2012 Article IV Consultation with Italy - Concluding Statement of the IMF Mission
IMF News, May 16, 2012
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- Published: May 16, 2012
Overview and near-term outlook
- With broad political support, the authorities have embarked on an ambitious and wide-ranging agenda that has lifted Italy from the brink and is now seen as a model for fiscal stabilization and growth-enhancing reforms.
- The work has only just begun; emphasis should remain on comprehensive structural reforms, a supportive growth-friendly and sustainable fiscal strategy, and measures to promote a more dynamic and resilient banking system.
- Italy’s success depends on progress at the European level to resolve the crisis and promote growth.
- Short-term outlook:
- The economy is expected to contract this year due to strong headwinds from fiscal consolidation, tight financial conditions, and the global slowdown.
- Economic activity is expected to recover in early 2013, led by a modest pickup in exports and investment.
- Headline inflation is expected to ease only gradually, as weak demand will be partly offset by higher indirect taxes.
- Risks to the outlook:
- Downside: renewed financial turmoil could push government bond yields higher, tighten bank credit, and weaken activity; slow implementation of fiscal and structural reforms could undermine confidence and raise fiscal concerns.
- Upside: a more robust global recovery or faster progress in reforms could boost market sentiment and activity.
- European dimension:
- Progress in creating a more complete monetary union, greater fiscal and financial discipline and risk sharing, and further monetary easing and unconventional measures by the ECB would support Italy’s adjustment.
I. Structural Reforms to Jumpstart Growth
- Potential gains:
- IMF staff estimates suggest that product and labor market reforms that bring Italy closer to OECD best practices could increase the level of GDP by about 6 percent over the medium term.
- Priority reform areas and recommendations:
- Labor market:
- Pass the labor market reform bill quickly to reduce uncertainty and encourage new hires; the bill promotes open-ended and apprenticeship contracts for young workers and makes unemployment insurance more universal.
- Clarify conditions for reinstatement via the judicial process to reduce uncertainty and facilitate out-of-court settlements of dismissal disputes.
- Bridge the gap between permanent and temporary workers:
- Allow a more flexible open-ended contract for new workers that gradually increases employment protection with tenure.
- Reduce marginal tax rates for married second-earners to raise female labor participation.
- Allow firms and workers to set firm-level contracts by default, unless opting out to national ones.
- Greater differentiation of public wages across regions to support private wage flexibility and employment, especially in the South.
- Product markets:
- Accelerate reforms in energy, public and professional services sectors.
- Complete planned separation of gas distribution and production by end year to improve competition and reduce energy prices.
- Accelerate opening of professional orders to strengthen competition and lower rents.
- Push for privatization, especially of local public utilities, to enhance efficiency, cost, and quality of public services.
- Increase efficiency of the judicial system to reduce legal backlog, lower business costs and uncertainty, and strengthen labor market reforms.
- SMEs and access to finance:
- Reduce high start-up costs and streamline tax and other regulations.
- Expand risk-based lending (as opposed to collateral-based) and develop the venture capital and private equity industry.
- Recent initiatives to foster firm recapitalization, such as the allowance for corporate equity, are welcome.
- Promote greater inward FDI (among the lowest in the OECD) to help SMEs access global supply chains and technology transfer.
II. Making Fiscal Consolidation More Growth-Friendly
- Recent fiscal actions:
- The government has enacted an impressive fiscal package to improve the primary surplus—significant and front-loaded consolidation; pension reforms; a modest shift from direct to indirect taxes (supporting a “fiscal devaluation”); and more aggressive action against tax evasion.
- As a result, the primary surplus of the general government is expected to rise significantly, to above 4 percent of GDP by 2013, the highest in the euro area.
- Assessment and guidance:
- The fiscal adjustment in 2012–13 is appropriate; sizeable improvement in the structural primary balance will weigh on growth but is critical for fiscal sustainability.
- The mission welcomes focus on targeting a structural balance which adjusts for the economic cycle.
- The mission welcomes government efforts to identify and implement expenditure cuts to avoid an increase in the VAT rate later this year.
- Composition of adjustment and recommendations:
- Shift further toward expenditure cuts and lower taxes to better distribute the burden and support growth.
- Specific measures could include:
- Cutting government expenditure, such as the public sector wage bill or other areas identified in the ongoing spending review.
- Reducing Italy’s sizeable tax expenditures.
- Stepping up efforts against tax evasion.
- Using savings to reduce the labor tax wedge, raise the allowance for corporate equity, or finance a modest, well-targeted increase in public infrastructure investment.
- Staff estimates that a sizeable shift in composition of adjustment could raise the level of GDP by 1 percent over the long term.
- Fiscal institutions and medium-term anchor:
- Newly adopted constitutional fiscal rule is important for strengthening fiscal discipline.
- Adopt a binding multi-year expenditure framework and unify/enhance the role of spending reviews.
- The fiscal council should be fully independent in staffing, funding, and work agenda.
- To raise buffers, target a 1 percent of GDP structural surplus from 2014 onwards as the medium-term anchor for the fiscal rule to put the debt ratio on a more robust downward path.
- Public payments and debt management:
- Complete the stocktaking exercise to determine the size of pending and overdue public payments at central and subnational levels and develop a strategy for improved reporting and timeliness.
- Improve coordination among levels of government and maintain incentives for subnational fiscal prudence.
- Debt management should maintain favorable maturity structure and diversify the investor base.
- Provide collateral in swap transactions and report such transactions regularly in government accounts to enhance transparency.
- Assess scope to mobilize public assets, including through privatization, to maximize revenue generation and reduce public debt.
III. Promoting a More Dynamic and Resilient Banking System
- System strengths:
- Italian banks benefit from a large and stable retail funding base, low leverage, and a traditional lending model with limited exposures to risky assets.
- Resilience has been supported by firm supervision and regulation; banks strengthened capital bases without large-scale government equity support.
- Key vulnerabilities and statistics:
- Gross impaired loans (including bad, substandard, restructured, and past-due loans) have risen to 11 percent in 2011, from less than 6 percent before the crisis.
- Declines in provisioning rates below pre-crisis levels leave banks vulnerable, especially from weaker SME and construction sectors.
- Exceptional liquidity support from the ECB has been critical for meeting banks’ funding needs and preventing a sharp contraction of credit.
- Policy recommendations:
- Reduce impaired loans to free up resources for new lending:
- Encourage banks to develop strategies for selling, restructuring, or writing down impaired loans.
- Facilitate a market for restructuring distressed assets by ensuring adequate bank provisioning, aligning tax deductibility of loan loss provisioning and write-offs, and streamlining bankruptcy and foreclosure procedures.
- Maintain adequate capital and liquidity buffers:
- The Bank of Italy (BoI) should encourage large banks under the EBA to meet capital needs by raising equity or disposing of noncore assets rather than cutting loans.
- Consider extending BoI stress tests to a larger set of institutions, including mid-sized banks, and publish results in regular Financial Stability Reports to enhance transparency and market discipline.
- Encourage banks to improve capacity to post eligible collateral at the BoI to facilitate access to Eurosystem liquidity facilities.
- Acknowledgement:
- The IMF team visited Italy from May 3 to May 16, 2012, for the annual evaluation of the economy as part of the regular consultations under Article IV of the IMF’s Articles of Agreement; this statement describes the preliminary findings of the staff.
Concluding Statement of the IMF Mission, May 16, 2012.