Italy: Staff Concluding Statement of the 2020 Article IV Mission
IMF News, January 29, 2020
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- Published: January 29, 2020
Fiscal policy and market sentiment in 2019
- Fiscal policy implementation in 2019 was better than expected and contributed to improving market sentiment.
- Constructive engagement with the European Commission helped avoid the launch of the EU’s Excessive Deficit Procedure.
- Budget execution was prudent even as new social programs were launched (the “Quota 100” early retirement rule and the citizenship income program).
- Revenue collection was higher than expected.
- The new government’s pro-EU stance and accommodative ECB policy helped reduce sovereign yields to near historical lows.
Economic situation and outlook
- Current conditions:
- Real GDP growth in 2019 is estimated at 0.2 percent, down from a 10-year high of 1.7 percent in 2017.
- Real personal incomes remain about 7 percent below the pre-crisis (2007) peak.
- Unemployment is high at close to 10 percent, with much higher rates in the South and among the youth.
- Female workforce participation is the lowest in the EU.
- Projections and risks:
- Real GDP growth is forecast at ½ percent in 2020 and 0.6-0.7 percent thereafter.
- These forecasts are the lowest in the EU, reflecting weak potential growth.
- Downside shocks (escalating trade tensions, slowdown in key trading partners, geopolitical events) could lead to a much weaker outlook.
Priority: comprehensive reforms to raise growth and resilience
- Overarching objectives:
- Use current low interest rates as a window of opportunity.
- (i) Structural reforms to address barriers to competition, rigid wage bargaining, and public sector and judicial inefficiencies.
- (ii) Credible medium-term fiscal consolidation to lower public debt, underpinned by measures to support growth, protect the poor, and combat climate change.
- (iii) Strengthening banking system stability by bolstering capital in weak banks and improving profitability and asset quality.
Structural reforms to raise growth and create jobs
- Expected gains:
- Reforms to liberalize markets and decentralize wage bargaining are estimated to yield real income gains of about 6-7 percent of GDP over a decade.
- Product and service markets:
- Lower regulatory barriers in professional services, retail, and local services.
- Facilitate entry into high-markup sectors, remove exit barriers, and lift impediments to firm growth.
- Implement legislated pro-competition measures (e.g., liberalization of energy tariffs) and strengthen the competition authority’s enforcement powers.
- Labor markets:
- Wages remain high relative to productivity; realigning wages with productivity at the firm level would encourage investment and job creation.
- Modernize wage bargaining, ideally giving primacy to firm-level contracts; consider a statutory minimum wage accounting for regional productivity and living cost differences.
- Well-designed reductions in the tax wedge on secondary earners, combined with increased child- and elderly-care services, could raise female workforce participation and reduce gender gaps.
- Complementary reforms:
- Resolve uncertainty over the procurement code and rationalize local state-owned enterprises while safeguarding efficiency and transparency.
- Timely implementation of insolvency reform and streamlining of civil procedures; fold the special insolvency regime for large enterprises into the general framework.
- Improve higher education and skill acquisition.
Fiscal policies to safeguard sustainability and promote inclusive growth
- 2020 budget stance:
- The government’s fiscal plan is modestly expansionary in 2020 and neutral thereafter.
- Key measures: postponing VAT hikes, a modestly lower labor tax wedge, combating tax evasion, incentives for private investment, and higher public investment including the Green New Deal.
- IMF projection: overall deficit around 2.4 percent of GDP in 2020, after which it declines marginally (based on lower nominal growth assumptions than the authorities and excluding future VAT safeguard clauses).
- Medium-term consolidation needs:
- Debt projected to remain high at close to 135 percent of GDP over the medium term and to increase in the longer term owing to pension spending.
- Recommendation: legislate upfront high-quality measures to achieve a gradual and balanced adjustment aiming for an overall surplus of ½ percent of GDP by around 2025.
- A neutral fiscal stance for 2020 could be considered only if accompanied by a credible medium-term consolidation plan.
- Consolidation priorities (spending, pensions, poverty, investment):
- Spending: reduce current primary spending over the medium term while protecting the poor and continuing to increase public investment.
- Pensions: preserve indexation of retirement age to life expectancy; ensure actuarial fairness, including for early retirement; adjust pension parameters to secure affordability.
- Poverty alleviation: redesign the citizenship income program to align with international best practice—benefits are currently well above benchmarks, decline too quickly with family size, and fall sharply if a job offer is accepted.
- Supporting investment: improve public investment management (feasibility studies, prioritization, implementation) and limit tax uncertainty.
- Revenue-side recommendations:
- Improve tax design to promote growth and labor participation while protecting low- and middle-income households.
- Labor tax wedge:
- Italy’s average labor tax wedge is about 48 percent, compared to the EU average of about 42 percent.
- Authorities’ plan reduces the wedge modestly by 0.2-0.3 percent of GDP in 2020-21.
- A reduction to the EU average could cost 2 percent of GDP and should be offset by significant base broadening.
- Broadening the tax base:
- Rationalize tax credits and deductions in personal income tax.
- Streamline VAT reduced rates with attention to distributional consequences.
- Update property valuation to address equity concerns and increase collection at lower statutory rates.
- Tackling tax evasion:
- Compliance gap estimated at 6 percent of GDP.
- Mandated electronic invoicing and transmission; improve monitoring and risk analysis by accessing financial data (addressing privacy concerns).
- Strengthen institutional and governance arrangements of the tax agency and remove legal obstacles to tax debt collection.
Climate policy
- Carbon taxation:
- Carbon taxation is highlighted as the most effective tool.
- While carbon taxes are high in some sectors, the bulk of emissions (mostly in electricity) is taxed at low rates.
- A uniform carbon tax of €70 per ton of CO 2, above which excises should be added to correct for other externalities, would reduce emissions by 20 percent by 2030.
- Such a tax could be phased in gradually; revenues could compensate impacted households or offset distortionary taxes.
- Complementary measures: well-targeted public investment and incentives, energy price liberalization, and regulatory standards to promote clean technology.
Financial sector: progress and remaining challenges
- Progress to date:
- Prudential requirements raised and measures implemented to facilitate capitalization, lower NPLs, improve governance, and encourage consolidation of mutual banks.
- Restructuring or recapitalization of several weak banks.
- NPL ratio fell from 16 percent of loans in 2016 to 7.3 percent in September 2019; NPL sales at or above targets even considering market strains in 2018-19.
- Remaining challenges:
- The capital ratio (fully loaded Common Equity Tier 1) is about 1.5 percentage points below the EU average.
- The NPL ratio is over twice the EU average.
- Profitability remains low, especially for small- and mid-sized banks, due to limited revenue growth potential, structurally high operating costs, business model challenges, and governance weaknesses.
- Exposures to the Italian sovereign are relatively large; many banks are heavy users of the ECB’s Targeted Longer-Term Refinancing Operations.
- IMF FSAP recommendations to enhance resilience:
- Capital and asset quality:
- Further boost capital buffers in weaker banks.
- Continue robust NPL reduction plans, with attention to unlikely-to-pay loans.
- Extend SSM approach on provisioning expectations to less significant institutions with high NPLs.
- Consider prudential policies to moderate the sovereign-bank nexus, phased-in to avoid market disruptions.
- Profitability and governance:
- Reduce costs and invest in technology.
- Strong supervisory focus on business model viability and cost reduction plans.
- Further bank consolidation is needed.
- Close legislative gaps in implementation of EU fit and proper rules for banks’ management.
- Supervision and crisis management:
- Consider more escalated corrective measures and use all available tools in a timely manner.
- Ensure special administration does not delay decisive action.
- Build additional loss absorbing capacity over an appropriate transition period to facilitate orderly resolution or liquidation for less significant institutions.
- Avoid using the deposit guarantee scheme for preventive measures as much as possible.
- Enhance EU-level crisis management framework, including introduction of an orderly liquidation regime for non-systemic banks.
Source: Italy: Staff Concluding Statement of the 2020 Article IV Mission (January 29, 2020).