Italy: Staff Concluding Statement of the 2024 Article IV Mission
IMF News, May 20, 2024
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Bibliographic details
- Published: May 20, 2024
Mission context and headline assessment
- Mission period: May 6 – 20, 2024; led by Rachel van Elkan with Aleksandra Babii, Aidyn Bibolov, Yan Chen, Gee Hee Hong, and Sylwia Nowak.
- Headline assessment:
- The economy recovered well from sequential pandemic and energy price shocks on the rebound in tourism and substantial policy support.
- Growth has moderated; expansionary fiscal policy has kept the deficit and public debt very high, elevating Italy’s risk premium and acting as a drag on private sector investment.
Recent performance and near-term outlook
- Key statistics and past performance:
- Activity expanded by 0.9 percent in 2023.
- Activity expanded by 0.6 percent (year-on-year) in Q1:2024.
- GDP surpassed its pre-COVID level by 4.5 percent.
- Drivers of recent performance:
- Exuberant spending on home renovations financed with generous tax credits.
- Ramp up in utilizing large EU-financed National Recovery and Resilience Plan (NRRP) resources.
- Other supports: publicly-guaranteed loans, energy compensation measures, pandemic-era transfers.
- Employment rose broadly in line with GDP, notably in services and construction, partly due to labor cost subsidies.
- Rapid and orderly disinflation led by the drop in energy prices; current account returned to surplus from a large, but temporary, deficit.
- Projections:
- GDP is projected to rise by 0.7 percent in 2024 and 2025.
- Headline inflation is projected to fall to an average of 1.7 percent in 2024 and return to the 2 percent target in 2025.
- Forecast narrative: NRRP-related spending (to be finalized by mid-2026) largely offsets phasing out of Superbonus-boosted residential investment in 2024–25; a temporary slowdown expected in 2026 and 2027 as NRRP is completed unless the allowable spending period is extended.
- Risks to the outlook (tilted to the downside):
- Intensification of regional conflicts causing new supply shocks and commodity price volatility.
- Spillovers from sharp slowdowns in major trading partners, geoeconomic fragmentation, extreme climate events.
- Significantly higher-than-expected interest rates leading to repricing of Italian government bonds and deteriorating public debt dynamics.
- Domestic risks: failure to complete NRRP spending, ineffective reform implementation, large fiscal deficits eroding investor confidence.
Fiscal policy — findings and recommendations
- Findings:
- Expansionary fiscal policy has supported recovery but kept deficit and public debt very high.
- Already-accrued tax credit liabilities will further add to debt in coming years.
- The primary deficit has decreased, but remains far from the pre-pandemic 1¾ percent primary surplus.
- A much higher primary surplus closer to 3 percent of GDP will be required to ensure a gradually declining debt ratio.
- Shift in 2024 to cash-based accounting for newly-authorized housing tax credits will—under a recent law—no longer allow transferability.
- Near-term recommendations (frontloading adjustment):
- Faster roll back of inefficient or temporary measures, including terminating housing renovation subsidies and measures to compensate for high inflation.
- Use simultaneous ramp up in NRRP spending and reforms to cushion activity while frontloading adjustment.
- Frontloading supported by benign global risk perceptions and buoyant tax revenues.
- Medium-term recommendations:
- Maintain a primary surplus of around 3 percent of GDP; consider additional fiscal effort to finance productivity-enhancing investments and address latent spending pressures, especially from aging.
- Considerable savings to finance growth- and efficiency-enhancing measures by:
- Replacing tax wedge cuts and hiring subsidies with measures that permanently boost labor productivity.
- Further streamlining pension spending by raising the effective retirement age and avoiding costly early retirement schemes.
- Rationalizing tax expenditures to broaden the base, increase progressivity and reduce complexity.
- Improving control and oversight of tax credits by requiring explicit prior authorization, monitoring real-time take up, and annulling tax credits absent full ex-post compliance with program goals.
- Budget process and fiscal governance:
- Move to a fully-fledged multi-year fiscal plan as required under the new EU governance framework to reconcile medium-term priorities with available resources.
- Require realistic macroeconomic and fiscal forecasts and robust monitoring and control systems to limit deviations from medium-term targets.
- Publicly-guaranteed loans should not substitute for on-budget spending; guarantees should be prudently managed, centrally monitored, well provisioned, and the stock of outstanding guarantees kept on a downward path.
Financial sector resilience — findings and recommendations
- Current position:
- Adjustment to tighter financial conditions proceeded smoothly; banking system remains sound.
- Policy rate increases quickly passed through to sovereign bond yields and bank lending rates.
- Widening interest margins and reduced need for loan-loss provisions pushed up bank profits; lower risk-weighted assets raised capital ratios to record levels.
- Significant decline in stock of credit to firms; some firms used cash buffers and current profits to accelerate loan redemptions.
- Banks maintain ample liquidity despite reducing most pandemic-era long term liabilities to the ECB; funding more expensive and competition for retail savings from government bonds has increased.
- Risks:
- Sustained high interest rates and declining liquidity buffers could weaken borrowers’ debt servicing capacity and lead to future weaknesses.
- Stability risks could rise as tightening cycle matures and effects of exceptional support measures wane.
- Policy recommendations to strengthen resilience:
- Use current exceptional net interest income to reinforce resilience by requiring banks to lock in a modest part of their existing capital headroom.
- The reserve accumulation option under the excess profit tax on banks is helpful but not calibrated to target systemic and individual bank risks.
- Recent increase in capital buffer requirement for “other systemically important institutions” and activation of a releasable systemic risk buffer are welcome.
- Ensure IFRS9 loan classification is sufficiently forward looking; discourage practice of replacing borrower default probability with guarantors’.
- Ensure banks’ funding mix includes adequate long-term liabilities to limit liquidity risk.
- Debt workouts and resolution:
- Strengthen mechanisms for debt workouts and disposals to prevent buildup of nonperforming exposures and reduce borrowers’ burden from legacy debt.
- Debt resolution and insolvency procedures should be less time consuming and costly; time to conclude court cases should be considerably shortened by streamlining and digitalizing procedures and adding support staff.
- Faster case turnover will raise absorptive capacity of secondary-market buyers, increase recovery rates, reduce warehousing of legacy claims, and speed cleansing of stressed borrowers’ accounts.
- Any scheme allowing borrowers to buy back at a lower price their previously-sold bad loans risks undermining the secondary market and eroding payment discipline.
- Focus on less significant banks:
- Continue strengthened supervisory and regulatory oversight of smaller banks.
- Encourage consolidation or mutual cooperation in areas such as digitalization to reinforce efficiency and resilience, provided sectoral and geographical concentrations are not increased.
Structural reforms and medium-to-long term growth priorities
- Overarching recommendation:
- Replace near-term demand stimulus focus with market-friendly support for medium- and long-term growth.
- Key priorities:
- Reinvigorate productivity through:
- Full and timely execution of the NRRP and a successor medium-term structural fiscal plan focusing on critical public infrastructure, research and innovation, education system reform, and improving the business climate.
- Investments in education reform and skill upgrading, and closing investment gaps.
- Diffusion of frontier technologies and deepening capital markets within the EU to diversify financing sources beyond traditional bank loans.
- Avoid frequent changes to tax and other policies; limit and target industrial policies where market failures exist.
- Labor force expansion and demographic policy:
- Address low fertility and low female labor force participation to boost growth prospects.
- Identify barriers that vary by region, family income, and individual characteristics; design well-targeted policies.
- Policy measures suggested:
- Make sufficient childcare capacity available and ensure childcare and school opening times are compatible with regular working hours.
- Remove policy-induced disincentives for female employment, including favorable tax treatment of single-earner families and minimum required lifetime social security contributions that deter formal employment.
- Increase transparency of gender wage differentials for comparable work and make parental leave gender neutral.
- Target financial assistance to poorer households and structure it to avoid discouraging women’s labor market participation.
- Acknowledge that reversing demographic trends is unlikely in coming decades, but well-designed policies may slow the declining birth rate and lift female participation.
Closing
- The mission expressed gratitude to the Italian authorities and private sector counterparts for their time, helpful discussions, and hospitality.
Source: Italy: Staff Concluding Statement of the 2024 Article IV Mission (May 20, 2024).