; 2014 0.5; 2015 0.6; 2016 0.4; 2017 0.6.
- Fiscal memorandum: Primary current expenditure real growth rate (percent): 2008 0.8; 2009 3.4; 2010 -0.2; 2011 -2.5; 2012 -2.3; 2013 -2.3; 2014 -1.9; 2015 -2.0; 2016 0.2; 2017 -0.5.

### Balance sheet, financial sector, and financial soundness indicators (selected)
- Banking FSIs (percent, latest available where shown):
  - Regulatory capital to risk-weighted assets: 10.4; 11.7; 12.1; 13.0; 13.2 (Mar).
  - Regulatory tier I capital to risk-weighted assets: 6.9; 8.3; 8.7; 10.0; 10.4 (Mar).
  - Regulatory core tier I capital to risk-weighted assets: 7.0; 8.2; 8.3; 9.3; 9.9 (Mar).
  - Nonperforming loans net of provisions to capital: 37.1; 54.8; 60.2; 64.6 (Dec).
  - Nonperforming loans to total gross loans: 6.3; 9.4; 10.0; 11.7 (Dec).
  - Return on assets: 0.3; 0.3; 0.3; -0.9 (Dec).
  - Return on equity: 4.9; 4.0; 3.7; -13.0 (Dec).
  - Spread between reference lending and deposit rates (basis points): 413.1; 336.2; 298.6; 305.2 (Dec).
  - Customer deposits to total (noninterbank) loans: 59.0; 64.0; 58.6; 56.1 (Dec).
- General government balance sheet indicators (selected, percent of GDP):
  - Net financial worth: -93.4; -90.3; -86.6; -89.5; -100.6; -99.2; -93.8 (years shown).
  - Financial liabilities (percent of GDP series): 119.4; 116.9; 112.1; 114.7; 127.7; 126.4; 119.7 (years shown).

### External sector and balance of payments (selected)
- Current account balance (billions of euros): 2009 -30.2; 2010 -54.7; 2011 -51.5; 2012 -34.5; 2013 -32.3 (prel./proj.).
- Current account balance (percent of GDP): 2009 -2.0; 2010 -3.5; 2011 -3.3; 2012 -2.2; 2013 -2.0.
- Balance of goods and services (percent of GDP): 2009 -0.5; 2010 -1.9; 2011 -1.5; 2012 -0.4; 2013 -0.3.
- Gross external debt (percent of GDP): 2009 116.5; 2010 117.3; 2011 114.7; 2012 119.2; 2013 121.0.
- Composition of gross external debt (percent of GDP): Public sector 52.0; 52.5; 54.9; 61.5; 62.1. Private sector 64.5; 64.9; 59.8; 57.7; 58.9.

### Authorities' structural reform agenda — highlights (Product market and Labor market)
- Product market reforms / Enhance competition and liberalize economic activity:
  - Energy: Ownership separation of ENI from gas distribution activity; lower tariffs for vulnerable customers; promote strategic investments. Electricity: Promote investment in the transmission network; increase transparency. Petroleum products: Eliminate restrictions on contractual arrangements and activities; replace outdated systems; improve information transparency.
  - Transport: Railways—introduce competitive tender process for local railway services. Highways—review tariffs systems for new concessions. Taxi services—limit entry and activity restrictions.
  - Professional services: Abolish tariffs for regulated professions; reform professional orders to ease entry and activity restrictions; separate administrative, education, and disciplinary functions within orders. Increase the number of pharmacies and notaries; abolish some restrictions.
  - Local public services: Require competitive tendering and territorial consolidation in service provision to increase efficiency/reduce costs.
  - Other sectors: Reduce administrative constraints to establishing and running a business; liberalize opening hours for retailers.
  - Regulatory framework: Strengthen the powers of the Antitrust Authority; establish independent Transport Authority; strengthen the role of Communication Authority in the postal sector and Energy and Gas Authority in the water sector.
  - Reduce public sector ownership: Define a privatization plan (earlier target: at least €5 billion revenue per year over 2012–14); improve public asset management; plans to sell shares in state-owned companies and establish a real estate fund to manage disposal of public assets at all levels of government.
- Labor market reforms / Reduce labor market dualism:
  - Employment protection: Modify job protection on standard contracts to reduce costs of individual dismissal by limiting the compulsory reinstatement in case of dismissal for economic reasons.
  - Contracts: Encourage stable employment relationships (tax disincentives for fixed-term contracts; control abuse of atypical contracts) and promote apprenticeship contracts.
  - Social safety net: Reorganize social safety net to make the coverage more uniform (within the overall fiscal constraints); extend wage guarantee funds; early retirement schemes.
  - Raise labor participation: Promote female employment (protection against illegal 'blank resignations' and vouchers for baby-sitting services); strengthen activation policies. Existing measures focus on tax deductions for hiring of women, youth, and new employees, and establishing a special type of company for young entrepreneurs.
- Notes:
  - The law on competition, liberalization, and infrastructure was approved by the parliament on March 24, 2012.
  - The government approved a draft law on labor market reform on April 5, 2012; the law is yet to be approved by the parliament.

### Annex I — Debt Sustainability Analysis (summary)
- Background findings:
  - Sovereign yields: Current level of yields on Italian debt is "not unprecedented," with part of the rise in spreads attributable to declining German bund-yields.
  - Maturity and rollover: Average maturity just under 7 years; a 100 basis points shock to the yield curve is estimated to raise the interest bill by just over 0.2 percent of GDP.
  - Effective interest rate: Forecast to rise from 4.2 percent in 2011 to 4.6 percent in 2012.
  - Government financing needs: Large, at about 30 percent of GDP in 2012, largely due to the rollover of existing debt.
  - Primary surplus: Italy runs a primary surplus; recent pension reforms have significantly reduced the long-run impact of aging on fiscal accounts.
  - Debt ratio vulnerability: Italy’s public debt-to-GDP ratio is the second highest in the euro area; growth performance has been disappointing; debt-to-GDP remains vulnerable to adverse shocks.
- Scenario analysis — Baseline:
  - Staff forecast that the debt-to-GDP ratio will peak at about 126.4 percent in 2013, before declining to about 119 percent in 2017. Although spreads are assumed to moderate from current levels, the effective interest rate is forecast to rise from 4.2 percent in 2011 to 4.6 percent in 2012.

*ITALY 2012 ARTICLE IV REPORT — excerpt.*

### 5.3 percent in 2017. The structural primary balance improves with the implementation of the

### 5.3 percent in 2017. The structural primary balance improves with the implementation of the

### Debt-sustainability scenarios
- Structural surplus scenario
  - Staff recommends targeting a structural overall surplus of 1 percent of GDP from 2014 under the new fiscal rule.
  - Structural primary balance would improve to 6.7 percent of GDP.
  - Debt-to-GDP ratio would drop to about 116 percent by 2017.
  - Spreads are assumed to tighten relative to the baseline.
- Slow recovery scenario
  - Medium-term real annual growth stagnates at 0.25 percent (the average annual growth rate experienced over the last decade).
  - Average growth over 2013-17 would be flat.
  - Primary surplus reaches only 4.2 percent of GDP by 2017.
  - Debt-ratio reaches 128 percent of GDP in 2017.
- High interest rate scenario
  - Spreads rise to about 580 bps from 2013.
  - Government interest bill reaches 8 percent of GDP by 2017.
  - Implicit average interest rate of 6.5 percent.
  - Debt-to-GDP ratio approaches 130 percent by 2017 despite a sizeable structural primary surplus.
  - Same scenario applied to staff’s recommended fiscal stance (1 percent structural surplus) provides a greater buffer.
- Policy slippage scenario
  - Starting in 2012, only 25 percent of the planned adjustment is undertaken.
  - Rising risk premia: 25 basis points increase for each 1 percent of GDP slippage.
  - Debt-to-GDP ratio does not stabilize until 2017 at about 131 percent.
- Deep recession and interest rate shock
  - Annual GDP growth is 1 percentage point lower than in the baseline.
  - 100 bps increase in interest rates from 2013-2017.
  - These assumptions push the debt-ratio above 140 percent of GDP and keep it on a rising path.
- Structural reform scenario
  - Comprehensive product and labor market reforms could raise the level of real GDP by 5¾ percent after 5 years.
  - With these higher growth assumptions, debt-to-GDP ratio improves to about 108 percent by 2017.

### Fiscal projections in the baseline (Percent of GDP, unless otherwise indicated)
Assumptions (2011–2017)
- Real GDP growth (percent): 0.4 -1.9 -0.3 0.5 1.0 1.2 1.2
- Nominal GDP growth (percent): 1.7 -0.7 1.3 1.8 2.3 2.6 2.7
- Ouput gap 1/: -2.3 -3.9 -4.1 -3.7 -2.9 -2.0 -1.2
- Implicit/effective interest rate (percent): 4.2 4.6 4.6 4.7 4.9 5.1 5.3

Outcomes (2011–2017)
- Primary balance: 1.0 3.0 4.2 4.5 4.7 5.2 5.6
- Overall balance: -3.9 -2.6 -1.5 -1.4 -1.3 -1.0 -0.6
- Structural primary balance 1/: 1.4 4.7 6.0 6.0 6.0 6.1 6.2
- Structural overall balance 1/: -3.4 -0.7 0.5 0.4 0.2 0.0 0.0
- Debt-stabilizing primary balance: 3.8 6.5 4.2 3.7 3.2 3.1 3.1
- Public debt 2/: 120.1 125.8 126.4 125.6 124.1 122.0 119.4

Notes
- 1/ Percent of potential GDP.
- 2/ Debt projections incorporate Italy’s planned contributions to the EFSF and the ESM, increasing debt by 2 percent of GDP in 2012.
- Sources: National Authorities; and IMF staff calculations.

### Sensitivity analysis
- Debt-to-GDP is sensitive to the growth-interest rate differential.
- Fan-chart simulations (using staff forecast for primary balance and stochastic simulations for real GDP growth and interest rates) indicate a 95 percent probability that the debt-to-GDP ratio will remain below 130 percent in the medium term, given the sizeable primary surplus.

### External competitiveness and trade findings
- Italy’s merchandise balance has deteriorated, owing primarily to a widening energy deficit.
- Non-energy surplus has declined only marginally since the introduction of the euro.
- Italian exports have a relative predominance of labor-intensive and low-technology goods, similar to many emerging-market economies.
- Some restructuring toward higher-quality goods within manufacturing is occurring, but adjustment is constrained by structural factors.
- Since late 2009, CPI- and ULC-based real effective exchange rates have depreciated by around 5 and 7 percent, respectively, mostly reflecting the lower euro.
- Producer prices in Italy (excluding construction) increased by 10½ percent since 2009; in line with German prices, but around 1 point below the euro-area average.
- Nominal wages in Italy increased by 3¼ percent, compared to around 5¼ percent in Germany and 4½ percent in the Euro area.
- Staff assesses Italy’s real effective exchange rate to be modestly overvalued by around 5–10 percent.
- The External Balances Assessment (EBA) approach finds the structural current account deficit is around 1–1½ percent of GDP above the level justified by fundamentals and appropriate policies.
- Simulations suggest full implementation of the authorities’ reform agenda should close this competitiveness gap.

### Appendix I: Main 2011 Article IV recommendations and authorities’ response (selected)
Fiscal Policy
- Identify specific measures to achieve the near-balanced budget by 2014
  - Authorities enacted three fiscal adjustment packages in 2011 and identified measures needed to balance the budget in structural terms in 2013.
- To achieve durable fiscal consolidation, improve the efficiency of public expenditure and rationalize it through periodic expenditure reviews
  - Consolidation remains mostly revenue-based. In April, the government launched a new spending review to identify expenditure cuts.
- Reduce substantially tax expenditure; simplify tax system
  - Comprehensive review of tax expenditure completed; little progress so far in reducing tax expenditure. A wider tax reform is being discussed.
- Accelerate further pension reforms
  - December 2011 fiscal package introduced further pension reforms to strengthen long-term sustainability.
- Strengthen further budgetary procedures
  - April 2012: parliament approved a structural balanced budget rule in the constitution set to take effect in 2014 and legislated creation of a fiscal council.
- Allow local authorities to tax all real estate properties; integrate fiscal federalism reform with fiscal consolidation
  - Local tax on primary residence was re-introduced as part of the December 2011 fiscal package.

Financial Sector Policy
- Further recapitalize banks and frontload recapitalization
  - Banking system core tier 1 ratio increased from 8.3 percent in 2010 to 9.3 percent in 2011; further important capital actions took place in 2012.
- Introduce governance reforms in the banking system, including in Banche Popolari and Fondazioni
  - Measures taken, including a law against interlocking directors in financial institutions; eligibility criteria for board members of Fondazioni enhanced.
- Further recapitalize or restructure enterprises; ameliorate reorganization and debt restructuring frameworks
  - Measures to foster firms recapitalization introduced, including an allowance for corporate equity (ACE). Legal framework for personal insolvency proceedings introduced.

Structural Reforms
- Implement further product market reforms to remove impediments to competition, improve regulation, give more powers to the Antitrust Authority, open further services and network industries, and reduce public ownership
  - Comprehensive packages of liberalization and administrative simplification reforms approved in 2012 and 2011; powers of the Antitrust Authority strengthened; limited progress on privatization but plans announced to sell shares in state-owned companies.
- Implement policies to address labor market duality and low participation; harmonize labor contracts; promote decentralized wage bargaining
  - April 2011 labor market reform bill submitted to parliament aiming to make labor market more flexible and inclusive; more could be done to address duality and increase participation. Limited progress on wage bargaining decentralization.

### Fund relations (as of May 31, 2012)
- Membership Status: Joined 3/27/47; Article VIII.
- Quota: 7,882.30 SDR Million, 100.00 Percent Quota.
- Fund holdings of currency: 5,332.73, 67.53 Percent Quota.
- Reserve Tranche Position: 2,559.58, 32.47 Percent Quota.
- New arrangements to borrow: 1,550.33.
- Mission: Rome and Milan, May 3–16, 2012. Concluding statement available at: http://www.imf.org/external/np/ms/2012/051612.htm
- Staff team: Mr. Husain (head), Mr. Kang, Ms. Barkbu, Ms. Lusinyan, Mr. Tyson, Ms. Zoli (all EUR), Messrs. Eyraud (FAD), Guzzo and Moore (MCM), and Tiffin (SPR). Mr. Spilimbergo (EUR) and Ms. Nardin (EXR) also joined for a few days. Mr. Moghadam participated in the concluding meetings and press briefing. Mr. Sadun (OED) attended the policy meetings.

*Source: ITALY 2012 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND (selected excerpts).*

### 2011. The associated Executive Board’s assessment is available at:

### ITALY 2012 ARTICLE IV REPORT — INFORMATIONAL ANNEX

### SDR Department and Fund Obligations
- Net cumulative allocation: 6,576.11 SDR Million
- Holdings: 5,975.19 SDR Million (90.86 percent)
- IV. Outstanding Purchases and Loans: None
- V. Financial Arrangements: None
- VI. Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs):
  - Presented in the source as:
    - Forthcoming 20122013201420152016
    - Principal
    - Charges/Interest 0.390.86    0.860.860.86
    - Total 0.390.86    0.860.860.86

### Exchange Rate Arrangement and Article VIII Status
- Italy accepted the obligations under Article VIII.
- Italy 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.
- Italy maintains an exchange system free of restrictions on the making of payments and transfers for current international transactions, except for exchange restrictions imposed solely for the preservation of national or international security that have been notified pursuant to Executive Board Decision No. 144-(52/51).
- VIII. Article IV Consultations: Italy is on the standard 12-month consultation cycle. Previous consultation discussions took place during April 26–May 11, 2011, and the staff report (Country Report No. 11/157, 07/12/11) was discussed on July 11, 2011.

### Statistical Issues and Data Quality
- Italy subscribes to the Special Data Dissemination Standard (SDDS) and has posted metadata on the Dissemination Standards Bulletin Board (DSBB).
- Data provision is adequate for surveillance; Italy’s economic database is comprehensive and of generally high quality.
- Italy is subject to statistical requirements and timeliness and reporting standards of Eurostat and the European Central Bank (ECB), and has adopted the European System of Accounts 1995 (ESA95).
- The shift to chain-weighted indices for national accounts has been largely completed over the course of 2006.
- Key findings from ROSC and updates:
  - ROSC—Data Module (Country Report No. 02/234, 10/18/02):
    - Macroeconomic statistics generally high quality but shortcomings that hinder accurate and timely analysis:
      - No statistical agency responsible for compiling and disseminating a comprehensive statement of government finances; persistent difference between the SGP-monitored fiscal deficit and the PSBR net of privatization receipts.
      - Need to strengthen source data/statistical techniques: raise response rates on enterprise surveys used in national accounts and producer price index; make CPI price collection more efficient; improve coverage of cross-border financial transactions.
      - Balance of payments and government finance statistics could be closer aligned with internationally accepted methodological guidelines on concepts and definitions, scope, classification and sectorization, and/or valuation.
      - Resources under pressure in some parts of Istat given statistical requirements of the EU and the Euro area.
    - Changes in inventories are derived as a residual and lumped with the statistical discrepancy, hampering economic analysis.
  - ROSC—Fiscal Transparency Module—Update (Country Report No. 06/64, February 2006):
    - Progress made toward strengthening data integrity; outstanding issues include:
      - Improve transparency and timeliness of budget documents; key details underlying budgetary plans often available only well after the draft budget.
      - Provide more information on financial transactions between government and public enterprises to help address discrepancies in fiscal balances.
      - Address lack of data on operations of larger nonstate entities where the state is a shareholder (e.g., the road company).
      - As public private partnerships gain ground, ensure these operations and associated contingent liabilities are transparently recorded, including in budget documentation; strengthen project evaluation across all levels of government.
    - Recent progress:
      - Reconciliation of the discrepancy between the cash-based net borrowing requirement and the accrual budget deficit has reduced the statistical discrepancy in recent years.
      - On-line access to main fiscal documents has improved.
      - Consolidated cash accounts of central government economic entities (such as the road company, Anas) are reported in the quarterly cash reports (relazione trimestrale di cassa) of the Ministry of Economy and Finance.

### Table 1 — Common Indicators Required for Surveillance (As of June 13, 2012)
- Date of latest observation and Date received for key series (selected entries as presented):
  - Exchange Rates: May 2012; May 2012; Frequency: D; Frequency of Reporting: D; Frequency of Publication: D; Data Quality – Methodological soundness: (blank); Data Quality – Accuracy and reliability: (blank)
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Apr 2012; May 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - Reserve/Base Money: Apr 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M; Data Quality – Methodological soundness: O,O,LO,LO; Data Quality – Accuracy and reliability: O,O,O,O,LO
  - Broad Money: Apr 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - Central Bank Balance Sheet: May 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - Consolidated Balance Sheet of the Banking System: Apr 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - Interest Rates: May 2012; May 2012; Frequency: D; Frequency of Reporting: D; Frequency of Publication: D
  - Consumer Price Index: May 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M; Data Quality – Methodological soundness: O,O,O,O; Data Quality – Accuracy and reliability: LO,O,LO,O,O
  - Revenue, Expenditure, Balance and Composition of Financing – General Government: Q4 2011; April 2012; Frequency: Q; Frequency of Reporting: Q; Frequency of Publication: Q; Data Quality – Methodological soundness: LO,O,LO,O; Data Quality – Accuracy and reliability: LO,O,O,O,LO
  - Revenue, Expenditure, Balance and Composition of Financing – Central Government: Apr 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - Stocks of Central Government and Central Government-Guaranteed Debt: Apr 2012; June 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - External Current Account Balance: March 2012; May 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M; Data Quality – Methodological soundness: O,LO,LO,O; Data Quality – Accuracy and reliability: LO,O,LO,O
  - Exports and Imports of Goods and Services: March 2012; May 2012; Frequency: M; Frequency of Reporting: M; Frequency of Publication: M
  - GDP/GNP: Q1 2012; May 2012; Frequency: Q; Frequency of Reporting: Q; Frequency of Publication: Q; Data Quality – Methodological soundness: O,O,O,O; Data Quality – Accuracy and reliability: LO,LO,O,O,O
  - Gross External Debt: Q4 2011; March 2012; Frequency: Q; Frequency of Reporting: Q; Frequency of Publication: Q
  - International Investment Position: Q4 2011; March 2012; Frequency: Q; Frequency of Reporting: Q; Frequency of Publication: Q
- Footnotes as presented in the source clarify coverage and assessment notation (O, LO, LNO, NO, NA) and frequency codes (D, W, M, Q, A, I, NA).

### ROSCs/FSAP
- Standard Code Assessment and dates (as presented):
  - Fiscal Transparency — October 9, 2002 — Country Report No. 02/231
  - Data — October 18, 2002 — Country Report No. 02/234
  - Fiscal ROSC update — November 2003 — Country Report No. 03/353
  - Fiscal ROSC update — February 2006 — Country Report No. 06/64
  - FSAP — March 14, 2006 — Country Report No. 06/112

### Statement by the Staff Representative on Italy — Executive Board Meeting, July 9, 2012
- Purpose: Provide additional information on policy actions in Italy since the Article IV mission complementing the staff report (SM/12/152). The additional information does not change the thrust of the staff appraisal.
- Recent macroeconomic developments:
  - Continued contraction in Q2 2012, in line with staff’s projections.
  - Unemployment rate: came down from 10.2 percent in April to 10.1 percent in May, reflecting a 0.3 percent increase in employment.
  - Retail sales: fell significantly in April, bringing the annual decline to about 7 percent.
  - Business and consumer confidence indicators remained at low levels through June.
- Bankruptcy and civil justice reforms and other growth measures:
  - A decree law on growth measures entered into effect on June 26.
  - Measures include modifications to the bankruptcy regime, such as a new tax provision on deductibility of losses to facilitate financing of companies in distress.
  - In civil justice, the decree aims to speed up the judicial process by streamlining appeals procedures.
  - The decree provides for favorable tax treatment for project bonds to promote public-private partnerships, extends tax incentives in infrastructure and construction, amends the VAT regime for real estate leases and sales, and introduces new debt financing instruments for non-listed companies to improve access to capital markets.
- Bank recapitalization:
  - On June 26, the Council of Ministers approved measures to increase the capital base of Banca Monte dei Paschi (MPS), Italy’s third largest commercial bank.
  - State support of up to €3.9 billion, which includes a replacement of €1.9 billion provided in 2009, will help MPS meet the target of 9 percent core Tier 1 ratio as determined by the European Banking Authority (EBA).

*Italic: Source — _cr12167 - 2011 (Italy 2012 Article IV Report — Informational Annex), PDF chapter/section (canonical URL provided with content).*

### 5.      Labor market reform. On June 27, the parliament approved the labor market reform

### 5. Labor market reform. On June 27, the parliament approved the labor market reform

### Labor market reform: scope and main provisions
- Parliament approved a labor market reform law on June 27, largely in line with the government’s April proposal.
- Modifications introduced:
  - Extension of tax incentives for firm-level bargaining.
  - A minimum remuneration for some temporary contracts.
  - Increased flexibility for firms to use temporary and apprenticeship contracts.
- Reform objectives:
  - Increase productivity.
  - Create more jobs.
  - Boost growth.
  - Reduce rigidities and disparities between over-protected traditional jobs and limited benefits for new entrants.
  - Provide a universal unemployment insurance system to which all companies will contribute.
- Coverage and benefits:
  - Unemployment benefits will be extended to a much larger segment of the workforce, including workers with relatively shorter tenures.
  - Introduction of a faster, out-of-court procedure to handle labor disputes in case of dismissal for economic or other objective reasons.
  - Strengthened active labor market policies: facilitate youth entry into the labor force, widen use of apprenticeship contracts, and retrain displaced workers.

### Recent developments and near-term outlook
- Context:
  - Italy faced intensive financial market pressure as the European debt crisis intensified in mid-2011, requiring multiple rounds of austerity.
  - Priority: achieve lasting consolidation of public finances and restore growth by addressing structural weaknesses.
- Economic activity:
  - Continued contraction through Q1 2012; modest recovery expected in the second half of 2012 led by exports.
  - Private consumption and investment expected to contribute positively to GDP growth in 2013 as austerity effects wear off.
- Inflation and wages:
  - Inflation in the first half of the year was somewhat higher than the European average due to energy price spikes and VAT increases.
  - Core inflation remains at 2.2 percent because of sluggish demand and restrained wage rates.
  - Public sector wages frozen for two years; significant reductions for senior officers.

### Fiscal consolidation: measures and targets
- Recent fiscal adjustment:
  - Measures enacted in the last 12 months represent a fiscal adjustment of about 5 percent of GDP.
  - Aim to reduce the deficit from 3.9 percent in 2011 to 1.7 percent in 2012 and to 0.5 percent in 2013.
  - Structural deficit path: decline from 3.6 percent in 2011 to 0.4 percent in 2012 and to a surplus of 0.6 percent in 2013.
- Policy mix:
  - Short term: bulk of adjustment through tax increases (VAT rates increased; reinstatement of a real estate tax abolished earlier).
  - Measures to support growth: tax reductions for companies hiring new employees and on capital investments.
  - Spending-side measures: comprehensive spending review launched to reduce the overall level of government spending and improve its quality.
  - Public sector wage actions: wages frozen since 2010; senior officials’ wages cut by 10 percent.

### Debt reduction strategy and sensitivity
- Debt objectives and projections:
  - A structural primary surplus of more than 1 percent was reached last year; authorities expect it to increase to well above 4 percent in 2012 and to stabilize around 6 percent from 2013 onward.
  - Debt should start to decline as of next year, one year ahead of staff projections, and should reach the 114.4 percent level by 2015.
- Additional measures:
  - Considering disposal of liquid assets, including stocks of state-owned companies.
  - Initiatives to establish companies, trusts, or real estate funds for development and sale of public real estate.
- Sensitivity analysis outcomes:
  - Assuming a 0.5 percent reduction in GDP growth or higher interest rates of 100 b.p. with respect to the baseline, the debt-to-GDP ratio is projected to decline by 2014 at the latest.
  - Under a staff scenario of permanent no-growth and an increase in interest rates of 100 b.p., the debt could be pushed toward 140 percent of GDP.

### Spending review and public expenditure priorities
- Rationale:
  - Frontloaded fiscal adjustment increased fiscal pressure; medium-term debt reduction will rely increasingly on reducing current expenditure.
- Approach:
  - Comprehensive spending review replacing linear cuts with analytical assessment of needed resources.
  - All areas of government spending under review with top priorities identified in the budget of key central agencies and local governments.

### Reforms agenda and measures to restore growth and competitiveness
- Pension reform:
  - Completed pension reform increases retirement age to the highest level in Europe and ensures long-term sustainability.
- Product and service market reforms:
  - Measures submitted in the “Sviluppo Italia” package include:
    - Reduction of the tax wedge on labor (notably for employment of women and young workers).
    - Re-funding the guarantee fund for SMEs.
    - Simplifying the incentives scheme for enterprises.
    - Redesign and extension of tax incentives on building renovations and energy efficiency investments.
    - Introduction of substantial tax benefits for companies’ recapitalization.
  - Liberalizations across professional services, distribution, transportation, and network industries; planned liberalizations in the energy sector include breaking up the vertically-integrated cartel in gas and electricity.
- Investment facilitation:
  - Expedite investment in key infrastructure by facilitating private capital participation, reducing administrative burden, and coordinating regional programs co-financed by EU structural funds.
  - Measures taken to accelerate disbursement of approved payments to ease financial pressures on government suppliers.

### Financial sector: resilience, pressures, and capital strengthening
- Banking system strengths:
  - Broad resilience due to a sound business model (retail funding accounts for about 85 percent of the total bank loans), prudent risk management, and effective supervision.
  - Italian banks avoided over-extended leveraging and large exposures to inflated real estate markets or Program countries.
- Crisis impact:
  - Two recessions in three years and intensified euro area crisis led to deteriorated access to wholesale markets, higher funding costs, declining credit growth, and worsening loan quality.
- ECB and liquidity:
  - Funding pressures eased considerably following ECB LTRO operations.
  - For the 32 banking groups covered by Banca d’Italia weekly liquidity monitoring, LTRO funding is sufficient to meet in full those bonds held by institutional investors that come due in the next two years.
- Capital positions:
  - For the five largest banking groups (covering about 70 percent of total consolidated assets), the core tier 1 capital ratio increased from less than 6 percent in 2007 to 9.5 percent by March 2012.
  - To meet the EBA Recommendations, four of the largest banks strengthened their capital by about €15 billion by end-June 2012. Half of this amount was raised by the largest bank through new equity issuance; the rest via asset disposal, retained earnings, and one case of issuing recapitalization bonds subscribed by the government.
- Credit quality:
  - Gross impaired loans rose to 11 percent in 2011, from less than 6 percent before the crisis.
  - Banks’ exposure to the sovereign has also increased.
  - Higher funding costs and tighter lending standards have pushed up corporate borrowing rates, especially for smaller firms.
- Policy priorities to support banking resilience:
  - Maintain adequate capital and liquidity buffers.
  - Reduce impaired loans to free up resources for new lending.
  - Improve efficiency of bankruptcy proceedings and out-of-court workouts to support corporate restructuring.

### Executive Board Assessment: priorities and recommendations
- Overall view:
  - Directors commended authorities for the ambitious agenda to secure fiscal sustainability and promote growth but noted the situation remains challenging with downside risks.
- Policy priorities emphasized by Directors:
  - Raise productivity and labor participation.
  - Pursue growth-friendly fiscal consolidation.
  - Promote a more dynamic and resilient banking system.
  - Sustain reform momentum and secure progress at the European level in strengthening the currency union.
- Labor and product market recommendations:
  - Further action needed to bridge the gap between permanent and temporary workers, raise female labor participation, and better match wages to productivity via greater wage-setting decentralization.
  - Accelerate reforms in the energy and services sectors; improve the investment climate and reduce the cost of doing business.
  - Continue efforts to enhance judicial system efficiency.
- Fiscal policy recommendations:
  - Rebalance adjustment towards expenditure cuts and lower taxes.
  - Swift follow-up on the spending review to reduce overall government spending and improve quality.
  - Scope for cutting the public sector wage bill, reducing tax expenditures, and stepping up efforts against tax evasion to create space for growth-supporting measures (e.g., reduce the labor tax wedge and encourage investment).
  - Continue efforts to lock in prudent medium-term policies to reduce high public debt, pursue privatization and asset sales as planned.
- Financial sector recommendations:
  - Maintain capital and liquidity buffers.
  - Reduce impaired loans.
  - Improve bankruptcy and out-of-court workout procedures.

### Key statistics and projections (selected, as reported)
- Real GDP growth:
  - 2009: -5.5
  - 2010: 1.8
  - 2011: 0.4
  - 2012: -1.9
  - 2013: -0.3
- Final domestic demand:
  - 2009: -3.2
  - 2010: 1.0
  - 2011: -0.4
  - 2012: -3.0
  - 2013: -0.7
- Exports of goods and services:
  - 2009: -17.5
  - 2010: 11.6
  - 2011: 5.6
  - 2012: 0.6
  - 2013: 1.9
- Imports of goods and services:
  - 2009: -13.4
  - 2010: 12.7
  - 2011: 0.4
  - 2012: -6.3
  - 2013: 1.2
- Consumer prices:
  - 2009: 0.8
  - 2010: 1.6
  - 2011: 2.9
  - 2012: 3.0
  - 2013: 2.1
- Unemployment rate (in percent):
  - 2009: 7.8
  - 2010: 8.4
  - 2011: 8.4
  - 2012: 10.3
  - 2013: 11.1
- Private sector credit (end-period, percent change):
  - 2009: -0.5
  - 2010: 3.6
  - 2011: 2.3
- General government balance (percent of GDP):
  - 2009: -5.4
  - 2010: -4.5
  - 2011: -3.9
  - 2012: -2.6
  - 2013: -1.5
- Structural overall balance (percent of potential GDP):
  - 2009: -3.6
  - 2010: -3.3
  - 2011: -3.4
  - 2012: -0.7
  - 2013: 0.5
- General government debt (percent of GDP):
  - 2009: 116.1
  - 2010: 118.7
  - 2011: 120.1
  - 2012: 125.8
  - 2013: 126.4
- 6-month interbank rate (end-period):
  - 2009: 1.0
  - 2010: 2.3
  - 2011: 2.3
- 10-year government bond yield (end-period):
  - 2009: 4.1
  - 2010: 4.8
  - 2011: 5.0
- Trade balance (goods and services, percent of GDP):
  - 2009: 0.1
  - 2010: -1.3
  - 2011: -1.1
  - 2012: -0.2
  - 2013: -0.1
- Current account (percent of GDP):
  - 2009: -2.1
  - 2010: -3.6
  - 2011: -3.1
  - 2012: -2.2
  - 2013: -2.0
- Euros per US dollar:
  - 2009: 0.7
  - 2010: 0.8
  - 2011: 0.7
- Nominal effective rate (1999Q1=100):
  - 2009: 104.6
  - 2010: 101.3
  - 2011: 101.6
- Real effective rate (1999Q1=100, CPI based):
  - 2009: 103.3
  - 2010: 99.4
  - 2011: 99.4

*Statement by Arrigo Sadun, Executive Director for Italy July 9, 2012*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12167.pdf_