## 2012 Article IV Consultation with Italy - Concluding Statement of the IMF Mission

_IMF News, May 16, 2012_

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## Bibliographic details
- Published: May 16, 2012

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### 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.*

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## References

- [Italy and the IMF](http://www.imf.org/external/country/ITA/index.htm)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [Opening Remarks by Reza Moghadam](https://www.imf.org/external/np/speeches/2012/051612a.htm)
- [PRESS CENTER](http://presscenter.imf.org/)
- [Article IV](https://www.imf.org/external/pubs/ft/aa/aa04.htm)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/52/mcs051612_