1. The economy is in the third year of a moderate recovery.
It has been helped by the government’s policy and reform efforts,
exceptional monetary accommodation, and low commodity prices. Unemployment
and nonperforming loans (NPLs) have declined somewhat from their
crisis-driven peaks. Public debt has stabilized, albeit at a very high
level. However, weak productivity and low aggregate investment remain key
challenges for faster growth, held back by structural weaknesses, high
public debt, and impaired bank balance sheets. Despite some improvement,
further progress in reducing vulnerabilities and raising real incomes will
require enhanced policy efforts. A decade after the global financial
crisis, real disposable incomes per capita remain below pre-euro accession
levels, while the burden of the crisis has fallen disproportionately on
younger generations.
2.
The recovery is expected to continue, but risks ahead are significant.
Growth is projected at about 1.3 percent this year. As favorable
tailwinds—terms of trade, fiscal and monetary policies—become less
supportive in the coming years, growth is projected (on current policy
settings) to moderate to around 1 percent in 2018–20. Growth could surprise
on the upside in the near term, including from a stronger European
recovery. Nevertheless, downside risks are significant, related among
others to financial fragilities, political uncertainties, possible setbacks
to the reform process, and re-evaluation of credit risk in the course of
monetary policy normalization. Uncertainty about U.S. policies and Brexit
negotiations add to these risks. Under a moderate growth outlook, real
income per capita is expected to return to pre-crisis levels only several
years from now, and Italy would diverge further from its euro area peers.
3.
The key priorities are to raise growth, increase economic resilience,
and protect the vulnerable.
The overarching challenge is to boost productivity, which requires more
ambitious policy efforts and broad and sustained political support. In a
complex economic and political environment, the authorities have advanced
important reform initiatives, which have succeeded in jumpstarting the
recovery and broadly stabilizing imbalances. Further steps are now needed
to narrow competitiveness gaps with euro area partners, reduce imbalances,
and raise incomes including for those being left behind. The current
backdrop of cyclical recovery and exceptional monetary accommodation
provides a favorable, if narrowing, window to press ahead urgently with
reforms.
Structural reforms
4.
Ambitious and comprehensive structural reforms will help foster
stronger growth.
These should build on the authorities’ recent efforts that include the Jobs
Act, decrees to modernize the public administration, measures to accelerate
insolvency and debt enforcement procedures as well as civil justice, and an
education reform to improve school outcomes. Further reforms include
enhancing competition in product and service markets, improving wage
bargaining to align wages with productivity at the firm level, and
broadening public sector reform.
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Liberalizing product and service markets.
Regulatory barriers to competition remain notable in sectors such as
network industries, professions, and local public services.
Notwithstanding a requirement to legislate annually measures that would
promote competition, no law has yet been approved and a draft law has
been in parliament for over two years. This draft, aimed initially at
an ambitious overhaul of barriers, includes pro-competition measures in
sectors such as communication and energy. However, during discussions
in parliament, it has been weakened in some areas, such as insurance
and professions, and introduces restrictions in tourism. Strengthening
the draft in line with the recommendations of the competition
commission, adhering to the requirement of legislating annual
pro-competition laws, and enhancing the authority to sanction
anti-competitive practices would help improve efficiency, productivity,
and investment.
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Reforming labor markets.
Wages have grown persistently above productivity under the sectoral
wage bargaining framework, hindering job creation, competitiveness, and
investment. Efforts to strengthen second-tier firm-level bargaining
have not been effective in reversing this dynamic, owing in part to
legal uncertainties and low levels of cooperation in labor-employer
relations. Consideration should therefore be given to strengthening the
collective wage bargaining system to better align wages with
productivity at the firm level. This includes giving clear primacy to
firm-level contracts, strengthening opt-outs from collective
agreements, and introducing a minimum wage, possibly differentiated
across regions. Other measures to strengthen labor market functioning
include reducing the tax wedge on secondary earners, increasing
spending on active labor market policies, and extending the new Jobs
Act contract to all open-ended contracts in the private sector.
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Modernizing the public sector.
Following the 2015 framework law to reform the public administration,
important implementing decrees were issued, such as to simplify
procedures and accelerate decision making. But some key actions have
been delayed, such as on improving public sector management and
regulating local public services (except transport), or weakened, such
as on rationalizing state-owned enterprises. Broadening and completing
public sector reform are important to raise productivity, lower the
cost of business, and enhance the gains from other reforms. Measures
are also needed to improve the skill mix of the public sector, widen
the scope of procurement reform, and tackle privileges and employment
in public enterprises, including through privatization and cuts in
subsidies. Monitoring outcomes is essential.
Financial stability
5.
Accelerating the repair of bank balance sheets will strengthen
financial stability and support intermediation
. Encouraging progress is being made, market pressure on banks has eased
recently, and credit supply conditions are improving. This reflects, inter
alia, important actions taken regarding strengthening the capital buffers
of some large banks and plans for sizable NPL sales, procedures initiated
for the precautionary recapitalization of some weak banks, and bank
consolidation. The Single Supervisory Mechanism has also issued guidance to
significant institutions to tackle NPLs. Complementary measures can help to
accelerate addressing the weak asset quality and profitability problems, so
that vulnerabilities do not linger and monetary transmission is repaired.
These include: improving the capacity to materially tackle NPLs, enhancing
banks’ operational efficiency, addressing weak banks, and fully aligning
governance rules to EU standards.
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Resolving NPLs.
(i) Oversight: banks’ NPL reduction strategies and targets
need to be ambitious and credible, aided by supervisory assessments of
banks’ capacity to resolve NPLs in a realistic and timely manner. Banks
with weak internal capacity should be required to take the necessary
actions, such as engaging specialist collection and workout firms, to
achieve their targets. NPL guidance should be extended to less
significant institutions. (ii) Effective insolvency procedures
: progress in accelerating corporate insolvencies in practice has been
limited. The authorities’ plans for a comprehensive insolvency overhaul
can rationalize the present complex framework and address shortcomings.
It should be adopted, maintaining ambitious steps for corporate
restructuring. Implementation requires considerable efforts to improve
court functioning and develop uniform practices. It should be
complemented with more intensive use of out-of-court restructuring.
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Enhancing efficiency.
(i) Rationalization: elevated operating costs weaken
banks’ ability to generate capital through retained earnings. The
supervisor should seek to ensure—through intensive and assertive
supervisory challenges—that banks have realistic and coherent business
model assumptions, so that capital destructive practices are
recognized, streamlined, divested, or closed. (ii) Consolidation: consolidation of Italy’s fragmented banking
system is planned and can help increase efficiency. Three new banking
groups are expected to emerge by end-2018 from the consolidation of
over 300 cooperative banks. Supervisors should ensure that these groups
start with a clean bill of health, are well governed, and profitable
over the long term. This involves undertaking an asset quality review
of the emerging groups and ensuring robust governance and risk
management structures. Issues identified in the process could be
followed up in the remaining smaller banks as well.
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Addressing problem banks.
Finding timely and low cost solutions to problem banks has proven
difficult. This is due in part to the need to clarify expectations and
processes of the new bank recovery and resolution framework, the
complex coordination challenges across multiple authorities both at the
national and the EU levels, and concerns about resolving banks and
applying bail-in. These issues should be addressed. For problem banks,
swift recapitalization or the timely and effective use of the
resolution framework is essential to avoid weaknesses from lingering
too long, burdening the rest of the system, and threatening stability.
Where burden sharing or bail-in is required, protection should be
provided for vulnerable households. Any cases of mis-selling should be
addressed by the regulatory and supervisory authorities as well as the
banks.
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Improving governance.
Legislative gaps in Italy’s implementation of the EU fit and proper
rules for bank management should be closed.
Fiscal sustainability
6.
The ongoing recovery and improving financial conditions provide a
favorable backdrop to implement the needed fiscal adjustment.
High public debt leaves Italy exposed to shocks, with little room to
respond and at risk of a sharp, pro-cyclical correction. A gradual
adjustment, as announced in the authorities’ multi-year budget plans in
April and aiming for an overall deficit of 1.2 percent of GDP in 2018 and a
broadly balanced budget by 2019, is appropriate to ensure debt is on a
firmly declining trajectory. Thereafter, a small
structural surplus of about ½ percent of GDP would provide valuable
insurance for a declining debt path against shocks. In line with this,
utmost priority needs to be placed on permanent, growth-friendly measures
to underpin the consolidation.
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Revenue rebalancing.
Tax rates on productive factors could be lowered gradually, taxation
shifted toward properties and consumption, and the tax base broadened.
VAT policy and compliance gaps are among the highest in the euro area;
reducing these gaps, together with lowering further the labor tax
wedge, would support jobs and growth. The reform of cadastral values
should be accelerated and a modern real estate tax introduced. A
comprehensive rationalization of tax expenditures and stronger
enforcement of collections would enhance the design and efficiency of
the tax system. Reducing tax uncertainty would improve the investment
climate.
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Spending measures.
Notwithstanding efforts in recent years, further steps are needed to
reduce current spending, albeit with targeted support for the
vulnerable. This includes fully implementing procurement reform and
improving the efficiency of health spending. Italy has done more than
most to put its pension system on a firm footing. Nevertheless,
consideration should be given to reducing the high levels of pension
spending over the medium term, so as to address fiscal pressures that
would persist before the savings from pension reforms materialize over
the very long run. Pockets of excesses exist in the pension system that
need to be rationalized, related not least to the grandfathering of
generous benefits. Pension parameters could also be reviewed and
adjusted as necessary, consistent with current policy settings. On the
other hand, the share of transfers to those with low incomes is the
lowest in the euro area. Targeting should be improved, social
protection programs rationalized, and the income inclusion program
expanded into a universal anti-poverty scheme.
The mission would like to thank the authorities and other interlocutors
for their time, helpful discussions, and hospitality.
