Italy: Staff Concluding Statement of the 2023 Article IV Mission

IMF News, May 26, 2023

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Italy: Staff Concluding Statement of the 2023 Article IV Mission

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• Published: May 26, 2023

Growth, inflation, and labor market — key findings

• Real GDP growth: 3.7 percent in 2022.
• Early 2023 activity: expansion of 1.8 percent (year-on-year) in Q1 2023.
• Public debt ratio: declined by 10 percentage points from its peak in 2020 on the large rebound in nominal GDP.
• Employment: picked up strongly; unemployment rate fell sharply.
• Inflation: energy price spike largely reversed, but broadening price pressures have driven core inflation to high levels.
• Growth forecast: moderate to 1.1 percent in 2023 and 1.1 percent in 2024.
• Near-term outlook: growth expected to temporarily tick up from 2025 as NRRP spending peaks and remain modestly above its long-term trend.
• Inflation path: core inflation is forecast to decline gradually, with inflation returning to target only around 2026.
• Demographics: falling working-age population will be a drag on long-term growth absent sustained productivity improvements.

Downside and upside scenarios — risks to the outlook

• Downside risks highlighted:
  • Sharper tightening of monetary policy from more persistent euro-area inflation could raise borrowing costs for Italy.
  • Renewed global financial stress (for example, an impasse on the U.S. debt ceiling) could reduce funding availability, retrench public and private spending, and revive sovereign-bank-corporate linkages concerns.
  • Policies slowing public debt reduction or prolonged delays in NextGenerationEU disbursements could raise financing concerns.
  • Escalating geopolitical tensions or extreme weather events could create supply disruptions.
  • Stalled progress on NRRP implementation would lower output support and weaken future productivity.
• Upside possibilities:
  • More resilient growth supported by improved confidence among consumers and service sector firms, notably tourism benefiting from pent-up foreign demand, especially from Asia.

Fiscal policy recommendations

• Overall stance:
  • Fiscal policy should help the economy navigate shocks while protecting public finance sustainability.
  • Opportunistically save most windfall revenue from inflation surprises and tax credit accounting changes.
  • A credible medium-term debt reduction plan, underpinned by specific measures, is advised.
• Specific guidance:
  • Saving revenue windfalls would smooth the significant fiscal effort needed to place the public debt ratio on a downward path and support disinflation.
  • The primary balance for 2023 remains below pre-COVID levels; a faster than planned improvement in the primary balance is warranted and feasible.
  • There is scope to increase spending efficiency and refine targeting of benefits; limit compensation to the temporary portion of higher energy prices.
  • Over time, replace saved windfall revenues with efficient fiscal measures that promote sustainable and inclusive growth and boost productivity.
  • Tax system reform should encourage employment, abolish ineffective tax expenditures, reinforce revenue collection, and protect progressivity.
  • To contain aging-related spending: link the retirement age to life expectancy; better align benefits with lifetime contributions; discontinue early retirement arrangements.
  • Suggested spending path: pursue a spending path—including tax expenditures—whereby primary current spending grows 1-2 percentage points below nominal GDP growth while maintaining a 3 percent of GDP primary surplus from 2025 onwards; this would create room for public investment and lower the debt ratio.
  • Conduct a comprehensive spending review to identify needed savings.
• Public sector guarantees:
  • Strong centralized oversight and prudent management is encouraged.
  • Stress test the guarantee portfolio under adverse scenarios.
  • Strictly limit new guarantees, lower coverage rates, enhance credit risk assessments, and gradually reduce the stock of guarantees.

Financial sector resilience — findings and recommendations

• Current conditions:
  • Banks’ capital and liquidity buffers broadly stable at comfortable levels over the past year.
  • Nonperforming loans (NPLs) declined further.
  • Higher net interest income and release of pandemic-era provisions boosted banks’ return on equity.
  • Credit volumes expected to decline and NPLs likely to rise as borrowers’ repayment capacity is crimped by rising interest rates and slower growth.
  • Funding costs expected to increase, particularly for banks with smaller excess reserves relative to maturing TLTRO borrowing.
  • Fixed income securities portfolios values declined on rising yields; hedging strategies dampened unrealized losses for some banks.
  • Pockets of weakness among less significant banks: weaker credit quality, lower provisioning coverage, larger sovereign bond holdings relative to capital.
  • Insurance companies: increased surrenders of life insurance policies, declines in premium income, unrealized securities losses, though solvency remains solid.
  • Commercial real estate is a focus area; Italian real estate investment funds are mostly closed-end with limited early redemption risk; residential real estate risks appear limited.
• Policy recommendations:
  • Closely monitor banks’ funding plans and adequacy of forward-looking liquidity buffers after TLTRO repayment.
  • Assess feasibility of using interest rate swaps to bridge duration risk.
  • Continue tailored stress tests capturing credit, duration, and liquidity risks, including concentrated funding and sovereign exposures.
  • Calibrate capital and liquidity buffers and challenge dividend and share buyback plans based on stress test results.
  • Continue comprehensive supervision of less significant banks, with higher capital requirements and guidance.
  • Complete data collection on current price loan-to-value at individual loan level for commercial real estate exposures.
• On policy measures and instruments:
  • Introducing a new windfall tax on bank profits could reduce deposit rates, raise loan costs, and reduce financial intermediation; design should consider impacts on credit availability, credit cost, and resilience.
  • Limit use of non-standard financial vehicles to mutualize banking sector costs; avoid public-private schemes that use deposit guarantee resources or voluntary contributions to prevent bank failures outside resolution except where rehabilitation prospects are strong.
  • Reintroduction of a GACS-like scheme should face a high bar given current low NPL rate and ongoing sales/securitizations.
  • Cap the proposed Guaranteed Loan Active Management (GLAM) scheme at the proposed level of ½ percent of GDP.

Structural reforms and long-term priorities

• NRRP implementation:
  • Full and timely implementation of the National Recovery and Resilience Plan (NRRP) is needed to lift productivity and boost potential growth.
  • Strengthen administrative and execution capacity of implementing municipalities to manage high project volumes.
  • Accelerate procedures to promote competition and integrity of financial resources.
• Labor market and productivity:
  • Pursue ambitious, productivity-enhancing structural reforms to offset the drag from a shrinking workforce.
  • Reduce unemployment and inactivity traps, decrease informality, and avoid propping up declining firms.
• Energy and climate:
  • Accelerate transition to renewables to reinforce energy security and meet climate targets.
  • Prepare for adverse winter scenarios, including a complete shut-off of Russian gas or further hydroelectric disruptions.
  • Return to market-based energy pricing to encourage efficiency, conservation, and faster renewable uptake.
  • Identify and resolve bottlenecks delaying renewable projects; avoid new long-term fossil fuel dependence in energy contracts.
  • Replace excise taxes on electricity with carbon taxes on input fuels to encourage renewable investment.
  • Amend the superbonus scheme: sharply reduce the subsidy component, limit eligible investments to those achieving significant energy efficiency improvements, and embed mandatory green standards into building codes.
• Economic fragmentation:
  • Assess and prepare for risks from global economic fragmentation by enhancing efficiency and productivity, identifying exposed products, and developing coping strategies.
  • Support EU-level solutions that preserve global integration benefits and multilateralism while accelerating the green transition to strengthen energy security.

Mission conducted May 8 – 23, 2023; statement issued May 26, 2023. The mission was led by Rachel van Elkan and comprised Apostolos Apostolou, Aleksandra Babii, Karina Garcia, Sylwia Nowak, Magali Pinat, and Sam Zhang.

References

• Italy and the IMF
• IMF Policy Advice -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home