IMF Executive Board Concludes 2013 Article IV Consultation with ItalyPress Release No.13/362
September 27, 2013
Italy’s economy has been in recession for almost two years. GDP contracted by 2.4 percent in 2012, and at a similar annualized rate in the first half of 2013. The contraction was led by a sharp fall in domestic demand, reflecting tight credit conditions, fiscal adjustment, and depressed confidence. The unemployment rate is at post-war highs of 12 percent, with youth unemployment nearing 40 percent. Weak demand has also contributed to the narrowing of external imbalances. The current account deficit has declined from 3½ percent of GDP in 2010 to near zero in the first half of 2013, reflecting mainly a collapse in imports and steady exports.
A modest recovery is expected to start in late 2013, supported by net exports. After sharp declines in previous years, domestic demand is expected to recover slowly in the face of stiff headwinds from tight credit conditions. On this basis, growth is projected at -1.8 percent this year, before rising to 0.7 percent next year. Risks to the outlook are tilted to the downside, stemming mainly from potential policy slippages and banking weaknesses.
The lengthy recession and tight credit conditions have taken a heavy toll on Italian banks. The ratio of nonperforming loans has almost tripled since 2007, while outflows of nonresident deposits and limited access to wholesale financing have raised the cost of funding. Credit conditions remain tight and have depressed private spending as Italian banks have responded to pressures by keeping lending rates high and reducing loans to the corporate sector. Notwithstanding the weak economy, stress tests results suggest that the Italian banking system as a whole is able to withstand the losses under an adverse macroeconomic scenario.
The nominal budget deficit fell to 3 percent of GDP in 2012 on the back of sizeable fiscal adjustment, allowing the country to exit from the European Union’s Excessive Deficit Procedure, and is projected to be close to that level in 2013. In structural terms, the overall balance is projected to be near zero this year. Following the fiscal consolidation and the announcement of the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) framework in August 2012, sovereign yields have fallen considerably. Debt, however, continues to rise and is forecast to exceed 130 percent of GDP in 2013.
In the absence of further structural reforms, medium-term growth is projected to remain low. The origins of Italy’s low trend growth pre-date the crisis and stem from its stagnant productivity, difficult business environment, and leveraged public sector. The inefficient judicial system has also been linked to the high cost of doing business, low inward foreign direct investment, as well as the small size of firms and capital markets. Weak productivity has also contributed to Italy’s gradually widening competitiveness gap.
Executive Board Assessment
Executive Directors welcomed the important steps the authorities have taken to secure fiscal sustainability and implement structural reforms. The economy is showing signs of stabilizing but unemployment is still high and trend growth remains low. Against this backdrop, Directors stressed the need to maintain the reform momentum to sustain a robust recovery. These reforms should be complemented with steps at the euro area level to strengthen the currency union.
Directors commended the authorities on the substantial fiscal adjustment undertaken despite the difficult growth environment. This resulted in the achievement of one of the highest primary surpluses in the euro area and strengthened confidence and policy credibility. To protect these gains, Directors urged the authorities to identify measures to offset the revenue loss from the proposed repeal of the property tax on primary residences. They stressed the need to rebalance fiscal adjustment to support growth, by cutting expenditures and broadening the tax base in order to lower the taxes on labor and capital. Intensifying efforts to tackle tax evasion could also yield savings.
Directors considered it appropriate to target a structural fiscal balance in the near term while ensuring a continued commitment to meeting the nominal deficit target, in line with EU procedures. Most Directors agreed that over the medium term, after a firm recovery takes hold, building a buffer in the structural balance rule would reduce vulnerabilities from high public debt. A few Directors, however, saw merit in using a structural surplus to undertake growth-enhancing fiscal measures. Directors also noted that timely execution of the privatization agenda would help reduce debt.
Directors noted that Italy’s financial sector has weathered the shocks from the crisis in Europe and a prolonged recession. They welcomed the stabilization of the system and banks’ strengthening of capital buffers. As highlighted in the Financial System Stability Assessment, low profitability and weak asset quality remain the most pressing vulnerabilities, requiring adequate capital buffers and continued ECB liquidity support. Directors saw scope for encouraging further increases in provisions, including through improving their tax treatment, and reforming the judicial process to accelerate write-offs and support new lending. They also supported strengthening capital plans where needed, enhancing governance in certain parts of the system, and steps to improve bank profitability and efficiency. In addition, Directors considered that actions at the European level, including addressing financial fragmentation and implementing a banking union, would help to strengthen financial system resilience and reduce lending costs.
Directors welcomed the growth package and labor market measures passed during the summer, but emphasized that further reforms are needed to boost productivity and raise the employment rate, especially of youth and women. They encouraged the authorities to improve active labor market policies, simplify contracts, decentralize wage setting, and reduce the labor tax wedge. Directors also highlighted the key role judicial system reforms would play in improving the business environment.