Italy: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, May 19, 2022
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- Published: May 19, 2022
Macro outlook and key findings
- Italy achieved an "impressive recovery" from the pandemic shock, returning close to the pre-COVID level of output by late 2021; employment has rebounded and the labor market is tightening.
- New shocks: the war in Ukraine and COVID-related supply disruptions have pushed up energy prices and intensified shortages; Italy is relatively more affected owing to high dependence on imported energy from Russia.
- Near-term performance: services (notably tourism) are recovering toward pre-COVID levels; construction is booming owing to generous investment tax credits; manufacturing has remained in growth territory through April but is moderating since end-2021.
- Baseline growth projections:
- 2022: around 2½ percent
- 2023: 1¾ percent
- Year-average inflation is projected to peak this year at 5½ percent.
- Over the medium term, growth is forecast to stabilize at just over 1 percent on continued NRRP-related spending and some moderation of commodity prices.
- Downside risks highlighted:
- Abrupt tightening of financial conditions could reduce growth, increase funding costs, slow public debt decline, and cause banks to scale back lending.
- Difficulties achieving NRRP investments and reforms would slow growth and delay EU funding.
- Additional fiscal stimulus risks fueling a price-wage spiral amid supply constraints.
- An abrupt near-term shutoff of Russian energy imports could significantly reduce output in 2022 and 2023 even assuming replacement of about half the immediate shortfall by next winter.
Managing the energy shock
- Government actions consistent with REPowerEU:
- Securing replacement supplies (amounting to about half of normal gas imports from Russia by next winter).
- Expanding LNG regasification capacity.
- Delaying phase out of coal power plants.
- Accelerating seasonal gas storage and speeding approvals for renewable electricity capacity.
- Trade-offs and recommendations:
- Temporary setbacks to decarbonization may occur, but security and sustainability should reinforce over the longer term.
- Review pricing and tax arrangements for energy imports and renewables-based electricity to limit excessive windfall rents and their transmission to end-user prices.
- Compensation design:
- Preserve price signals while cushioning the most vulnerable.
- Cutting energy taxes and fees lowers prices broadly but discourages energy efficiency and benefits all customers.
- The "social bonus" (targeted cash transfers to vulnerable households) is preferred.
- Temporary tax credits to energy-intensive firms are appropriate when prices temporarily overshoot long-run levels and support is targeted to viable firms.
Fiscal strategy and public debt dynamics
- Rationale for restraint:
- Recent pandemic support, strengthened social safety net (universal means-tested child allowance), and compensation for higher energy bills occurred amid already elevated public debt and rising financing costs.
- Given apparent resilience of demand and output to the energy shock, additional windfall revenue from stronger cyclical conditions should be saved.
- Two-pronged credible strategy to reduce deficit and debt:
- Comprehensive structural reforms, including a revenue-neutral broadening of the tax base to make the tax system more equitable, to boost productivity and GDP growth.
- Consistently growing non-interest current spending by 1–2 percentage points below nominal GDP growth and further improving tax compliance.
- Timing: fiscal adjustment should commence already in 2023 in the baseline.
- Expected outcome: could deliver a primary surplus of 2 percent of GDP by 2030.
- Budget review and spending-based strategy:
- A comprehensive review of the budget to find meaningful savings from existing spending and tax programs should underpin the strategy.
- Over the longer term, maintaining spending restraint and keeping the primary surplus at 2 percent would allow priority investments (climate, energy, education, digitalization, innovation) while reducing public debt to around 135 percent of GDP by 2030, with further sustained debt reduction thereafter.
- Policy design improvements to reduce fiscal slippage:
- Strengthening job acceptance requirements and links to training in the Citizenship Income program is welcome, but benefit withdrawal in response to earned income should be gradual given high benefit levels relative to cost of living in some areas.
- Reinforce controls on approvals of Superbonus tax credits to limit spending overruns due to the 110 percent subsidy.
- Tax on windfall profits of energy companies should be based on the full range of items that determine their profits.
Financial sector resilience and guidance
- Banks' condition:
- Improved financial strength since the pandemic should allow banks to weather tighter financial conditions under the baseline.
- Reductions in nonperforming loans, recourse to public guarantee schemes, and fiscal support to borrowers have de-risked balance sheets.
- Capital and liquidity positions strengthened; households and firms maintain large liquidity cushions.
- Direct and indirect exposures to Russia and Ukraine are concentrated but limited; energy-intensive companies comprise a relatively small share of loans for most banks.
- Risks and supervisory recommendations:
- Tighter financial conditions and slower growth are likely to pressure banks’ capital on average, with heterogeneity across the sector.
- New loan guarantee scheme targeting energy-intensive firms is helpful but eligibility should be selective, with enhanced credit risk assessments and guarantee coverage rates lower than in pandemic schemes.
- No generalized liquidity support measures currently called for.
- Banks should diligently apply loan classification standards and recovery procedures on guarantee portfolios.
- Preparation for severe scenarios:
- Banks should prepare using scenario-based assessments of credit quality and other exposures.
- Temporary conservation of capital may be advisable for specific banks; consider reviewing dividend payouts and share buy-backs and postponing drawdown of provisions.
- Addressing weaker banks:
- Prioritize robust supervisory assessments with targeted asset quality reviews, including for less significant institutions.
- Avoid using resources of the deposit guarantee scheme to prevent failures outside resolution except where strong prospects for rehabilitation exist.
- Continue increasing digitalization, improving governance, and further consolidating the sector amid competition from fintechs.
Policies for a severe scenario
- Scale and targeting:
- A comprehensive response would be appropriate but should reflect more constrained policy space (public debt some 15 percentage points of GDP higher than before the pandemic and tighter financing conditions).
- A smaller response than during the pandemic—scaled by the size of the growth markdown—would be warranted; support should be targeted and temporary.
- Fiscal and liquidity toolkit adjustments:
- Keep existing social safety nets at the core (short-time work scheme and means-tested citizenship income), adjust eligibility thresholds if prolonged high inflation occurs.
- Fiscal consolidation should commence as soon as the intense phase of the emergency has passed to avoid procyclical tightening.
- Enhance liquidity support tools to avoid corporate insolvencies; publicly-guaranteed loans preferable to moratoria.
- New guarantees could be provided and maturities lengthened, but banks should retain a larger part of credit risk for new/lengthened guarantees and excessive issuance should be avoided.
- Consider further extending duration of the government support scheme for securitizing impaired loans to prevent near-term NPL increases from becoming structural.
- Temporarily allow banks greater flexibility to restructure non-guaranteed loans without triggering forborne thresholds, based on recent Italian experience.
Structural priorities and NRRP implementation
- Climate and energy transition:
- Italy has reduced carbon emissions notably in energy and manufacturing (EU ETS-covered sectors); progress in residential sector limited—marked acceleration needed to meet Fit-for-55 goals.
- Much larger private sector investment in renewable energy is key to a greener, more self-sufficient electricity sector and to enable electrification in buildings and transport.
- Recent measures to streamline approvals and ex ante site identification for renewable capacity are showing positive results.
- Less volatile fossil fuel prices and a gradually increasing carbon price floor could encourage investment.
- Improve value for money of the housing Superbonus: energy efficiency improvements are poorly targeted and the subsidy rate is excessive despite planned reductions.
- NRRP urgency:
- Full and timely implementation of the NRRP is critical to lift productivity and boost potential growth.
- Frontloading of reforms (public administration, simplification of procedures, civil justice, competition) is intended to support efficient execution of public investments scheduled for the second half of the Plan.
- Completing reforms is crucial for improving the quality of public infrastructure and the efficiency of resource utilization.
Concluding remarks
- If facing a sharp curtailment of energy supplies, comprehensive liquidity and income support measures would be required, but the scale should reflect constrained policy room.
- Delivering NRRP investments and reforms would support productivity, potential growth, and accelerate the green transition.
- Gratitude expressed to the Italian authorities and private sector counterparts for their time and informative discussions.
Italy: Staff Concluding Statement of the 2022 Article IV Mission — May 19, 2022