Transcript of a Conference Call on the 2012 Article IV Consultation with ItalyWith Aasim Husain, Deputy Director, European Department
Kenneth Kang, Advisor, European Department
Tuesday, July 10, 2012
MS. NARDIN: Good morning and welcome to this conference call on the release of the Staff Report for the 2012 Article IV consultation with Italy. My name is Simonetta Nardin, from the External Relations Department of the IMF. I'm here with Aasim Husain, who is Deputy Director in the European Department, and Kenneth Kang, who is an advisor in the same department. They will offer introductory remarks on the Staff Report, and we will then open it up for your questions.
MR. HUSAIN: Thank you, Simonetta. With broad political support, the Italian government has embarked on an ambitious and wide-ranging reform agenda. The fiscal adjustment and growth-enhancing measures that are underway have been critical in saving Italy from the difficulties and financial market turmoil that surfaced late last year.
But the program of adjustment and reform has only just begun, and a lot remains to be done to revive growth and restore dynamism to the economy. Just as the challenges of anemic growth and high debt did not build up overnight, so too should the solutions not be expected to magically fix all the difficulties right away. The important thing is to move forcefully and expeditiously to implement the reform agenda.
The emphasis should continue to be on comprehensive structural reforms to boost productivity and labor participation, a supportive fiscal strategy that is both growth-friendly and sustainable, and steps to promote a more dynamic and resilient banking system. And, of course, Italy's success in reviving growth and economic dynamism will also depend a lot on progress at the European level to resolve the crisis and promote growth. Let me now turn it over to my colleague Ken, who will tell you more about the work that we have done.
MR. KANG: Let me describe the report itself. Building on the progress that has been done, the focus of this year's Staff Report is on "An Agenda for Reviving Growth."
First, on structural reform, as you know well, the difficult business environment, limited competition in the service sector, fragmented labor market, and high energy prices are among a number of factors that have held back Italy's growth. Addressing these bottlenecks will be crucial to reviving growth and alleviating the social costs of the crisis.
Here, we believe that the potential gains from deepening structural reforms are substantial. The team has done some analysis, featured in an accompanying paper in the "Selected Issues," as well as in Box 3 of the Staff Report, showing that products in labor market reforms that bring Italy to the median of OECD countries' beset practices could raise the level of GDP by about 6 percent over the medium term -- a significant payoff from reform. Here, the government has made important progress in passing the labor market reform bill, which will reduce business uncertainty, and encourage new hires.
More, though, can be done to expand employment. The gap between permanent and temporary workers remains high, making it difficult for new entrants to find jobs. Here, we recommend allowing for more flexible, open-ended contracts for new workers that would gradually increase employment protection over time. This would be particularly well suited for young workers entering the labor force.
At the same time, there is a need to increase labor participation, especially for women. Female labor participation rates in Italy are around 50 percent, one of the lowest among advanced economies. Improving child care and maternity support, and lowering the marginal tax rate for working spouses would encourage more women to join the labor force.
In the area of product market reform, we would place a priority on accelerating reforms in the energy, local public and professional services sectors, which have the broadest impact on growth. For example, electricity prices in Italy are some 50 percent higher than the European average.
Completing the government's plan to separate the ownership of gas distribution and production this year would improve competition, and eventually drive down energy prices.
Small and medium-size enterprise reform is another important area. SMEs are the backbone of the Italian economy, but face difficulties in growing. Improving access to financing, and streamlining tax and other regulations would help companies to be a source of jobs and innovation in the economy.
Let me turn to fiscal policies, and ways to make adjustment more growth friendly.
Fiscal consolidation is an area where considerable progress has been made. If the authorities' fiscal plans are implemented, Italy will have over a 4 percent of GDP primary surplus next year -- the highest in the euro area. The fiscal stance this year and for next year is appropriate, and we welcome the shift to targeting a structural balance which will allow fiscal policy to remain flexible in a more severe downturn.
We believe, though, that within this plan there is scope to re-balance the composition of adjustments to make it more growth-friendly. Here, we would place priority on the spending review that is underway to cut government expenditures. The government has taken the important first step of outlining around 26 billion euros in spending cuts through 2014. The review should continue to identify further cuts, and use the savings to lower the tax on labor to create jobs, and raise the allowance on corporate equity to encourage investments.
Finally, Italian banks have a number of strengths, including their large and stable retail deposit base, and low leverage. To ensure that banks continue to provide lending support to the economy, banks need to maintain adequate capital and liquidity buffers.
Here, supervisors should encourage banks to meet their capital needs by raising equity, or disposing of non-core assets, rather than by cutting loans. Non-performing loans are also high and rising, tying up resources that could be used for new lending. The buildup of bad loans on banks' balance sheets reflects, in part, an efficient legal process that can take, on average, eight years to complete bankruptcy procedures. Streamlining bankruptcy processes, and promoting more out-of-court workouts would provide banks with strong tools to address impaired loans. This could, in turn, foster a private market for restructuring distressed assets, which, in other countries, have proved useful in helping address their problem loans.
Let me start again by emphasizing again that the key for Italy is to continue pressing ahead with its reforms across several fronts, in order to maintain confidence, and lay the basis for a strong revival of growth.
QUESTIONER: It looks like that, in the debt-sustainability scenarios, you paint a picture where Italy’s debt dynamics really seem kind of on the brink, aren't they? You talked about a 100-basis-point change, and a 1 percent difference in growth really pushing this off track. I'm just wondering if you could give us some sense of the tolerance limits here. Aren't they kind of on the verge of a bigger problem? It sounded that, in fact, the rise in rates in recent months is already showing up in their budget -- if I read that correctly.
MR. HUSAIN: First of all, the rise in interest rates that we have seen over the past year, and sort of the outlook for high rates, is already embedded in the baseline debt sustainability analysis. What you point to, in terms of the shocks that we've applied and the idea of how they affect Italy's debt dynamics, the fact of the matter is that that is very high, and that is the key vulnerability. Debt sustainability analysis is very important.
Now, as to the shock -- this 1 percent decline in growth, 100-basis-point increase in spreads -- those are, I should emphasis, sustained shocks -- A sustained cut in growth, and a sustained increase, above and beyond current levels. It's not just a temporary shock that we're looking at. You need to see it in that light.
QUESTION: But it seems, given what's happened, that's not at all beyond -- I mean, if anything the last two years has taught us, it's that these downside scenarios tend to be realized.
MR. HUSAIN: And that's certainly why one looks at shocks, and so forth, that shocks can and do happen. I will let you interpret, yourself, the likelihood of sustained shock stretching many years of those magnitudes. From our perspective, we do this, you know, in terms of adverse scenarios and extreme scenarios.
I would just point out that in our baseline scenario, where our growth forecasts are already on the pessimistic side, we expect growth to be negative this year. Given the sizable primary surplus that the government has already generated, public debt ratio will peak next year, and then it will be on a downward path thereafter. That is quite an impressive achievement, for a country to maintain such a sizable primary surplus, and that is an important factor in the downward trend in the public debt ratio.
The debt sustainability analysis, it's a scenario analysis. It looks at changes outside the baseline. And we would view these as low probability events taking place. I think, also, for that reason we do focus on, in the Staff Report, on the need to implement fully the government's plan not just to strengthen the medium-term framework, the adoption of this new constitutional balance rule will help strengthen the fiscal discipline, and ensure that -- I think, promote the effectiveness of fiscal planning in the future.
QUESTIONER Mr. Kang, can you specify the financing needs of the government for the rest of the year, and how much of that is already settled by the government? And the second question is, you have this interesting analysis about the flight of foreign capital from Italy. This is Box 5 in the Selected Issues Paper. The analysis ends somehow at the end of February, or sometimes in the first quarter. I'm just wondering whether you can give your impression: Has this flight of capital stopped, or is it going on -- of foreign capital? And how do you expect it's going to develop in the future?
MR. KANG: On your first question, the government, to date, has met over 50 percent of its financing needs for the year. The auctions so far have met with fairly decent demand. And the government has passed the peak of its redemptions, which should fall off in the coming months, in the summer.
Now, on your second question, about the box which outlines the changes in the investor base for the government bonds, yes, it's true, non-residents have been withdrawing, have been reducing their exposure to Italian sovereign debt. We don't have any more updated information, since the publication of the Staff Report, on changes in investor behavior. But the fact that the auctions to date have gone fairly smoothly, the bid-to-cover ratios have been fairly high, suggests that there is still demand for Italian government bonds. Now, of course, some of that is coming from domestic investors. To the extent that recent demand is from the non-residents, it's difficult for us to say without more up-to-date data.
QUESTION: The government’s projected fiscal deficit is for 2012 is 2.0 percent of GDP, while the IMF foresees it as 2.6 percent of GDP. Could you average about the difference of fiscal deficit?
MR. HUSAIN: I think the difference stems mainly from our somewhat more pessimistic outlook, in terms of GDP growth. The denominator in the deficit accounts for the difference. But I think the important thing to emphasize is that, actually, Italy will have the highest primary surplus -- that is the deficit-excluding-interest bill -- in the entire euro area this year, based on our projections, and even more so next year.
QUESTIONER: I note in the report that you talk about analysts' worries over the political uncertainty that will follow the technocrat government, once its mandate expires early next year.
Is it usual for the IMF, in its Article IV consultations, to comment on political developments like this? And could you elaborate on that?
MR. Husain: What we have pointed to in the report is the importance of political, parliamentary, and public support, for the reform process. What is striking is that the widespread support that the Monti administration has enjoyed since it has been in place since late last year.
This has led to the passage of very significant reforms that are outlined in the report. And the key will be, going forward, continued implementation -- forceful and expeditious implementation -- of these reforms. Obviously, to the extent that public support weakens -- and one reason for that might be as economic conditions weaken -- then this will become more challenging. So far, though, we're seeing, even in sort of recent weeks, passage of significant measures. The labor reform went through, I believe, just about 10 days ago. And two weeks prior to that, the significant growth measures were also announced.
So the public support is still there. It is important that it remains there, and that the reform process continues to be consultative, and to garner that support.
QUESTIONER: I noticed that you mentioned, or the team mentions in one of its detailed items, that greater regional differentiation of salaries in the public sector would help the same process occur in the private sector, and would be good for Italy's job growth, productivity gains, and so forth. And it was noted that the government considers that politically challenging. The recent labor reform doesn't cover public servants. I was wondering if you had anything more to add on that, given that Italy's large public servant -- has a large number of public servants, they're rather well paid, and they tend to be older, and any effort to shed them might actually raise the pension bill.
MR. KANG: The point about greater wage differentiation of public wages across the region in the Staff Report is that , given that in some regions, as you've pointed out, the public sector does account for a significant share in the economy, public wage-setting would have an important impact on how private wages are set. Allowing for public wages to adjust to productivity, to the various changes in the cost of living, for example, would promote more flexibility in private wage-setting as well.
Now, we discussed this issue with the authorities in Rome, and their point is that to make this change would require a broader reform of local government -- the relationship between local governments, national government. This would be tackled in subsequent reforms, looking at public employment. We expect more details of this program in the coming months.
QUESTIONER: I just wanted to get a little comment, if I could, on the banking situation there. You note that the government is relying ever more heavily on the banks to buy its bonds, to lend it money, at the same time that the non-performing loans (NPLs) are going up faster because of the economic situation. It seems reminiscent of the dynamic you've seen in other countries that have gotten into trouble. I am wondering if you have any thoughts about whether this is heading down the same path as Spain?
MR. KANG: As we mention in the report, Italian banks do benefit from a number of important strengths. They have a very large and stable retail deposit base, and a very low degree of leverage, and a traditional banking model that's helped them to avoid some of the excesses that other banking systems faced from this global financial crisis.
That being said, the report does point out that the NPLs in Italy are high and have been rising, and much of that is due to this very inefficient legal process, where it takes a considerable amount of time for banks to address their problem loans. Because of the inefficient legal process, it can take up to eight years for banks to resolve distressed assets. This is unfortunate, because it does tie of resources that banks could use to extend new loans in support of firms.
It is important that in our forecast, as you know, we have growth declining this year, and growth remaining weak next year, as well. And banks, because of their high NPLs are exposed to the economic downturn. Therefore it's important that banks develop strategies for reducing their NPLs -- not just to free loans, but also to improve the quality of balance sheets and core profitability.
QUESTIONER: I just wanted to have a judgment from your part, Monti has been criticized to have slowed down on reforms lately. Now, as you also said, he had realized the labor reform, and now he presented the spending review. Is he back on track now? Is he doing enough?
MR. HUSAIN: I think the important thing to emphasize is that this is a process that is not going to be done in week or a month. This is a process that's going to take quite some time. Just as the challenge of high debt and stagnant growth took a while to build up, resolving that challenge will take a while, as well.
The steps that were taken initially were very big and very bold. Starting in January, the authorities have engaged in a broad consultative process to define and then to implement their reform agenda. They are continuing to take important steps. But I think the thing to remember is this is a process that must continue, and must continue forcefully and expeditiously if it is going to succeed.