2013 Article IV Consultation with Italy - Concluding Statement of the IMF Mission
IMF News, July 4, 2013
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- Published: July 4, 2013
Overview and main message
- The authorities took bold steps since the late 2011 crisis to strengthen public finances and transform the economy, but growth prospects remain weak, unemployment is unacceptably high, and market sentiment is still fragile.
- Accelerating reforms is essential to jumpstart growth and create jobs; Europe must also act to address financial fragmentation and strengthen the currency union.
- An IMF team visited Italy from June 24 to July 4, 2013, for the annual evaluation under Article IV. This statement describes the preliminary findings of staff.
A Difficult Recovery — current outlook and risks
- Economy:
- Growth is projected at -1.8 percent this year, before recovering to 0.7 percent next year.
- The recovery is expected to start in late 2013, supported by exports and a modest turnaround in investment led in part by the clearance of public arrears.
- Headwinds:
- Business and household confidence have picked up but have yet to lift activity and employment.
- Sovereign pressures and the pace of fiscal adjustment have eased this year, but financial conditions remain tight, restraining private spending.
- Downside risks:
- Policy slippages (including at the European level) could undermine market confidence, intensify funding pressures on banks, and tighten credit.
- A prolonged recession would increase banks’ nonperforming loans (NPLs), especially for SME and construction sectors, and raise fiscal concerns.
- A slowdown in emerging market economies or market turmoil could jeopardize an export-led recovery and push up sovereign and private interest rates.
- Medium-term growth:
- Italy’s low growth predates the euro zone crisis and reflects stagnant productivity, a difficult business environment, and an over-leveraged public sector.
- Comprehensive reforms are required to limit long-term unemployment risks, especially for youth, and raise trend growth.
I. Structural reforms to improve the business environment
- Key constraints identified:
- High entry barriers and regulatory hurdles, especially in services.
- High cost of electricity (up to 40 percent greater than in France and Germany).
- Lengthy and inefficient justice system linked to high business costs, low inward FDI, small firm size, and shallow capital markets.
- Specific reform priorities and recommendations:
- Product markets:
- Complete appointment of transport regulators, enhance competition in the electricity sector, and reform the legal profession quickly.
- Public services:
- Implement the privatization agenda, especially at the local level, and complete spending reviews to enhance public administration efficiency.
- Further strengthen the legal framework on corruption and ensure effective implementation.
- Judicial reforms:
- Continue court system reorganization, compulsory mediation, and backlog reduction.
- Conduct a comprehensive review of all court fees and align grounds for appeals with international practice.
- Employment:
- Close half the employment gap with the rest of Europe (some 4½ percentage points) could lift GDP by as much as 2½ percent by 2018.
- Improve coordination and efficiency of active labor market policies and employment services at the local level to support the youth guarantee program.
- Shift to a more flexible, single contract for new workers that gradually increases protection with seniority to lower hiring costs and support apprenticeships.
- Encourage firm-level contracts to better match wages with productivity.
- Lower the marginal tax rate for married, second earners to lift labor participation, noting women’s labor participation is 50 percent, one of the lowest in the OECD.
II. Fiscal policy — reducing vulnerabilities and supporting growth
- Fiscal stance and targets:
- Italy is set to reach its target of structural balance this year.
- Achieving one of the highest primary surpluses in the euro area last year strengthened credibility and confidence.
- Rebalancing adjustment to support growth:
- Accelerate payment of arrears, up to the amount of 40 billion euro over the next 12 months, to ease firms’ credit constraints.
- Continue efforts to legislate the Delega Fiscale to improve tax system efficiency.
- Rebalance composition of adjustment towards expenditure cuts and lower taxes:
- Spending reviews:
- Primary expenditure declined by nearly 2 percent in nominal terms over recent years.
- Implement a more comprehensive spending review starting with the 2014 budget to improve public spending efficiency and find additional savings to lower taxes.
- Broadening the tax base:
- Undertake spending reviews jointly with systemic review of tax expenditures.
- Maintain the property tax on primary residences for equity and efficiency; accelerate review of cadastral values.
- Step up efforts to combat tax evasion, including better use of anti-money laundering tools, and increase the inheritance tax.
- Lower marginal tax rates on labor and capital:
- Savings from above measures would help reduce the high tax on labor (4 percentage points of GDP higher than the euro area average) and raise the allowance for corporate equity returns (ACE) to spur investment.
- Public investment:
- Measures are being taken to speed up public infrastructure investment.
- If space allows, a modest, well-targeted increase in public infrastructure investment could catalyze private spending.
- Debt and fiscal buffer:
- Public debt ratio is projected to be significantly higher than a year ago, primarily due to the weak economy and clearance of public arrears.
- Authorities could consider gradually building a structural surplus buffer above the balance in the new fiscal rule after 2014—once recovery is firmly underway.
- Budget institutions:
- Strengthen credibility through binding multi-year expenditure ceilings.
- Set up an independent new Parliamentary Budget Office with professionally qualified board members from January 2014.
III. Banking sector — strengthening balance sheets and lending
- Recent developments and vulnerabilities:
- NPL ratio has almost tripled since 2007; provisioning coverage has declined.
- Lower sovereign yields have boosted trading gains, but core profitability remains weak as rising loan losses absorb nearly all operating profits.
- Bank credit continues to contract and lending rates remain high, especially for SMEs.
- Policies to accelerate NPL resolution:
- Enhance provisioning / write-offs:
- BoI inspections of 20 large and medium-size banking groups last autumn have arrested the decline in provisioning coverage; BoI intends to continue these measures.
- Expand inspections to more impaired and performing loans and smaller banks to strengthen provisioning further and prepare for the ECB/EBA asset quality review and stress tests.
- Publish general findings of inspections and guidance on provisioning to encourage convergence to best practices.
- Harmonize and strengthen prudential considerations in write-off practices to accelerate NPL disposal.
- Increase tax deductibility of loan losses:
- Allow full deductibility of new loan loss provisions and, as fiscal space allows, accelerate deductibility on old ones to encourage provisioning and write-offs.
- Expedite the judicial process:
- Expand specialized insolvency courts beyond Milan to reduce time in solvency.
- Increase reliance on on-line court filings and decisions to accelerate collateral foreclosure.
- Introduce best practice guidelines on workouts to encourage out-of-court restructuring.
- Capital, liquidity and governance:
- Italian banks have bolstered capital positions; the IMF FSAP stress tests found capital system-wide to be well above regulatory minima and sufficient for Basel III additional requirements.
- Given low profitability, extra capital buffers could be quickly depleted in an adverse macro scenario; targeted action to improve profitability and efficiency and strengthen capital plans where needed is recommended.
- Corporate governance:
- Foundations should implement proper governance frameworks, cap leverage, enforce strict disinvestment procedures, and strengthen fit and proper tests for bank directors and controlling shareholders.
- Encourage largest cooperative banks to convert to joint stock companies.
- Monitor Banca Monte dei Paschi di Siena’s restructuring plan closely and be prepared to act if it fails to meet targets.
- SME finance:
- Initiatives such as mini-bonds, lending support from the Cassa Depositi e Prestiti, and expansion of the Central Guarantee Fund have eased SME credit constraints.
- Monitor expansion of public credit guarantees and strengthen the fee system to limit moral hazard.
- Expand SME securitization and covered bonds, with potential ECB support through reduced collateral haircuts.
The role of Europe
- Complementary euro-area actions recommended:
- Direct asset purchases by the ECB, such as for SME credits.
- Another LTRO of considerable tenor and lower haircuts on eligible collateral to lower bank funding costs and lending rates.
- Greater progress on the banking union, especially the single resolution mechanism and ESM backstop, to help sever the sovereign–banking link.
- Moves to strengthen the common market, such as the Services Directive, to enhance cross-border benefits of reforms.
- The combination of European policy progress and vigorous Italian reforms would support a more vibrant and dynamic currency union.
Concluding Statement of the IMF Mission, July 4, 2013.