## _cr14283 ## Source details **Canonical URL:** [_cr14283](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14283.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14283.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14283.pdf.json) --- ### 1. Impact of Financial Conditions on Growth — macro context and key indicators - Real GDP contracted in the first half of 2014 by 0.1 percent compared to second half of last year, pushing Italy back into recession. - Investment remains 27 percent below pre-crisis levels. - Clearance of government arrears to date equals 1.6 percent of GDP. - Italy’s share of global exports increased for the first time since 2007. - Unemployment rate stabilized around 12.3 percent; wage supplementation adds another 2 percent of workers not counted in official figures. - Long-term unemployment incidence is 58 percent (20 points above the OECD average). - Headline inflation dropped to 0.4 percent (y/y) in 2014:Q2; core inflation was 0.7 percent (y/y). - Output gap estimated at 3.8 percent. - Nominal wages increased 1.4 percent (y/y) in the first quarter, producing a 0.9 percent real increase given falling inflation. - Regional crisis impact (2007–13): GDP fell 6.7 percent in the north and 13.6 percent in the south; unemployment rose about 4 percentage points more in the south than in the north. - Potential growth estimates remain at around ½ percent; growth projected to average 1 percent during 2014–19. ### 2. Financial Conditions Index (FCI) and growth impact - Construction and interpretation: - FCI components: stock market returns, sovereign spreads, the NEER, inflation expectations, the ECB policy rate and balance sheet, EURIBOR-OIS spread, nominal bank lending rates, credit volume to the private sector (bank loans and bonds), and lending standards. - Negative FCI values indicate tighter than average conditions. - Recent developments: - The FCI tightened significantly in 2011 and early 2012, but has eased recently on the back of gains in equities and sovereign spreads and stable bank lending standards. - Nominal lending rates to the private sector have remained high; falling inflation has driven real lending rates up. - Persistence of financial fragmentation in the euro area explains tight conditions despite ECB accommodation. - Growth impact (VAR evidence): - A negative shock that raises real corporate lending rates by 260bps through a 200bps increase in nominal rates and a 60bps decline in inflation expectations (to 0.5 percent) would lower growth by a cumulative 0.4 percentage point over three quarters. - Reference observation: real rates have increased by around 300 bps since mid-2012. - FCI shocks have a significant impact on growth, mainly through investment. ### 3. Policy implications from financial conditions analysis - Measures to normalize corporate financial conditions would support a robust and sustained recovery, mainly through investment. - Bank-focused actions (bank lending rates account for the lion’s share of FCI tightening): - Domestic and euro area measures to address financial fragmentation. - Mend corporate balance sheets. - Strengthen banks’ capacity to lend. - Objective: minimize the risk of a weak, creditless recovery. ### 4. Outlook and risks (projections and downside scenarios) - Staff projections: - Growth of -0.1 percent in 2014 and 1.1 percent in 2015. - Inflation expected to pick up slowly but remain below the ECB’s euro area target over the projection period. - Key downside risks (interconnected): - Geopolitical tensions and export slowdown; Italy imports 90 percent of its gas. - Stagnation and low inflation could necessitate further fiscal adjustment, especially if growth is lower than the real interest rate on debt. - Bond market stress and financial instability from domestic policy slippages, delays in EU reforms, or negative surprises in the European AQR. - Clearance of public arrears and unlocking of corporate cash holdings (2 percent of GDP in 2012–2013) could provide upside to investment. - Authorities’ assessments and expectations: - MEF acknowledged downside risks to its 2014 growth forecast of 0.8 percent but saw reforms raising growth (0.8 percent higher in 2015 relative to a no-reform counter-factual). - BoI estimates the June ECB announcements would raise growth by 0.5 percent by 2016. - Authorities expect growth to approach 2 percent in 2018 once all reforms are implemented. - BoI projects inflation to rise to 0.8 percent in 2015 from 0.4 percent in 2014. ### 5. Competitiveness and external position - Cyclically-adjusted current account in 2013: near balance at 0.3 percent of GDP. - NIIP: deteriorated by 16 percent of GDP since joining the Euro area; net liabilities equal to 29 percent of GDP. - Foreign portfolio investment in debt securities turned positive in 2013, led by government securities. - Staff view: a real effective depreciation of 0–5 percent, supported by structural reforms and fiscal consolidation, would help close the competitiveness gap over the medium term. ### 6. Geopolitical and spillover implications - Trade and energy exposure: - More than half of Italy’s merchandise exports are directed to the EU; rebound since 2009 driven by exports to non-EU countries, including EMs. - Italy imports nearly 80 percent of its energy needs and is a net importer of oil and natural gas. - Financial exposures: - Direct exposure of Italian banks to the euro area is considerable (23 percent of GDP), largest exposures to Germany and Austria. - Italian banks’ consolidated claims in Russia and Ukraine total roughly 2 percent of Italy’s GDP. - Italian direct investment into Russia and Ukraine reached US$3 billion in 2012 after averaging less than US$50 million annually during 2002-07; total direct investment stock in the two countries combined totals less than 1 percent of Italy’s GDP. - Simulation: a shock that pushes up oil and gas prices by 15–20 percent and increases long-term sovereign yields by 100 bps could shave up to half a percentage point from GDP growth in Italy over the medium-term. - Outward spillovers: GVAR estimates show notable spillover effects from an increase in Italian sovereign credit spreads to those in Ireland, Portugal and Spain. ### 7. Improving the economy’s growth potential — structural constraints and reform priorities - Institutional constraints holding back productivity: - Fragmented labor market unwilling to invest in young workers. - Inefficient and lengthy judicial system that discourages investment. - Ineffective and indebted public sector reliant on high taxes. - Financial system saddled with bad loans and hamstrung in its ability to provide credit. - PM Renzi’s reform agenda: electoral law, labor market, judicial system, and public sector; Delega Fiscale passed to simplify and improve the tax system. - Emphasis: delivering real change and pursuing wide-ranging reforms simultaneously to generate growth synergies. ### 8. Labor market reforms — findings, staff advice, and authorities’ stance - Jobs Act ideas: universal unemployment benefits tied to training and job-search; a national agency for ALMP; rationalized contracts with more flexibility. - Current situation: - With 70 percent of new contracts being temporary, marginal measures do little to reduce duality. - Staff advice and status: - Link unemployment support to employability (proposed in Jobs Act but not yet implemented). - Single labor contract with gradually increasing protection (staff proposal goes further than “trial” contract in Jobs Act). - National coordination of ALMP and build market-based job matching institutions (staff proposes beyond Jobs Act). - Promote firm-level wage bargaining; idea not included in Jobs Act. - Authorities’ view: - Short-term priority: create new jobs via lifting restrictions on temporary contracts. - Will develop options to improve ALMPs and design an experimental contract with gradually increasing protection. - Caution on fully decentralized wage setting due to potential costs and disruption. ### 9. Judicial reforms, dispute resolution, and anti-corruption measures - Key problems: - More than a thousand days to enforce a contract — more than twice the OECD average. - Backlog of 5.2 million civil cases (slowly decreasing). - Halving duration of labor disputes associated with an increase in probability of employment by about 8 percent (staff regional analysis). - Time to resolve cases in labor court and slow judicial processes constrain firms; electronic filing and court performance monitoring seen as potential gains. - Italy is one of few EU countries requiring lawyers in compulsory mediation. - Public sector corruption remains a serious problem; Transparency International places Italy 30 out of 31 among high income OECD countries in perceptions of corruption. - Policy options and recommendations: - Promote mediation; allow all qualified professionals to be mediators. - Rationalize Supreme Court case types; require performance indicators for courts. - Disseminate regional best practices (e.g., Strasbourg Program in Turin Court). - Explore assisted dispute resolution, restrict appeals to the Supreme Court, change statute of limitation rules, criminalize false accounting, and strengthen ANAC and anti-corruption legal framework. - Implementation notes: - Backlog of cases fell by 11 percent since 2009; processing times reduced by 3.7 percent since 2011. - 2012 anti-corruption legislation aligns with international standards. - Since 2013, BoI requires enhanced due diligence on domestic “politically exposed persons”. ### 10. Competition policy, product markets, and expected effects - Findings: - Potential growth has fallen; weak productivity, especially in services. - Liberalization progress uneven: gas sector liberalized; opening professional services and privatization of local services stalled. - Transport authority established in 2011 but understaffed. - Recommendations: - Accelerate reforms in sectors that are essential inputs to production to reduce markups and raise productivity. - Address staffing shortages in regulators; open up legal profession; enhance retail competition. - Implement antitrust recommendations (commitment to legislate by September 2014) and restructure rail and local public transport by end-2014. - Short-term effect: adjustment costs from liberalization could be offset by improved sentiment and new investment. ### 11. Non-performing loans (NPLs) and bank balance sheet cleanup - Current metrics and problems: - Since 2007, the NPL ratio has tripled to 16 percent at end-2013; corporate NPLs reached 29 percent (higher in the South). - Largest increase in “bad debt” loans in insolvency (“sofferenze”); low provisioning and lengthy foreclosure procedures are main obstacles. - Recovery process: three years to foreclose on collateral and seven years to complete a bankruptcy. - Italy ranks 21 out of 31 among high income OECD countries in resolving insolvency (Doing Business). - Despite rising NPL stock, write-off rates continue to decline; recent NPL sales limited to defaults over ten years. - Three-pronged recommendation: a) Stronger provisioning and write offs: - Foster convergence in provisioning rates, including forbearance loans under the moratorium program. - Supervisor to monitor bank progress and conduct targeted on-site inspections. - Consider higher capital charges or time-limits for writing off old NPLs. b) Develop the distressed debt market: - Encourage private NPL asset management companies (AMCs) via tax incentives while ensuring transfers at fair market value. c) Enhanced enforcement and insolvency regimes: - Expand specialized insolvency benches and introduce time-limits to expedite reorganization. - Adopt INSOL Principles for Multi-Creditor Workouts and rely more on online court filings. - Quantitative target: write-off rates would need to triple from their historic average to bring the bad debt ratio to pre-crisis levels within 10 years. ### 12. Financial sector recapitalization, governance, and market funding - Recent developments and figures: - Ahead of the AQR, large Italian banks booked net losses of nearly €22 billion in 2013, announced plans to dispose of NPLs and have raised €11 billion in capital. - Foundation owner of Banca Monte dei Paschi di Siena sold most of its shares, raised €5 billion in capital in June, and repaid the bulk of its state aid. - Provisioning and supervisory changes: - Provisioning coverage varies and is lower in mid-size banks where capital buffers are thin. - Supervisory responsibility, including minimum prudential standards on provisioning, to be transferred to the Single Supervisory Mechanism (SSM) in the fall. - Governance recommendations: - Strengthen independent board members and “fit and proper” tests. - Require published audited accounts by foundations participating in banks; limits on their leverage. - Apply ban on foundations controlling banks; reduce foundation stakes within concentration limits. - Encourage largest cooperative banks to convert to joint stock companies and consolidate. - Capital markets and funding diversification: - Corporates’ debt-to-equity ratio is 123 percent; this is 17 percentage points higher than the Euro area average. - Pension assets: 16 percent in equities (compared to 50 percent for the largest international pension funds) and less than 1 percent in Italian equities. - Recommendations: encourage institutional investors to raise allocations in equities and alternative assets; reduce tax bias against equity financing. - Bank cost and profitability: - Encourage operational cost reductions: branch rationalization, digitalization, and mergers. - Large banks cut branch networks by 7 percent since 2008; more scope exists for technology in retail banking. - Regulatory progress: - BoI inspections in 2012 covered 40 percent of NPLs using a conservative definition in line with EBA standards. - ECB’s AQR also examines performing loans, including those under moratorium, potentially raising provisioning needs. - National arrangements for resolution mechanisms and public backstops are being put in place. ### 13. SME support, restructuring, and access to finance - SME role and vulnerabilities: - SMEs account for about 80 percent of the corporate workforce and 70 percent of firm value added in Italy. - SMEs are more prevalent and smaller than elsewhere in the euro area and suffer from high leverage and weak profitability. - Business startup and firm exit rates are lower than the euro area, limiting resource reallocation and innovation. - Policy recommendations: - Establish creditor-led restructuring guidelines and standard criteria for assessing SME loans. - Shift public support toward financing for new firms and restructuring viable but distressed firms (staff advice; authorities disagree on shifting away from guarantees for existing firms). - Introduce a new fiduciary loan contract to allow efficient collateral enforcement not relying on courts and enable quick enforcement on default. - Introduce a nationwide electronic registry for all types of collateral. - Expand sharing of credit information: broaden access to registries by nonbanks and include tax payments, retail credit, and utility bills. - Existing government support: - Moratorium scheme covering some €23 billion in principal. - Central Guarantee Fund expansion and Cassa Depositi e Prestiti support. - Payment of government arrears: some 60 billion planned over 2 years to provide liquidity to SMEs. - Fondo Italiano d’Investimento (created in 2009) invests in SME risk capital. ### 14. ECB actions, national measures, and fiduciary loan contract proposal - ECB and BoI actions: - Recent ECB actions eased conditions: bank funding costs eased and several banks reissued unsecured senior debt. - Italian banks repaid one third of their Eurosystem borrowing. - BoI: T-LTRO could provide liquidity of more than €200 billion over the life of the program. - BoI measures: extend eligible collateral for refinancing to SME loans and mortgages; exploring refinancing of overdraft bills. - Policy advice: - If inflation remains too low, ECB should consider substantial expansion of its balance sheet, including through asset purchases. - Faster progress toward banking union and completion of national arrangements for resolution and backstopping recommended. - Box — New fiduciary loan contract (concept and benefits): - Fiducia agreements transfer title (not possession) to a fiduciary third party; on default fiduciary transfers title to lender without court proceedings. - Benefits: reduced uncertainty, time and cost of securing collateral; borrowers keep possession/use and may obtain lower rates. - Examples cited: France (2006 “fiducie-sûreté”) and Brazil (2004 fiduciary ownership agreements). - Note: fiduciary arrangements do not exist in Italy. ### 15. Fiscal policy diagnostics, consolidation, and reallocation priorities - Structural problems: - Labor tax wedge around 48 percent of total labor cost versus OECD average of 36 percent. - Public spending has high elderly bias and low education spending. - Efficiency of public spending varies across regions; South weakest. - Recent measures: - Government reduced PIT for low earners by around ½ percent of GDP in 2014 (roughly 1,000 euro per household). - Increase in ACE welcome and should be extended. - Financing tax cuts and savings: - PIT cut partly funded by one-off measures (VAT on arrears payments and taxes on revalued BoI shares). - Need for permanent measures: lower tax expenditures, higher taxes on wealth (including inheritance), savings from spending review, stronger tax evasion enforcement. - Spending review and reallocation: - Key areas: pensions, health, and regional efficiency gaps. - Focus on savings from current pensions (e.g., higher progressive indexation) and health standard costs. - Use savings to lower marginal tax rates and shift resources to education, ALMPs, and public investment. - Authorities’ view: - Reorienting budget priorities requires permanent savings; prospects for further pension changes limited. - Emphasized higher growth over further consolidation and intend to seek EU flexibility in exchange for structural reforms. ### 16. Fiscal consolidation, debt dynamics, and staff advice (numerical highlights) - Fiscal outcomes and near-term outlook: - Structural primary surplus improved from 0.7 to 4.5 percent of GDP between 2011 and 2013. - Nominal headline deficit expected to remain at 3 percent of GDP this year. - For 2015, authorities plan a ½ percent of GDP adjustment to narrow the structural deficit to -0.1 percent of GDP. - Public debt and vulnerabilities: - Public debt set to rise, peaking at 136 percent of GDP in 2014 due to slower growth and arrears clearance. - Under baseline, public debt projected to decline modestly to 125 percent of GDP by 2019. - Annual gross financing needs of 24 percent of GDP (almost €400 billion). - Staff policy advice: - Conditional on recovery, a modest structural surplus next year appropriate to bring down debt faster. - Additional adjustment up to ½ percent of GDP (depending on recovery strength) to help achieve a small structural surplus by 2015. - After recovery entrenched, a 1 percent of GDP structural surplus buffer recommended. - Accelerating privatization (0.7 percent of GDP annually through 2017) would reduce debt faster and support investment. - Staff’s 2015 Additional Fiscal Measures (percent of GDP): - Additional fiscal effort (relative to authorities' plans): 0.5 - Lowering the tax wedge: -0.9 - Spending on ALMP/education/capital: -0.3 - Reduction in tax expenditures: 0.8 - Expenditure savings/Spending Review: 0.4 - Wealth tax measures: 0.3 - Higher taxes on financial income: 0.2 ### 17. Debt sustainability analysis (DSA) — baseline, shocks, and policy-advice scenario - Baseline DSA summary: - Debt-to-GDP ratio will peak at 136 percent in 2014, before declining to 124 percent in 2019. - Government financing requirements: 24 percent of GDP. - Average maturity of public debt: under 6½ years. - Share of debt with fixed interest rate: 70 percent. - Almost 2/3 of debt is held by domestic investors. - Sensitivities and shocks: - Interest pass-through: a 100 basis points shock to the yield curve estimated to raise the interest bill by just over 0.16 percent of GDP in year 1, 0.34 percent in year 2, and 0.44 percent in year 3. - Growth shock: growth lower by one standard deviation for two years starting 2014; debt-to-GDP increases rapidly to about 147 percent. - Interest rate shock: spreads increase by 200 bps; implicit average interest rate climbs to almost 5.3 percent by 2019; debt-to-GDP declines only modestly to 132 percent by 2019. - Contingent liability shock: one-time increase in non-interest expenditure of about 10 percent of banking sector assets; debt stabilizes at about 150 percent. - Low inflation and prolonged stagnation: inflation lower by 0.6 pp from 2015 onwards; debt-ratio increases to 145 percent of GDP in 2019. - Policy advice scenario: - Additional adjustment of around ½ percent of GDP in 2015. - Structural reforms provide a growth dividend of ¼ percent in 2016 rising permanently to 1 percent of GDP in 2019. - Interest rate declines by around 20 bps. - Debt-ratio declines to about 117 percent of GDP by 2019 and continues on a declining path. - Selected baseline and projections (key series): - Real GDP (annual percent change, 2011–2019 row): 0.4, -2.4, -1.9, -0.1, 1.1, 1.3, 1.2, 1.0, 1.0. - Unemployment rate (percent, 2011–2019): 8.4, 10.7, 12.2, 12.6, 12.0, 11.3, 10.5, 9.8, 9.2. - General government gross debt (percent of GDP, 2011–2019): 120.7, 127.0, 132.5, 136.4, 135.4, 132.9, 130.2, 127.6, 124.7. - Current account balance (percent of GDP, 2011–2019): -3.0, -0.3, 1.0, 1.5, 1.5, 1.2, 0.9, 0.5, 0.1. - Nonperforming loans to total gross loans (2009–2013): 9.4, 10.0, 11.7, 13.7, 16.5. - Regulatory capital to risk-weighted assets (2009–2013): 11.7, 12.1, 12.7, 13.4, 13.7. - Return on equity (2009–2013): 4.0, 3.7, -13.0, -0.9, -11.5. ### 18. Data, institutions, and implementation progress (Appendix I highlights) - Labor market: - Jobs Act outlines principles to improve ALMPs; Youth Guarantee launched. - Next steps: turn principles into actionable plans; implement single contract with gradually increasing protection. - Product markets and public services: - Transport Authority staffed and operational; need full implementation at regional/local level. - Privatization stocktaking ongoing; accelerate agenda, especially at local level. - Judicial system: - Reforms to be unveiled; task force studying appeal reform. - Next steps: comprehensive assessment of court fees; develop and use performance indicators; rationalize appeals. - NPLs and banking oversight: - Tax deductibility of loan-loss provisions accelerated from 18 years to 5 years. - As of April, 8 of 15 banks covered by AQR announced capital raising plans. - Next steps: expand BOI inspections to mid-tier banks, expedite judicial process, ensure deductibility in year provisions are booked. - Public Financial Management: - Spending review identified potential savings of €34 billion over 2014–16; €3 billion approved for 2014. - Create MTEF and make spending review permanent; PBO to issue first report in the fall. *Italic: Source — IMF staff summary of content unit _cr14283 (Italy Article IV staff report excerpts).* ### 1. Impact of Financial Conditions on Growth _______________________________________________________5 ### 1. Impact of Financial Conditions on Growth ### A struggling economy: key indicators and context - Real GDP contracted in the first half of 2014 by 0.1 percent compared to second half of last year, pushing Italy back into recession. - Investment remains 27 percent below pre-crisis levels. - Clearance of government arrears to date equals 1.6 percent of GDP. - Italy’s share of global exports increased for the first time since 2007. - Unemployment rate stabilized around 12.3 percent; wage supplementation adds another 2 percent of workers not counted in official figures. - Long-term unemployment incidence is 58 percent (20 points above the OECD average). - Headline inflation dropped to 0.4 percent (y/y) in 2014:Q2; core inflation was 0.7 percent (y/y). - Output gap estimated at 3.8 percent. - Nominal wages increased 1.4 percent (y/y) in the first quarter, producing a 0.9 percent real increase given falling inflation. - Regional crisis impact (2007–13): GDP fell 6.7 percent in the north and 13.6 percent in the south; unemployment rose about 4 percentage points more in the south than in the north. - Potential growth estimates remain at around ½ percent; growth projected to average 1 percent during 2014–19. ### Financial Conditions Index (FCI): construction and recent developments - The FCI is constructed from stock market returns, sovereign spreads, the NEER, inflation expectations, the ECB policy rate and balance sheet, EURIBOR-OIS spread, nominal bank lending rates, credit volume to the private sector (bank loans and bonds), and lending standards (see ECB WP 1541). - Negative FCI values indicate tighter than average conditions. - The FCI tightened significantly in 2011 and early 2012, but has eased recently on the back of gains in equities and sovereign spreads and stable bank lending standards. - Nominal lending rates to the private sector have remained high; falling inflation has driven real lending rates up. - The persistence of financial fragmentation in the euro area explains tight conditions despite ECB accommodation. ### Growth impact of tighter financial conditions - A bivariate VAR (with FCI affecting growth with a one-quarter lag) suggests: - A negative shock that raises real corporate lending rates by 260bps through a 200bps increase in nominal rates and a 60bps decline in inflation expectations (to 0.5 percent) would lower growth by a cumulative 0.4 percentage point over three quarters. - Reference observation: real rates have increased by around 300 bps since mid-2012. - FCI shocks have a significant impact on growth, mainly through investment. ### Policy implications drawn from the analysis - Measures to normalize corporate financial conditions would support a robust and sustained recovery, mainly through investment. - Since bank lending rates account for the lion’s share of the tightening in the FCI, recommended actions include: - Domestic and euro area measures to address financial fragmentation. - Mend corporate balance sheets. - Strengthen banks’ capacity to lend. - These measures would minimize the risk of a weak, creditless recovery. ### Caveats on the quantitative analysis - The quantitative results should be interpreted with caution because: - The model is very parsimonious. - Shocks are identified in a crude way. - The model does not capture factors such as fiscal tightening. - The model cannot disentangle different types of structural shocks (e.g., productivity shock vs. easing in monetary policy both raise equity prices). ### Outlook and risks - Staff projects growth of -0.1 percent in 2014 and 1.1 percent in 2015. - Inflation is expected to pick up slowly but remain below the ECB’s euro area target over the projection period. - Key downside risks (interconnected): - Geopolitical tensions and export slowdown; Italy imports 90 percent of its gas. - Stagnation and low inflation could necessitate further fiscal adjustment, especially if growth is lower than the real interest rate on debt. - Bond market stress and financial instability from domestic policy slippages, delays in EU reforms, or negative surprises in the European AQR. - Clearance of public arrears and unlocking of corporate cash holdings (2 percent of GDP in 2012–2013) could provide upside to investment. - Authorities’ assessment: - MEF acknowledged downside risks to its 2014 growth forecast of 0.8 percent but saw reforms raising growth (0.8 percent higher in 2015 relative to a no-reform counter-factual). - BoI estimates the June ECB announcements would raise growth by 0.5 percent by 2016. - Authorities expect growth to approach 2 percent in 2018 once all reforms are implemented. - BoI projects inflation to rise to 0.8 percent in 2015 from 0.4 percent in 2014. ### Competitiveness and external position - Italy’s cyclically-adjusted current account in 2013 was near balance (0.3 percent of GDP). - Italy’s net international investment position (NIIP) has deteriorated by 16 percent of GDP since joining the Euro area, with net liabilities equal to 29 percent of GDP. - Foreign investment in portfolio debt securities turned positive in 2013, led by investment in government securities. - A real effective depreciation of 0–5 percent, supported by structural reforms and continued progress in fiscal consolidation, would help close the competitiveness gap and address economic imbalances over the medium term. ### Spillover implications from geopolitical risks and low inflation (summary) - Trade and energy exposure: - More than half of Italy’s merchandise exports are directed to the EU, but the rebound since 2009 has been driven by exports to non-EU countries, including EMs. - Italy imports nearly 80 percent of its energy needs and is a net importer of oil and natural gas. - Financial exposures: - Direct exposure of Italian banks to the euro area is considerable (23 percent of GDP), with largest exposures to Germany and Austria. - Italian banks’ consolidated claims in Russia and Ukraine total roughly 2 percent of Italy’s GDP. - Italian direct investment into Russia and Ukraine reached US$3 billion in 2012 after averaging less than US$50 million annually during 2002-07; total direct investment stock in the two countries combined totals less than 1 percent of Italy’s GDP. - Simulation of geopolitical shock: - A shock that pushes up oil and gas prices by 15–20 percent and increases long-term sovereign yields by 100 bps could shave up to half a percentage point from GDP growth in Italy over the medium-term. - Outward spillovers: - Re-emergence of sovereign stress in the Euro area could have large outward spillovers; GVAR estimates show notable spillover effects from an increase in Italian sovereign credit spreads to those in Ireland, Portugal and Spain. - Spillovers from Italian sovereign spreads to the real sector are small; cross-border spillovers to GDP are channeled primarily through real economic ties. *Italic: Source — IMF staff summary of "1. Impact of Financial Conditions on Growth" (Italy Country Report excerpt).* ### 11. Improving the economy’s growth potential is ### 11. Improving the economy’s growth potential is ### Overview - Improving growth potential is critical for addressing the debt overhang risks and exiting the balance-sheet recession. - Institutional constraints that have held back Italy’s productivity include: - a fragmented labor market unwilling to invest in young workers; - an inefficient and lengthy judicial system that discourages investment; - an ineffective and indebted public sector reliant on high taxes; - a financial system saddled with bad loans and hamstrung in its ability to provide credit. - As a member of a currency union, addressing these structural and balance sheet weaknesses takes on greater importance. - PM Renzi’s reform agenda aims to overhaul the system, including reforms to the electoral law, the labor market, judicial system, and public sector. - Following the passage of the Delega Fiscale (tax reform) the government intends to take forward measures to simplify and improve the tax system. - Delivery of real change is crucial for strengthening confidence and securing a robust recovery; pursuing wide-ranging reforms simultaneously would be self-reinforcing and generate growth synergies. ### Labor market reforms — findings and priorities - Labor market reform is a cornerstone of PM Renzi’s agenda. - The “Jobs Act” outlines ideas for: - universal unemployment benefits tied to training and job-search; - a national agency responsible for coordinating active policies (ALMP); - rationalized contracts with more flexibility. - Legislation thus far has focused on increasing flexibility at the margin by: - reducing restrictions on short-term hires; - boosting female participation with tax incentives. - But dismal labor prospects and stagnant productivity call for more radical action: - With 70 percent of new contracts being temporary, additional flexibility at the margin does little to reduce duality and incentivize investment in workers. ### Staff advice and implementation status (labor) - Link unemployment support to employability: - In deep recessions, the current wage supplementation scheme hampers reallocation of labor from unprofitable firms and should shift to a more universal support system conditional on job search and training. - Status: Proposed in Jobs Act but not yet implemented. - Simple contracts: - A single labor contract with gradually increasing protection would enhance fairness by reducing duality, especially if it were to replace open-ended contracts. Grandfathering could ease adjustment to the new system. - Status: Staff proposal goes further than the “trial” contract in Jobs Act. - National coordination of ALMP: - Build on the experience of successful schemes like Finland’s, to reduce regional disparities and improve monitoring and evaluation. Greater information sharing on job openings and seekers could create new markets for more flexible work, especially among women and the elderly, similar to U.K. and U.S. job exchanges. - Status: Staff goes beyond Jobs Act and suggests new market-based institutions for job matching. - Decentralized wage setting: - To allow firms to adapt more quickly to changing economic conditions, Italy should promote more firm-level wage bargaining, together with greater flexibility in national contracts e.g. on non-wage terms such as shifts and working hours. - Status: The idea is not included in the Jobs Act. ### Authorities’ views on labor measures - Short-term priority: create new jobs. Lifting restrictions on temporary contracts was an urgent measure to boost labor demand given very high unemployment. - Moving forward, the authorities will: - develop options to improve ALMPs; - design an experimental contract with gradually increasing protection. - Social partners noted difficulty implementing the new experimental contract while keeping existing temporary contracts, highlighted the need to increase labor market participation, and welcomed the idea of creating job exchanges. - On wage setting, authorities warned moving to a fully decentralized system could be costly and disruptive; they agreed firm-level bargaining should be more representative but noted costs to negotiating all terms at firm level and saw need for national-level templates. - Labor economists emphasized sufficient flexibility in national-level agreements to allow for firm-level differences linked to productivity. ### Judicial reforms — findings and recommendations - The lengthy judicial process is a major factor behind Italy’s weak business environment. - It takes more than a thousand days to enforce a contract in Italy—more than twice the OECD average. - The huge backlog of 5.2 million civil cases is slowly decreasing but remains an obstacle to improving judicial performance. - Greater judicial efficiency would lower the cost of credit, encourage investment, and facilitate employment. - Staff analysis of regional disparities finds that halving the duration of labor disputes is associated with an increase in probability of employment by about 8 percent. - Recent reforms, such as the increase in court fees, are welcome, but the judicial system is still slow compared to the European average. - Measures to accelerate the judicial process include: - promoting the use of mediation and allowing all qualified professionals to be mediators; - rationalizing the types of cases that reach the Supreme Court; - requiring performance indicators for all courts; - disseminating regional best practices such as the Strasbourg Program to improve case management in the Turin Court (IMF WP/14/32). - Judicial reform remains a priority for the government: - The backlog of cases fell by 11 percent since 2009 and processing times were reduced by an average of *INTERNATIONAL MONETARY FUND* ### 3.7 percent since 2011. The authorities are now exploring options to use assisted ### _cr14283 - 3.7 percent since 2011. The authorities are now exploring options to use assisted ### Judicial efficiency, dispute resolution, and corruption - Finding: Time to resolve cases in labor court and slow judicial processes are cited as constraints; introduction of electronic document filing and monitoring court performance seen as potential efficiency gains. - Finding: Italy is one of the few EU countries that requires lawyers to be present in compulsory mediation; a prior proposal to drop that requirement was reinstated by the legal profession in parliament. - Finding: Public sector corruption remains a serious problem; Transparency International places Italy 30 out of 31 among high income OECD countries in perceptions of corruption. - Finding: Linkages exist between corruption and money laundering; lengthy appeals procedures allow statute of limitations to run and can result in dismissal of cases as time-barred even after first instance convictions. - Policy options / advice: - Explore assisted dispute resolution, restrict appeals to the Supreme Court, and reinforce commercial courts. - Consider changing the law to re-start the limitation period after the first instance court decision. - Criminalize the false accounting offense and change statute of limitation provisions to improve anti-corruption effectiveness. - Continue enhancing the anti-corruption legal framework and strengthen authorities (ANAC measures noted). - Implementation notes from authorities: - 2012 anti-corruption legislation aligns with international standards. - Since 2013, the BoI requires enhanced due diligence on domestic “politically exposed persons”. *Source: IMF staff text provided.* ### Competition policy and structural reform to boost productivity - Finding: Potential growth has fallen; weak productivity, especially in services, and diverging productivity and wages noted. - Finding: Liberalization progress: gas sector liberalized; opening up of professional services and privatization of local services have stalled. - Finding: Transport authority legally established in 2011 but remains understaffed. - Policy recommendations: - Accelerate reforms in sectors that are essential inputs to production to reduce markups and raise productivity. - Address staffing shortages in regulators (transport authority), open up the legal profession, and enhance competition in the retail sector. - Implement antitrust authority recommendations (commitment to legislate by September 2014) and restructure rail and local public transport by end-2014. - Expected short-term effect: Adjustment costs from liberalization could be offset by improved sentiment and new investment. *Source: IMF staff text provided.* ### Non-performing loans (NPLs) and bank balance sheet cleanup - Finding: Since 2007, the NPL ratio has tripled to 16 percent at end-2013; corporate NPLs reached 29 percent (higher in the South). - Finding: Largest increase in “bad debt” loans in insolvency (“sofferenze”); low provisioning and lengthy foreclosure procedures are main obstacles. - Finding: Recovery process: three years to foreclose on collateral and seven years to complete a bankruptcy. - Finding: Italy ranks 21 out of 31 among high income OECD countries in resolving insolvency (Doing Business). - Finding: Despite rising NPL stock, write-off rates continue to decline; recent NPL sales limited to defaults over ten years. - Recommendation: A three-pronged approach: a) Stronger provisioning and write offs: - Foster convergence in provisioning rates, including forbearance loans under the moratorium program. - Supervisor to monitor bank progress and conduct targeted on-site inspections. - Consider higher capital charges or time-limits for writing off old NPLs. b) Develop the distressed debt market: - Encourage private NPL asset management companies (AMCs) via tax incentives (accelerated depreciation or preferential capital gains) while ensuring transfers at fair market value. c) Enhanced enforcement and insolvency regimes: - Expand specialized insolvency benches and introduce time-limits to expedite reorganization. - Adopt INSOL Principles for Multi-Creditor Workouts and rely more on online court filings to speed foreclosures. - Quantitative target: Write-off rates would need to triple from their historic average to bring the bad debt ratio to pre-crisis levels within 10 years. *Source: IMF staff text provided.* ### Financial sector: recapitalization, governance, and market funding - Findings on recent developments: - Ahead of the AQR, large Italian banks booked net losses of nearly €22 billion in 2013, announced plans to dispose of NPLs and have raised €11 billion in capital. - The foundation owner of Banca Monte dei Paschi di Siena sold most of its shares, raised €5 billion in capital in June, and repaid the bulk of its state aid. - Findings on provisioning and governance: - Provisioning coverage varies and is lower in mid-size banks where capital buffers are thin. - Supervisory responsibility, including minimum prudential standards on provisioning, to be transferred to the Single Supervisory Mechanism (SSM) in the fall. - Governance recommendations: - Continue reforms to strengthen independent board members and “fit and proper” tests for directors. - Require published audited accounts by foundations participating in banks, limits on their leverage, and proper governance rules. - Apply in practice the ban on foundations controlling banks and reduce foundation stakes within concentration limits. - Encourage largest cooperative banks to convert to joint stock companies and consolidate to achieve synergies. - Capital market development and funding diversification: - Corporates’ debt-to-equity ratio is 123 percent; this is 17 percentage points higher than the Euro area average. - Pension assets: 16 percent in equities (compared to 50 percent for the largest international pension funds) and less than 1 percent in Italian equities. - Recommendations: Encourage institutional investors to raise allocations in equities and alternative assets; reduce tax bias against equity financing; reduce gap between taxation of public and private securities. - Bank cost and profitability measures: - Encourage further operational cost reductions via branch rationalization, digitalization of retail banking, and mergers. - Large banks cut branch networks by 7 percent since 2008; more scope exists for technology in retail banking. - Regulatory progress: - BoI inspections in 2012 covered 40 percent of NPLs using a conservative definition in line with EBA standards. - ECB’s AQR also examines performing loans, including those under moratorium, potentially raising provisioning needs. - National arrangements for resolution mechanisms and public backstops are being put in place, to be coordinated at the European level. *Source: IMF staff text provided.* ### SME support, restructuring, and access to finance - Findings: - SMEs account for about 80 percent of the corporate workforce and 70 percent of firm value added in Italy. - SMEs are more prevalent and smaller than elsewhere in the euro area and suffer from high leverage and weak profitability. - Business startup and firm exit rates are lower than the euro area, limiting resource reallocation and innovation. - Policy recommendations / measures: - Guidelines for creditor-led restructuring: establish standard criteria for assessing SME loans and restructuring viable but distressed firms to overcome creditor coordination problems and encourage insolvency regime and out-of-court workouts. - Shift public support from guarantees and moratoria for existing firms toward financing for new firms to support restructuring. - Introduce a new fiduciary loan contract to allow efficient collateral enforcement not relying on courts and enable quick enforcement in default. - Introduce a nationwide electronic registry for all types of collateral to support fiduciary contracts. - Expand sharing of credit information: broaden access to key registries by nonbanks and include tax payments, retail credit, and utility bills to move toward more risk-based lending. - Government support during the crisis: - Moratorium scheme for SME loans currently covering some €23 billion in principal. - Rapid expansion of the Central Guarantee Fund and support through Cassa Depositi e Prestiti. - Payment of government arrears: some 60 billion planned over 2 years to provide liquidity to SMEs. - The Fondo Italiano d’Investimento (created in 2009) invests in SME risk capital. - Legislative developments: - Authorities explored modifying contracts to allow 3rd party collateral but found this difficult without a new law; considering introducing guarantees on movable property and presented draft legislation to Parliament in December. *Source: IMF staff text provided.* *Italic: Content unit _cr14283 - 3.7 percent since 2011. The authorities are now exploring options to use assisted (IMF staff text provided).* ### 2013. Greater sharing of credit information is welcome but faces challenges from ### 2013. Greater sharing of credit information is welcome but faces challenges from Italy’s data privacy laws. ### ECB actions and financial conditions - Recent ECB actions helped ease financial conditions: bank funding costs have eased and several banks have reissued unsecured senior debt. - Gradual repayment of LTRO facilitated; Italian banks have repaid one third of their Eurosystem borrowing. - According to the BoI, recent ECB measures (T-LTRO) could provide liquidity of more than €200 billion over the life of the program. - BoI measures: extend eligible collateral for refinancing to SME loans and mortgages; exploring refinancing of overdraft bills widespread among SMEs. - Remaining challenges and policy advice: - Spread between yield on bank bonds and the swap rate has diminished, but fragmentation across the Euro area still persists and euro area inflation is below the ECB’s target. - If inflation remains too low, the ECB should consider a substantial expansion of its balance sheet, including through asset purchases. - Faster progress towards the banking union would reduce financial fragmentation; Italy should complete national arrangements for resolution and backstopping in advance of the ECB assessment. - Authorities’ view: Discussions are ongoing between the MEF and BOI on the national backstop; legal impediments to bail-in remain. Finalizing the national backstop and clarifying the bail-in process would enhance predictability of the resolution framework. ### Box: A New Fiduciary Loan Contract for Efficient Collateral Enforcement - Concept summary: - Fiducia (fiduciary ownership agreements) allow title transfer (not possession) of assets to a fiduciary third party in exchange for a loan. - If loan repaid in full, title reverts to borrower; on default, fiduciary transfers asset title to lender without court proceedings. - Lender benefits: reduced uncertainty, time and cost of securing collateral. Borrower benefits: lower cost and broader access to credit while maintaining possession/use of collateral. - Examples from other jurisdictions: - France: 2006 amendment to the French Civil Code introduced “fiducie-sûreté” — full title transferred to lender or third party to secure payment; on default fiduciary may realize assets; law flexible for present or future assets. - Brazil: 2004 introduction of “Fiduciary Ownership Agreements” — borrower transfers ownership of movable property to lender while keeping possession; lender acquires limited, transitory and conditional property; lender may recover asset through summary proceedings on default. - Potential cross-cutting benefits in Italy: - Expand credit availability; enhance market discipline via stronger contract enforcement. - Allow borrowers to voluntarily switch to fiduciary contract in exchange for a lower rate to signal willingness to repay. - Support alternative financing means (factoring, securitization of SME loans); unlock collateral beyond real estate; foster market for credit insurance (e.g., trade credit). - Note: These fiduciary arrangements do not exist in Italy. ### Small and Medium Enterprises (SMEs) — key findings from figures and surveys - SME prevalence and dynamics: - SMEs are more prevalent in Italy than elsewhere (figure context). - Startup and exit rates are relatively low (Enterprise "Churn" Rate, 2011). - Lending environment: - Lending standards tightened for all firms (Bank Lending Standards Survey). - Borrowing rates remain higher for smaller loans (Lending Rates, Percent). - Lending has declined for all firms (Loan Growth, 2008 = 100). - Firm investment and size: - Falling investment, especially by smaller firms (Firm Investment - Industry, 2009 = 100, firm size by employees). - Data sources cited: Eurostat; Bank of Italy; Cerved Group; and IMF staff estimates. ### Boosting growth through fiscal policy — diagnostics and policy recommendations - Structural problems: - High marginal tax rates on capital and labor; labor tax wedge at around 48 percent of total labor cost versus OECD average of 36 percent. - Public spending has one of the highest elderly bias and lowest levels of education spending in the EU. - Efficiency of public spending varies considerably across regions, with the South weakest. - Recent measures and needs: - Government reduced the personal income tax (PIT) for low earners by around ½ percent of GDP in 2014 (roughly 1,000 euro per household). - Further reductions in the labor tax wedge should come through lower social security contributions instead of cuts to PIT to better support new employment. - Increase in the tax allowance for corporate equity returns (ACE) is welcome and should be extended. - Financing tax cuts and savings: - The PIT cut was partly funded by one-off measures (VAT on arrears payments and taxes on revalued shares at the BoI). - More permanent measures needed: lower tax expenditures, higher taxes on wealth (including inheritance taxes), additional savings from the spending review. - Stronger efforts to curb tax evasion would generate savings and raise fairness of fiscal adjustment. - Spending review and reallocation: - Key areas for improvement: pensions, health, and addressing large regional gaps in efficiency. - With previous pension reforms strengthening long-term sustainability, focus should shift to savings from current pensions (e.g., higher progressive indexation). - Health: large regional differences in spending efficiency suggest room for savings; standard costs in health care and better allocation of regional transfers could provide savings. - Greater differentiation of public wages across regions could generate savings and better link wages to private sector productivity. - Savings could be used to lower marginal tax rates and shift resources to education, active labor market policies, and public investments—including EU-co financed projects where absorption remains low. - Authorities’ view: - Agreed reorienting budget priorities requires more permanent savings but found this challenging. - Viewed age-related spending as sustainable, albeit high. - Prospects for further pension changes, including progressive indexation for existing pensioners, seen as limited. - Emphasized higher growth over further consolidation; intended to seek greater flexibility within EU fiscal governance in exchange for more structural reforms. - Viewed their target of a structural balance as appropriate for securing long-term sustainability. ### Fiscal consolidation, debt dynamics, and staff advice (numerical highlights) - Recent fiscal outcomes and near-term outlook: - Structural primary surplus improved from 0.7 to 4.5 percent of GDP between 2011 and 2013. - Nominal headline deficit expected to remain at 3 percent of GDP this year. - For 2015, authorities plan a ½ percent of GDP adjustment to narrow the structural deficit to -0.1 percent of GDP. - Public debt and vulnerabilities: - Public debt set to rise further, peaking at 136 percent of GDP in 2014 due to slower growth and one-off operations from arrears clearance. - Under baseline, public debt projected to decline modestly to 125 percent of GDP by 2019 but remain vulnerable to adverse shocks. - Annual gross financing needs of 24 percent of GDP (almost €400 billion) increase vulnerability to swings in market sentiment. - Staff policy advice: - Conditional on recovery taking hold, a modest structural surplus next year would be appropriate to bring down debt faster. - An additional adjustment compared to authorities’ plans (up to ½ percent of GDP depending on strength of recovery) would help achieve a small structural surplus by 2015; if growth weaker, a slower pace of consolidation—but still enough to reduce the debt ratio—would be appropriate. - Beyond 2015, after recovery is entrenched, a 1 percent of GDP structural surplus buffer would provide insurance against shocks and generate additional interest savings. - Accelerating privatization program (0.7 percent of GDP annually through 2017) would reduce debt faster and support investment. - Staff’s 2015 Additional Fiscal Measures: Staff Advice (percent of GDP) - Additional fiscal effort (relative to authorities' plans): 0.5 - Lowering the tax wedge: -0.9 - Spending on ALMP/education/capital: -0.3 - Reduction in tax expenditures: 0.8 - Expenditure savings/Spending Review: 0.4 - Wealth tax measures: 0.3 - Higher taxes on financial income: 0.2 ### Strengthening fiscal institutions and implementation - Institutional progress: - Creation of the Parliamentary Budget Office (PBO) to strengthen monitoring and credibility of fiscal rules. - Government approved a public administration reform plan to simplify bureaucratic procedures. - Steps to simplify tax procedures and reform the cadastral land survey. - Recommended tools and processes: - Establish a medium-term expenditure framework (MTEF) to improve budget planning and spending efficiency; introduce MTEF in the near term (authorities agreed). - Make the spending review a permanent feature of the multi-year budget process to enhance prioritization, monitoring, and accountability. - Collect performance information systematically to promote output indicators and activity costing; hold ministries accountable for priorities. - Ensure the PBO has adequate access to fiscal data; PBO to issue first report in the fall on compliance with the fiscal rule. - Tax evasion and enforcement: - Stronger efforts to curb tax evasion: greater use of anti-money laundering framework (e.g., criminalizing self-laundering); greater information sharing (e.g., between FIU and the “fiscal registry” (anagrafe tributaria)). - Additional PFM reforms: electronic invoicing and cash budgeting at local levels to fight tax evasion and ensure new arrears do not arise. - Spending review outcomes: - Spending review commission identified potential savings of €34 billion over 2014–16; government approved measures of €3 billion for 2014, mainly administrative efficiency. - Staff analysis: additional savings difficult without addressing large pension spending (public pension spending accounts for almost 30 percent of total spending). - Bringing efficiency scores in 2011 for low performing regions to national average could have provided savings of almost 1 percent of GDP (figure likely smaller now after reforms). - Swift parliamentary approval of legislation determining standard costs would be needed to realize some regional savings. _Italic: IMF staff appraisal content based on the provided chapter._ ### 16. The economy is struggling to emerge from its deep balance-sheet recession... Steady ### 16. The economy is struggling to emerge from its deep balance-sheet recession... Steady ### Overview and near-term outlook - Growth is projected to be -0.1 percent in 2014, rising gradually to 1.1 percent in 2015. - Inflation is forecast to remain low. - Steady exports and an easing fiscal drag are being offset by stiff headwinds to investment from tight credit conditions, especially for indebted SMEs, and deeply-rooted structural rigidities. ### Downside risks - Risks are tilted to the downside. - Exposures: geopolitical tensions in Russia and Ukraine and the Middle East through trade and investment linkages. - Vulnerabilities: high public debt, large public financing needs, and elevated NPLs leave Italy vulnerable to financial contagion and/or low growth and inflation. - Policy risk: Failure to follow through on the reform agenda will exacerbate Italy’s declining productivity and weak medium-term growth prospects. ### External position and competitiveness - Improvement in the current account has reduced external imbalances. - Productivity and competitiveness indicators point to an external position weaker than suggested by medium-term fundamentals and desirable policies. - A modest weakening of the REER would lead to stronger growth, and a healthier external balance sheet. ### Structural reforms (simultaneous implementation emphasized) - Labor reforms: - Introduce a labor contract with gradually increasing protection to reduce duality and encourage firms to invest in workers. - Raise the quality of ALMP to the level of the best regions, with centralized monitoring, to address long-term unemployment. - Promote firm-level bargaining through greater flexibility under national contracts to better align wages to productivity. - Judicial reforms: - To speed up the judicial process, consider reviewing court fees, limiting excessive appeals, developing performance indicators for all courts, and incentivizing the use of mediation. - Disseminate regional best practices to reduce the performance gap. - Competition policy: - Legislative initiatives to remove regulatory barriers have been proposed, but implementation has been weak. - Deliver on commitment to legislate recommendations of the antitrust authority to enhance competition and lower the cost of services. - Corruption: - 2012 anti-corruption legislation and measures to enhance the power of ANAC are important steps. - Further legal improvements could include criminalizing the false accounting offense and changing statute of limitation provisions. ### Financial sector and NPLs - BoI inspections and the European AQR have improved provisioning coverage ratios and strengthened confidence, but NPLs continue to rise, weighing on bank profits and lending. - Policy measures to accelerate NPL reduction: - Encourage more provisioning and write-offs. - Develop the distressed debt market. - Enhance the insolvency regime to free up resources for the recovery. ### SME sector revival strategy - Complement financial reforms with a broad SME strategy that: - Supports viable firms and identifies non-viable firms for a quick exit. - Adopts a more standardized approach to assessing SME loans and restructures viable but distressed firms through insolvency or out-of-court workouts. - Introduces a new fiduciary loan contract to speed up enforcement of collateral. - Promotes greater sharing of corporate credit information to support development of alternative financing sources. - Scales back forms of support that do not distinguish between viable and non-viable firms. ### Corporate governance and capital markets - Reduce the influence of foundations controlling banks and encourage cooperative banks to convert to joint-stock companies to strengthen capital raising and market discipline. - Promote professional management of pension funds, with adequate safeguards, to draw in more equity investment in Italian firms. ### Fiscal policy and budget institutions - Fiscal balance: strike a delicate balance between setting the debt ratio on a downward path while helping the economy recover. - To support the economy, priority should be to lower the tax burden financed by savings from the spending review and lower tax expenditures. - Italy has achieved one of the highest primary surpluses in the euro area after difficult adjustment, but more is needed to bring down high public debt given low growth and a higher interest rate environment. - Conditional on the recovery taking hold, a modest structural surplus next year would be appropriate to strengthen public finances. - Adopt a Medium-Term Expenditure Framework (MTEF): - Make the spending review a permanent part of the multi-year budget process to enhance accountability and monitoring. - Integrate performance information systematically to promote the use of output indicators and activity costing for budget allocation. - Ensure the newly established PBO has adequate access to fiscal data to strengthen its oversight function. ### European-level policies - If inflation remains too low, the ECB should consider further easing measures. - Faster progress towards the banking union will help address financial fragmentation. - Italy should complete arrangements for resolution and backstopping in advance of the ECB assessment. ### Debt sustainability and macro-fiscal assumptions (Annex I summary) - Italy’s public debt is sustainable but subject to significant risks. - Public debt level: around 136 percent of GDP (second highest in the euro area). - Main risks: growth shock in the absence of structural reforms; contingent liabilities in the financial sector. - Debt structure mitigants: most public debt is held domestically, long duration, much under fixed interest rates. - Macroeconomic assumptions used in the DSA: - Real GDP growth projected at 0.1 percent in 2014, increasing to around 1 percent in the medium term. - Inflation projected at around 1.5 percent over the medium term. - Structural balance improves annually to meet the zero balance as required under the fiscal rule; in 2014 cyclically adjusted balance implies a slight relaxation. - Spreads assumed to moderate from current levels. - Effective interest rate forecast to rise from 4.0 percent in 2014 to 4.4 percent in 2019. ### Key statistics and selected projections (as presented) - Real GDP (annual percent change): 0.4, -2.4, -1.9, -0.1, 1.1, 1.3, 1.2, 1.0, 1.0 (2011–2019 row). - Unemployment rate (percent): 8.4, 10.7, 12.2, 12.6, 12.0, 11.3, 10.5, 9.8, 9.2 (2011–2019). - General government gross debt (percent of GDP): 120.7, 127.0, 132.5, 136.4, 135.4, 132.9, 130.2, 127.6, 124.7 (2011–2019). - Current account balance (percent of GDP): -3.0, -0.3, 1.0, 1.5, 1.5, 1.2, 0.9, 0.5, 0.1 (2011–2019). - Financial sector indicators (selected): - Nonperforming loans to total gross loans: 9.4, 10.0, 11.7, 13.7, 16.5 (2009–2013). - Regulatory capital to risk-weighted assets: 11.7, 12.1, 12.7, 13.4, 13.7 (2009–2013). - Return on equity: 4.0, 3.7, -13.0, -0.9, -11.5 (2009–2013). *Source: IMF staff report content provided in the specified content unit.* ### 2. The DSA tool that assesses the realism of the main assumptions on growth, primary ### 2. The DSA tool that assesses the realism of the main assumptions on growth, primary balance, and inflation does not indicate systematic forecast errors. ### DSA tool findings on forecasts and risks - Growth projections: - Current growth projections are in line with consensus but below the authorities’ forecasts. - Near–term risks are broadly balanced. - Upside risks: recent government initiative on electoral and structural reforms and arrears clearance. - Downside risks: trend decline in productivity, investment collapse, risk of a confidence shock given large debt levels. - Inflation: - Inflation projection errors have been small historically. - Risk of deflation is a particular concern given its implications on debt dynamics and the weak medium-term outlook. - Cyclically-adjusted primary balance (CAPB): - The maximum projected 3-year adjustment in the CAPB is large, but most adjustment was undertaken in 2012 and 2013. - Italy currently has the second largest structural primary balance in the Euro area. - Weak recovery may create pressure to relax fiscal targets, raising risks of a slower pace of future consolidations. ### Definition and measurement - Public debt definition: - Public debt comprises Excessive Deficit Procedure (EDP) debt of the General Government. - General Government includes the Central Government, Regional Governments, Local Government, and Social Security Funds; it excludes public enterprises. - EDP debt is a subset of General Government consolidated debt such as trade credits and other accounts payable. - Stocks are recorded at their face value and usually exclude unpaid accrued interest. ### Baseline projections and debt dynamics - Staff forecast: - Debt-to-GDP ratio will peak at 136 percent in 2014, before declining to 124 percent in 2019. - Debt profile projected higher than a year ago due to slower fiscal adjustment, additional arrears clearance program (0.8 percent of GDP), and lower-than-projected nominal growth. - Financing and rollover: - Government financing requirements: 24 percent of GDP. - External financing requirements: 48 percent of GDP. - Average maturity of public debt: under 6½ years. - Share of debt with fixed interest rate: 70 percent. - Almost 2/3 of debt is held by domestic investors. - Banks now account for around 20 percent (largest share), implying rollover of LTROs would be important. - Interest pass-through sensitivity: - A 100 basis points shock to the yield curve estimated to raise the interest bill by: - just over 0.16 percent of GDP in the first year, - 0.34 percent in the second year, - 0.44 percent in the third year. ### Shocks and stress tests (heat map and scenario outcomes) - Growth shock: - Real output growth rates assumed lower by one standard deviation for two years starting in 2014, resulting in an average growth of -1.3 percent in 2015–16. - For every 1 percentage point decline in growth, inflation declines by 0.25 percentage points. - Nominal primary balance reaches only 2.3 percent of GDP by 2019. - Debt-to-GDP increases rapidly to about 147 percent during the growth shock and then fails to come down over the projection period. - Gross financing needs rise significantly. - Interest rate shock: - Spreads increase by 200 bps. - Growth depressed by 0.4 percent. - Implicit average interest rate climbs to almost 5.3 percent by 2019. - Debt-to-GDP declines only modestly to 132 percent in 2019 despite sizeable primary surpluses. - Contingent liability shock: - One-time increase in non-interest expenditure of about 10 percent of banking sector assets. - Growth declines for two consecutive years by about 1.2 percent. - Inflation lowers by 0.3 percent. - Primary balance worsens by 12 percent of GDP in 2015 and by 1.4 percent of GDP from 2016 onwards. - Debt rises and stabilizes at about 150 percent of GDP. - Gross financing needs remain elevated at around 30 percent of GDP. - Primary balance shock: - Fiscal adjustment plans delayed by one year relative to baseline. - Slippage leads to a 30 bps increase in risk premiums for each 1 percent of GDP slippage. - Debt-to-GDP about 3.5 percentage points higher than baseline by 2019. - Low inflation and prolonged stagnation: - Inflation lower by 1 standard deviation (0.6 pp) from 2015 onwards, rising from 0.6 percent in 2015 to 1 percent in 2019. - Annual GDP growth is 0.5 to 1 percentage points lower than baseline. - 100 bps increase in interest rates from 2015–19. - Debt-ratio increases to 145 percent of GDP in 2019 and fails to stabilize over the projection period. - Policy advice scenario: - Additional adjustment of around ½ percent of GDP in 2015 compared to baseline. - Structural reforms provide a growth dividend of ¼ percent in 2016 rising permanently to 1 percent of GDP in 2019. - Interest rate declines by around 20 bps. - Debt-ratio declines to about 117 percent of GDP by 2019 and continues on a declining path. ### Baseline DSA table key figures (as of April 01, 2014) - Nominal gross public debt: - 2012: 109.5 - 2013: 126.9 - 2014: 132.5 - 2015: 136.2 - 2016: 135.2 - 2017: 132.7 - 2018: 130.0 - 2019: 127.4 - 2019 (alternate row): 124.5 - Spread (bp): 189 - Public gross financing needs: - 2012: 24.2 - 2013: 26.1 - 2014: 23.0 - 2015: 24.4 - 2016: 23.8 - 2017: 19.6 - 2018: 22.6 - 2019: 17.5 - alternate: 23.0 - Real GDP growth (percent): - 2012: 0.2 - 2013: -2.4 - 2014: -1.9 - 2015: -0.1 - 2016: 1.1 - 2017: 1.3 - 2018: 1.2 - 2019: 1.0 - alternate 2019: 1.0 - Inflation (GDP deflator, percent): 2.0, 1.6, 1.4, 1.1, 1.2, 1.4, 1.4, 1.5, 1.6 (by year sequence) - Nominal GDP growth (percent): 2.2, -0.8, -0.4, 1.0, 2.4, 2.7, 2.6, 2.5, 2.6 (by year sequence) - Effective interest rate (percent): 4/ 4.6, 4.4, 4.1, 4.0, 4.0, 4.2, 4.2, 4.4, 4.4 - Change in gross public sector debt (cumulative): 1.7, 6.2, 15.6, 33.7, -1.1, -2.5, -2.7, -2.6, -2.9, -8.0 - Identified debt-creating flows (cumulative): 1.1, 3.2, 3.2, 23.1, 9.1, -0.9, -2.3, -2.5, -2.5, -2.7, -9.4 - Primary deficit (percent of GDP): -1.0, -2.3, -2.0, -2.0, -3.0, -4.3, -4.6, -4.9, -5.0, -23.8 - Primary (noninterest) revenue (percent of GDP): 48.6, 51.2, 51.3, 51.7, 51.7, 51.9, 52.0, 52.0, 51.9, 31.1, 2 (table sequence) - Primary (noninterest) expenditure (percent of GDP): 47.6, 49.0, 49.3, 49.7, 48.6, 47.6, 47.5, 47.1, 46.9, 28.7, 5 (table sequence) - Automatic debt dynamics (contribution): 2.5, 6.4, 5.8, 3.9, 2.2, 2.0, 2.1, 2.4, 2.3, 14.9 - Real interest rate (contribution): 2.7, 3.5, 3.5, 3.8, 3.6, 3.6, 3.6, 3.7, 3.5, 21.8 - Real GDP growth (contribution): -0.2, 2.9, 2.4, 0.1, -1.5, -1.7, -1.5, -1.3, -1.2, -6.9 - Other identified debt-creating flows: -0.5, -0.9, -0.6, -0.5, 0.0, 0.0, 0.0, 0.0, -0.5 - Privatization receipts (negative): -0.3, -0.5, -0.1, -0.3, 0.0, 0.0, 0.0, 0.0, -0.3 - Contingent liabilities: 0.00 (no entries) - Other debt flows (incl. ESM and Euro): -0.2, -0.4, -0.5, -0.2, 0.0, 0.0, 0.0, 0.0, -0.2 - Residual, including asset changes: 0.6, 3.0, 2.4, 2.3, -0.2, -0.2, -0.2, -0.2, -0.2, 1.4 ### Public sector stress-test outcomes (selected series from figures) - Under baseline and shocks, gross nominal public debt trajectories: - Baseline and individual shocks project debt levels generally in the 117–150 percent of GDP range by 2019 depending on scenario. - Under the Policy Advice Scenario debt-ratio declines to about 117 percent of GDP by 2019. - Under the Contingent Liability Shock debt stabilizes at about 150 percent of GDP. - Under Low inflation and stagnation shock debt-ratio reaches about 145 percent of GDP in 2019. ### External sector assessment and policy implications - NIIP and external debt: - NIIP deteriorated by 16 percent of GDP since joining the Euro area. - NIIP net liabilities of 29 percent of GDP (September 2013) versus 13 percent at end-2000. - At 123 percent of GDP, Italy’s external debt is in line with the Euro area as a whole. - Composition: 40 percent of external debt is owed by the government. - Current account: - CA averaged a deficit of 2 percent of GDP over the past decade; moved into balance starting in 2012. - 2013 current account registered a surplus of 1 percent of GDP. - Improvement driven by modest trade surplus growing to more than 2 percent in 2013, higher exports, subdued imports. - Declining investment accounted for about three-fourths of the improvement in the current account; increased public saving more than offset lower private saving. - EBA model: cyclically-adjusted CA was 0.3 percent of GDP in 2013; staff assesses a gap of -1.5 to 0 percent of GDP given need for stronger growth. - Real exchange rate (REER): - Misalignment on order of 0 to 10 percent by price-based indices; labor-based indicators show a wider gap. - EBA REER gap estimates: +3 percent (overvaluation, REER regression) to -1 percent (undervaluation, CA regression). - Staff view: a real effective depreciation of 0-5 percent would support adjustment. - Capital and financial accounts: - Portfolio and other-investment inflows typically financed CA deficits; modest net FDI outflow. - Over 2011-12 banks relied more on euro system refinancing; TARGET2 liabilities declined as conditions stabilized. - Foreign investment in portfolio debt securities turned positive in 2013. - Italy remains vulnerable to a loss in market confidence owing to large refinancing needs of sovereign and banking sectors and financial fragmentation. - Policy recommendations: - Implementation of structural reforms critical to improving competitiveness and boosting potential growth. - Continued progress in medium-term fiscal consolidation to help close competitiveness gap and maintain investor confidence. - Combined measures to support growth and employment over the medium-term. *Source: IMF staff (Italy country report content provided).* ### Appendix I. Progress Against IMF Recommendations ### Appendix I. Progress Against IMF Recommendations ### Labor market - Findings since 2013 Art. IV: - Jobs Act outlines principles to improve ALMPs. - Youth Guarantee recently launched aims at improving training opportunities. - Jobs Act proposes a review of contract types and opens the door to experimental use of a contract with gradually increasing protection. - In 2014 social partners agreed upon a Consolidated Act on Representation. - Jobs Act introduces tax credit for working women with children and family income below a certain threshold. - Next steps / Recommendations: - Turn principles into an actionable plan including the proposed national coordination center. - Develop specific proposals and implement them (single contract with gradually increasing protection). - Move to an opt-in system for collective bargaining by operationalizing June 2011 agreement. - Boost female labor participation by reducing marginal tax rate for married second-earners (implement tax measures beyond the introduced credit). ### Product markets - Findings since 2013 Art. IV: - The Transportation Authority's board is staffed and operational. - Reform of professional services was approved but needs further implementation. - Next steps / Recommendations: - Needs full implementation, especially at the regional and local level for transport regulators and electricity sector competition. - Accelerate opening of professional services; ensure full implementation. ### Public services and privatization - Findings since 2013 Art. IV: - Stocktaking exercise on privatizations is ongoing. - Next steps / Recommendations: - Be pragmatic: identify local governments with weak balance sheets and assets most in need of restructuring and take concrete actions. - Accelerate the privatization agenda, especially at the local level. ### Judicial system - Findings since 2013 Art. IV: - Judicial reforms to be unveiled in June (no action yet on court fees or performance indicators). - A task force is studying options to reform the appeal system. - Next steps / Recommendations: - Comprehensive assessment of court fees (noting they "remain modest and capped"). - Develop and use performance indicators for all courts for management and accountability. - Rationalize appeals system. ### EU-level / Structural reforms to improve the business environment - Findings / Actions: - Structural Reforms to Improve the Business Environment referenced in table headings. - Recommendations: - Strengthen common market through implementation of the Services Directive. ### Rebalancing the budget - Findings since 2013 Art. IV: - A recent spending review identified medium-term savings of 34 billion EUR covering subsidies, defense, SOE management, health, pension and housing. Some policy decisions approved for 2014. - A tax reform bill that includes a review of cadastral values has been approved. Some subsidies identified in the spending review are tax expenditures. - PIT credit of 7 billion euro has been implemented for 2014 and measure is planned to make this permanent; 2014 budget increased ACE. - Announced budget neutral rebalancing towards investment, labor market policy and education. - Next steps / Recommendations: - Take policy decision on identified measures to achieve savings. Make spending review a permanent process combined with binding expenditure ceilings. - Update cadastre as soon as possible. Take policy decisions on tax expenditure, especially VAT reduced rates and exempt regimes. - Labor tax wedge should be reduced - with a focus on social security contributions. - Undertake well-targeted increase in public investment. ### Fiscal stance - Findings since 2013 Art. IV: - The structural balance in 2014 is estimated at -0.6 (authorities' definition) and is planned to be narrowed to -0.1 percent of GDP, short of the structural balance rule. - Next steps / Recommendations: - Additional fiscal effort of up to 1/2 percent of GDP in 2015, if economic conditions allow, would help place debt firmly on a downward path and achieve the zero structural balance rule while building a buffer gradually over medium-term. - Build a primary surplus buffer over the medium-term by targeting a 1 percent of GDP structural surplus. ### Public Financial Management (PFM) - Findings since 2013 Art. IV: - Expenditure plans continue to be revised frequently. Discussions are ongoing for a Medium Term expenditure Framework. - Three board members of the Parliamentary Budget Office were selected in April. - Next steps / Recommendations: - Adopt a binding multi-year expenditure ceiling; integrate spending review process with regular budget in a multi-year fiscal framework. - The PBO should build capacity to measure progress against fiscal rule and establish a record of independent analysis. Integration of work program with the budget process is important. ### Tax evasion and AML - Findings since 2013 Art. IV: - The tax reform bill has provisions broadening the scope of false accounting offenses. - Next steps / Recommendations: - Further strengthen AML tools, broadening the scope of false accounting offenses and providing the revenue authorities with access to suspicious transaction reports. - Revenue authorities should be able to undertake more targeted controls with greater information sharing with other public bodies while respecting confidentiality. ### Tackling NPLs and banking sector balance sheets - Findings since 2013 Art. IV: - There is no information on whether the BOI special inspections were expanded to mid-tier banks. - Tax changes reduce the period in which loan-loss provisions are tax deductible to 5 years from the previous 18 years. - As of April, 8 of the 15 banks covered by the AQR have announced capital raising plans. - MPS Foundation has reduced its share from 30 to 3 percent. Capital of 5 billion euros has been raised and state aid has been mostly repaid. - Recent ECB easures (T-LTRO) is expected to provide significant liquidity. - Next steps / Recommendations: - Enhance provisioning and write-offs by expanding BOI inspections to banks outside the AQR, issuing guidelines on provisioning and write-offs. - Ensure deductibility of loan loss provisions the year provisions are booked. - Expedite judicial process by expanding use of specialized insolvency courts, greater use of on-line filing and introduction of best practice guidelines. - Targeted action to support bank capital and prepare for the AQR; at the euro zone level, extension of an LTRO of sufficient tenor. - Attach strict conditionality to public support for problem banks (bail-in of shareholders and junior debt-holders, replacing the board and management, restricting dividends, and targets for capital raising). - Monitor implementation of MPS restructuring plan and take action if targets are missed. ### Corporate governance and foundations - Findings since 2013 Art. IV: - New rules improve “fit and proper tests” for directors and strengthen role of independent Board members. Cooperative bank boards are made more representative. Status of a law to reform Foundations is unclear. - Next steps / Recommendations: - Cap on leverage, disclosure, strict diversification rules and supervision for Foundations. - Stringent fit and proper tests for directors and controlling shareholders. - Cooperative banks should be converted to joint stock companies. ### Supporting SMEs - Findings since 2013 Art. IV: - ECB measures (T-LTRO) expected to provide significant liquidity. - Next steps / Recommendations: - Monitor the expansion of public credit guarantees for SMEs and strengthen the fee system. - Reform public support programs; encourage alternative market funding sources; remove obstacles to SME start-up and up-scaling; and facilitate restructuring. - ECB should consider LTRO linked to SME lending or direct purchase of select private assets. ### Appendix II — Key FSAP Technical Recommendations (selected banking and financial oversight items) - Banking sector recommendations and implementation status: - Issue prudential guidance to ensure a minimum level of harmonization in loan loss provisions and write-off practices [BI]: Not implemented. The supervisory responsibility, including for minimum prudential standards on provisioning, will be transferred to the SSM in fall. - Amend law to ensure effective oversight of banking foundations by the MEF, require the largest foundations to publish audited financial statements, have an asset allocation policy aimed at diversification, and impose leverage limits [Parliament/MEF]: Not implemented. Actions taken by BoI to strengthen banks’ corporate governance; role of foundations has diminished as banks sought outside capital. - Amend regulation to require related party transactions do not carry more favorable terms and exclude conflicted board members [BI/MEF]: A draft Decree pending parliament’s approval will address the duty for directors to abstain in decisions with conflicts of interest. - Gradually increase the tax deductibility of bank provisions in the same tax year [Parliament/MEF]: Tax deductibility accelerated from 18 years to 5 years and deductibility is permitted for the regional tax on productive activities. - Monitor closely the implementation of the restructuring plan for Monte dei Paschi di Siena and prepare contingency measures [MEF/BI]: The restructuring plan is ongoing; the bank has raised 5 billion EUR in capital and reimbursed most of its State Aid (the remainder is due by early 2015). - Financial sector oversight and safety nets: - Expand the definition of fit and proper for bank and ISP directors [Parliament/MEF]: A draft Decree pending parliament’s approval will introduce changes. - Clarify supervisory guidance for licensing that major shareholders' financial suitability includes capacity to provide additional capital [BI]: BI Circular no. 285/2013 imposes this assessment; it must be translated into supervisory practice. - Increase use of onsite inspections of ISPs including asset managers [Consob, BI]: In 2013, inspections increased to 34 (against 29 in 2012). In 2014, 32 inspections are planned. - Amend law to empower BI and Consob to impose fines on entities and raise ceilings [MEF]: A draft Decree pending parliament’s approval will address this. - Adopt statutory RRPs and resolution tools including bail-in [MEF, BI]: The European Bank Recovery and Resolution Directive, approved in April 2014, will implement this starting January 2015 (January 2016 for bail-in tools). National authorities shall adopt and publish relevant laws and regulation by December 2014. - Amend deposit guarantee framework to provide for ex ante funding and remove active bankers from DGS governance [MEF, BI]: The DGS Directive approved at European level will partially implement this recommendation (i.e. ex ante funding). ### Fund relations and mission details (administrative facts) - Membership Status: Joined 3/27/47; Article VIII. - Quota: 7,882.30 (SDR Million) — 100.00 Percent Quota. - Fund holdings of currency: 6,019.41 (SDR Million) — 76.37 Percent Quota. - Reserve Tranche Position: 1,863.05 (SDR Million) — 23.64 Percent Quota. - New arrangements to borrow: 1,792.63 (SDR Million). - SDR Department net cumulative allocation: 6,576.11 (SDR Million) — 100.00 Percent Allocation. - SDR Department holdings: 6,140.45 (SDR Million) — 93.38 Percent Allocation. - Mission: Rome, Naples, and Milan, June 5–June 18, 2014. - Staff team: Messrs. Kang (head), Lanau and Tyson, Ms. Tuladhar (all EUR), Mr. Esposito (LEG), Ms. Jassaud (MCM), Mr. Chevauchez (FAD) and, Ms. Segal (SPR). Mr. Husain (EUR) also joined for a few days. Mr. Montanino (OED) attended the policy meetings. - Country interlocutors: Finance Minister Padoan, Bank of Italy Director General Rossi, other senior officials from the Ministry of Economy and Finance, the Bank of Italy, the Ministry of Economic Development, the Ministry of Labor and Social Policies, the Ministry of Justice; Senate Budget Committee Technical Group; Parliamentary Budget Committee Technical Group; Fiscal Council; Regional Governments of Lombardia and Campania; Association of Municipalities – Fondazione IFEL; major Italian banks; rating agencies; the Securities and Exchange Commission (CONSOB); the Antitrust Authority; Consiglio Nazionale Forense; Court of Naples; High Council of the Judiciary; National Statistics Institute (Istat); representatives of trade unions (CGIL, CSIL, and UIL); Confederation of Italian Industry (Confindustria); Italian Banking Association (ABI); research centers; parliament and academic representatives. *Source: Appendix I. Progress Against IMF Recommendations (staff report for the 2014 Article IV consultation).* ### 2013. The associated Executive Board’s assessment is available at: ### _cr14283 - 2013. The associated Executive Board’s assessment is available at: ### Data adequacy and statistical issues - General assessment: "Data provision is adequate for surveillance." - Adoption and reporting standards: - Italy subscribes to the Fund’s Special Data Dissemination Standard (SDDS) since 1996 and posts metadata on the DSBB. - Italy has adopted the European System of Accounts 1995 (ESA95). - Subject to statistical requirements of Eurostat and the European Central Bank (ECB). - Italy has shown interest in adhering to the SDDS Plus; an STA mission found that Italy could be among the initial adherents when the SDDS Plus is launched. - Coverage and quality: - Economic and financial statistics are comprehensive and of generally high quality; comprehensive data are available on a timely basis (Table 1). - The authorities regularly publish a full range of economic and financial data and a calendar of main statistical releases. - Specific statistical issues and planned improvements: - National Accounts: "Further improvements should be considered regarding changes in inventories in the quarterly national accounts, which are currently derived as a residual and lumped together with the statistical discrepancy." - External Sector Statistics: "The first transmission of International Investment Position (IIP) data on the basis of the Balance of Payments and International Investment Position Manual, 6th edition (BPM6) will take place in June 2014, as envisaged by the work plan agreed with the ECB and the Eurosystem national central banks." - Financial Sector Surveillance: Participates in CDIS, CPIS and FSI databases. - Implementing G-20 DGI recommendations: "The authorities have already implemented a good number of the recommendations and work is underway to implement the remaining ones. Further progress in the near future is likely to be made on the reporting frequency of Financial Soundness Indicators." - Data ROSC history: - Data ROSC disseminated in 2002. - Standard Code Assessments and ROSC/FSAP entries include Fiscal Transparency (October 9, 2002, No. 02/231), Data (October 18, 2002, No. 02/234), Fiscal ROSC updates (November 2003 No. 03/353; February 2006 No. 06/64), and FSAP (September 2013 No. 13/300). ### Exchange rate arrangement and Article IV consultation - Exchange rate arrangement: - 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 the exchange restrictions imposed by Italy solely for the preservation of national or international security that have been notified to the Fund pursuant to Executive Board Decision No. 144-(52/51)." - Article IV consultations: - Italy is on the standard 12-month consultation cycle. - Previous consultation discussions: June 24–July 4, 2013. - Staff report (Country Report No. 13/298, 09/27/13) discussed on September 25, 2013. - Outstanding Fund arrangements: - Outstanding Purchases and Loans: None - Financial Arrangements: None - Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs): - Charges/Interest: 0.19 0.39 0.39 0.39 0.39 - Total: 0.19 0.39 0.39 0.39 0.39 ### IMF Press Release summary (Article IV consultation conclusions — September 12, 2014) - Near-term macroeconomic situation: - "The economy is struggling to emerge from a balance sheet recession. GDP contracted in the first half of the year but business surveys and resilient exports suggest a gradual increase in economic activity in coming quarters." - "Against the background of significant economic slack, inflation fell well below one percent and unemployment reached 12.3 percent." - "Sovereign spreads narrowed but financing conditions remain very tight for the corporate sector (especially for small and medium enterprises, SMEs) and non-performing loans (NPLs) continue to increase." - Growth outlook and risks: - Growth projection: "Growth is expected to pick up to 1.1 percent in 2015 as credit conditions normalize and the effects of the easing measures by the European Central Bank (ECB) are felt." - Risks: "Risks are still tilted to the downside and include geopolitical tensions and the possibility of stagnation and low inflation." - Structural reform agenda: - Prime Minister Renzi's agenda: "firm implementation is now essential to create jobs, increase productivity, and lift potential growth from a low estimate of about ½ percent." - Labor market: first phase focused on "increasing flexibility at the margin"; future measures to "explore a contract with gradually increasing protection and improve active labor market policies." - Ongoing reforms: judicial system and public administration reforms in progress; competition-enhancing reforms to be legislated soon. - "Implementing structural reforms simultaneously would be self-reinforcing and generate significant growth synergies." - Fiscal outlook: - Nominal budget deficit: "expected to be around 3 percent of GDP this year." - Structural terms: "a deficit of 0.8 percent of GDP is expected." - Public debt: "will peak this year at about 136 percent of GDP and is projected to decline thereafter." - Fiscal measures: "The passage of the delega fiscale establishes a framework for simplifying and improving the tax system and will be an important tool to achieve a growth-friendly fiscal rebalancing." ### Executive Board assessment and policy recommendations - Overall assessment: - Directors noted that "the Italian economy has yet to emerge from a prolonged recession and prospects remain uncertain with downside risks." - Concerns emphasized: high unemployment, declining inflation, tight credit conditions, weak corporate balance sheets, deep-rooted structural rigidities, and high public debt. - Structural reforms: - "Deep structural changes are needed to unleash Italy’s growth potential, secure a recovery, and address debt overhang issues." - Directors welcomed the government's proposed changes to the labor market, judicial system, public sector, and electoral law. - Labor market reforms: urgency to "reduce duality and increase flexibility," with support for "simplified labor contracts with gradually increasing protection" and "decentralized wage setting to promote firm-level wage bargaining." - Business climate: stressed importance of judicial reforms to "improving court efficiency and facilitating corporate restructuring," enhancing competition (especially retail and service sectors), and strengthening anti-corruption legal framework. - Financial sector and corporate restructuring: - Priority: "cleaning up banks’ bad loans remains an immediate priority." - Recommended actions: "more provisioning and write-offs, development of a private market for distressed debt, and an enhanced insolvency regime." - Support for improving corporate governance and "promote diversification of financing sources through deeper capital markets." - SME sector: encourage "restructuring support for viable but distressed firms, and facilitate a smooth exit for those that are not viable." - "Steps to strengthen collateral enforcement would help support new financing." - Fiscal policy stance: - Directors commended recent fiscal consolidation and underscored need to balance near-term growth support with putting the debt ratio on a downward path over the medium term. - Priority for growth-friendly adjustment: "create space for lowering marginal tax rates through spending savings and lower tax expenditures." - Cautionary recommendation: "given the environment of low growth, high real interest rates, and large financing needs, it would be prudent to build up a structural balance buffer once the recovery firmly takes hold." - Support for ongoing fiscal reforms: planned expenditure review, efforts to fight tax evasion, and intent to introduce a medium-term expenditure framework. ### Key quantitative projections and indicators (selected figures from "Italy: Summary of Economic Indicators, 2011―19") - Real GDP (annual percentage change): - 2011: 0.4 - 2012: -2.4 - 2013: -1.9 - 2014: -0.1 - 2015: 1.1 - 2016: 1.3 - 2017: 1.2 - 2018: 1.0 - 2019: 1.0 - Unemployment rate (percent): - 2011: 8.4 - 2012: 10.7 - 2013: 12.2 - 2014: 12.6 - 2015: 12.0 - 2016: 11.3 - 2017: 10.5 - 2018: 9.8 - 2019: 9.2 - Inflation and prices: - Consumer prices (annual percentage change): 2011: 2.9; 2012: 3.3; 2013: 1.3; 2014: 0.4; 2015: 1.0; 2016: 1.1; 2017: 1.3; 2018: 1.5; 2019: 1.6 - GDP deflator (annual percentage change): 2011: 1.4; 2012: 1.6; 2013: 1.4; 2014: 1.1; 2015: 1.2; 2016: 1.4; 2017: 1.5; 2018: 1.5; 2019: 1.6 - Fiscal indicators (percent of GDP): - General government net lending/borrowing: 2011: -3.6; 2012: -2.9; 2013: -3.0; 2014: -3.0; 2015: -2.1; 2016: -1.1; 2017: -0.7; 2018: -0.5; 2019: -0.4 - General government primary balance (excludes interest expenditure) 1/: - 2011: 1.2; 2012: 2.5; 2013: 2.2; 2014: 2.2; 2015: 3.2; 2016: 4.5; 2017: 4.8; 2018: 5.0; 2019: 5.1 - Structural overall balance (percent of potential GDP): 2011: -3.7; 2012: -1.6; 2013: -0.6; 2014: -0.8; 2015: -0.3; 2016: 0.0; 2017: 0.0; 2018: 0.0; 2019: 0.0 - General government gross debt (percent of GDP): 2011: 120.7; 2012: 127.0; 2013: 132.5; 2014: 136.4; 2015: 135.4; 2016: 132.9; 2017: 130.2; 2018: 127.6; 2019: 124.7 - External sector: - Current account balance (percent of GDP): 2011: -3.0; 2012: -0.3; 2013: 1.0; 2014: 1.5; 2015: 1.5; 2016: 1.2; 2017: 0.9; 2018: 0.5; 2019: 0.1 - Trade balance (percent of GDP): 2011: -1.1; 2012: 1.1; 2013: 2.4; 2014: 2.7; 2015: 2.9; 2016: 2.8; 2017: 2.6; 2018: 2.4; 2019: 2.2 *Source: IMF staff report and Executive Board assessment as summarized in the provided content.* ### Introduction ### _cr14283 - Introduction ### Introduction: context and overall assessment - The 2014 Article IV Report on Italy is focused on a set of reforms aimed at unleashing potential output. - Recent receding risks are attributed to: a sizeable fiscal consolidation, the resilience of the banking sector, and strengthened European institutions. - Structural reforms are identified as the fundamental component of the authorities’ agenda; implementing them requires political support, time, and unwavering commitment. - Collaboration between IMF staff and Italian authorities continued to be excellent, with broad agreement on main objectives, priorities, and instruments, but with some qualifications and points of disagreement. ### Structural reforms — Judicial - Improving the efficiency of the justice system is a central concern of the Italian authorities. - Recent measures adopted over recent years show some early positive results, but structural bottlenecks remain and further efforts are in progress. - On August 29, 2014 the government presented a new set of measures broadly consistent with staff suggestions, including: - norms to discourage litigations and to enhance mediation in civil justice; - criminalization of false accounting in criminal justice. - The authorities note surprise at the emphasis given to corruption in public sector in Para. 13 of the Report, stressing that the evidence cited pertains to perceptions of corruption, a different concept and measure from corruption itself. ### Structural reforms — Labor market - The reform of fixed-term contracts and of the apprenticeship became law in May (the Report states "last May"), making it easier for firms to hire new workers. - Work remains in progress on other matters and should be completed in coming months. - Objectives and instruments are broadly consistent with staff recommendations, with differences in emphasis on decentralized wage settings. - Authorities note erosion of the centrality of national contracts has been ongoing for several years; further improvements possible. - Staff did not consider that last January social parties agreed upon an Act on Representation which will help enforceability of industry-wide and company level agreements. - The 2012 Fornero Reform largely implemented provisions addressing employment protection, duality in the labor market, and a universal unemployment benefit system; first results are positive but further reforms are required. ### Structural reforms — Public Administration - An effective public administration is a pre-requisite for implementing structural reforms. - On August 7, 2014 reform provisions envisaged by the government in June were adopted by Parliament. Main measures include: - fostering mobility (voluntary and compulsory) of public sector workers; - strengthening caps to salaries of top civil servants; - introducing the possibility for the public administration to unilaterally terminate labor contracts with its employees under specific circumstances; - disallowing the public administration and enterprises where central or local governments have a stake to assign consultancy contracts to retired workers. - The government is determined to implement these provisions steadily and closely monitor their effectiveness. ### Structural reforms — Legislative system - Complexity of the Italian legislative process called for simplification, better coordination among layers of government, and enhanced accountability. - On August 8, 2014 the Senate approved a draft constitutional bill to revise the equal powers of both chambers and to intervene on relations between central and local governments; the House is examining the draft bill. - Notable measures in the provision: - only the House will be endowed with full legislative powers except for a few topics on which the Senate vote will be relevant; - the size of the Senate will shrink from the current 315 to 100 members, which will represent local authorities; - Provinces will be repealed; - indemnities for the Regions’ Presidents and for the members of Regional Councils will be capped and the allowances for regional political groups will be abolished. ### Competitiveness - Authorities concur with staff that addressing the competitiveness gap requires simultaneous wide-ranging reforms. - Assessment should use a broad set of indicators; staff’s 2013 Art. IV SIP highlighted that “labor-cost measures may present an incomplete picture, and should perhaps be complemented.” - Staff last year advocated a comprehensive approach relying largely on export market shares with other non-price factors; authorities agree. - Authorities note puzzlement that this year staff referred mainly to labor cost indicators to argue that “…competitiveness has yet to improve” (Fig. 1, page 7). - When assessed through PPI-based measures, Italian competitiveness “has improved by around 5 percent since 2008.” - Recent econometric analysis shows PPI-based indicators have greater power than other measures (including ULCs) in explaining Italian export dynamics. - Authorities note staff observation that “Italy’s share of global exports increased for the first time since 2007” (page 4). - Authorities stress the recent rise of real wages was due to a sizeable decrease of inflation, rather than to nominal wage dynamics. - Empirical research cited indicates neither centralized nor firm-level bargaining have been a source of rigidity for wage adjustment; the staggered nature of bargaining rounds should also be considered. - Conclusion: productivity-enhancing reforms are the appropriate way to tackle the competitive gap. ### Financial sector - Italian banks strengthened capital relying almost exclusively on private capital; public sector share reached only 0.3 per cent of GDP in the first quarter of 2013. - With repayment of the largest share of the State’s loan to Monte dei Paschi di Siena, the public contribution has been substantially wiped out. - Banks’ business model centered on traditional intermediation of savings mostly within the country helped them withstand crisis impacts originating in foreign markets and speculative products. - The protracted recession and sovereign debt crisis increased firms’ debt-service burden, raising NPLs. - Despite difficult circumstances, the banking system absorbed shocks smoothly; capital strengthening is proceeding in line with Basel 3 rules in force in the European Union since January. - Coverage ratio on NPLs increased to 42 percent in 2013 (up from 39 percent in 2012). - Inflow of new bad debt has been declining since the third quarter of 2013. - Further capital strengthening requires increasing profitability; supervisor encourages banks to reduce operational costs. - Progress on branch network rationalization and curbing administrative and staff expenses allowed keeping costs constant in proportion to revenues. - Banks must reduce NPL volumes to free resources for financing the economy; there is growing interest from specialized investors willing to pay higher prices due to reduction in risk premiums. - Recent changes in tax treatment of loan losses are expected to contribute positively; some disposals of NPLs have already taken place. ### Financing of the economy - Financial conditions remain tight, with the hardest credit supply restrictions on small- and medium-sized firms (SMEs). - Staff Report proposals largely aim to complement initiatives already undertaken by authorities. - Authorities disagree with staff suggestion to “shift public support schemes away from guarantees and moratorium for existing firms to financing for new firms.” - Argument: at a time of borrower soundness concerns, government guarantees preserve funding flow to firms with good growth opportunities. - Forbearance risks are characterized as well controlled: access to measures is precluded to financially distressed firms and the default rate of such schemes is among the lowest of comparable public guarantee schemes worldwide. - Authorities disagree with staff on alleged fragmentation of credit registries and bureaus: - The Italian Credit Register ensures very large coverage by international standards; the size threshold for loans is 30,000 euro. - Data covered only by private credit bureaus are limited to very small loans. - Authorities welcome staff proposals to develop capital markets, noting bank lending cannot be the sole source of funds and several steps have been taken in recent years. ### Fiscal policy - Italy pursued sizeable fiscal consolidation since the crisis; fiscal prudence confirmed in 2013 when the government kept the deficit below the Maastricht threshold and in line with official targets. - Authorities remain committed to a prudent and rigorous fiscal policy to keep public finances sustainable; they view the spending review as a strategic tool. - As envisaged by the domestic budgetary process, the government will present shortly by October 1, 2014 the Update to the Economic and Financial Document of last April, providing updated macro-economic and budgetary projections. - Given muted international perspectives and persistent domestic demand weakness, the authorities caution against policies that could further weaken economic conditions. - They do not concur with staff recommendations that additional consolidation is needed under the baseline scenario. - Authorities consider the staff-proposed medium-term target of a structural surplus of 1 per cent of GDP is not advisable, being well beyond what is requested by the EU fiscal rules, including the debt rule. ### Conclusion - Over the last year, the most pressing risks surrounding Italy’s outlook have gradually lessened, aided by sizeable consolidation efforts and other factors. - Authorities welcome the “supply-side” emphasis of the 2014 Art. IV Report as a framework to unleash potential output. - The return to a stable and sustainable growth path is an essential complement to policies aimed at repairing public and private balance sheets. - Growth strategy should be based on structural reforms, measures to foster investments and competitiveness, while pursuing budget consolidation. *Source: _cr14283 - Introduction* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14283.pdf_