Statement by the IMF Mission to Italy (Text)
Following is the text of the mission statement from the International Monetary Fund visit to Italy:
On July 9, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Italy.
Background Italy’s economy entered recession in late 2011. GDP contracted for a third consecutive quarter, by 0.8 percent quarter-on-quarter in Q1 2012, led by sharp falls in consumption and investment.
Exports also fell, along with the slowdown in global demand, but net exports contributed positively to growth due to sharp import compression. Household real disposable income continued to decline in 2011, and the unemployment rate reached 10.1 percent in May 2012, with youth unemployment at 36 percent. The external current account deficit narrowed from 3½ percent of GDP in 2010 to around 2¾ percent of GDP in the year to Q1 2012. Inflation increased to 2.9 percent in 2011, and further to 3.6 percent year-on-year in June mainly because of non-core components.
The economy is expected to continue contracting through the year owing to tight financial conditions, the global slowdown, and the needed fiscal consolidation. Absent shocks, the recovery will take hold in early 2013, led by a modest pickup in exports, but will lag the rest of the region. Inflation will ease only gradually, as the impact of weak demand is partly offset by higher indirect taxes.
The risks to the outlook are however on the downside, stemming mainly from an intensification of the euro area crisis. Over the medium term, low trend productivity and an aging society are likely to constrain Italy’s growth prospects. The steady loss in competitiveness over the past decade, if remained unaddressed, will remain a drag on growth.
The overall fiscal deficit continued to improve from 4.5 percent of GDP in 2010 to 3.9 percent of GDP in 2011, in line with the authorities’ target. In response to financial pressures in the second half of 2011, the authorities enacted three fiscal consolidation packages, bringing the total adjustment for 2012-14 to around 5 percent of GDP. As part of the consolidation, the pension system was strengthened further. In April, the Parliament approved a structural balanced budget rule in the constitution which is set to take effect in 2014 and legislated the creation of a fiscal council. Also, in April, the government embarked on a new spending review to identify expenditure cuts that would replace the need to increase VAT rates in October.
The financial turmoil has put banks under stress. Credit ratings for several banks were cut in late 2011 and again in 2012, and remain on a negative outlook. With limited access to wholesale markets and higher funding costs, Italian banks have relied heavily on Eurosystem support. Banks have made progress in strengthening their capital positions and raising private capital to meet their EBA targets. Gross impaired loans have risen to 11 percent in 2011, from less than 6 percent before the crisis, and banks’ exposure to the sovereign has also increased.
Higher funding costs and tighter lending standards, especially for smaller firms, have pushed up corporate borrowing rates. The government has embarked on wide-ranging structural reforms to boost productivity and potential growth. Important progress is being made in product market reforms. Parliament in March passed a comprehensive liberalization package that covered key sectors and strengthened the enforcement of competition rules. Administrative simplification reforms, which should lower the cost of doing business, were also approved.
Parliament has also passed a labor market reform bill aimed at making the labor market more inclusive and flexible. The bill promotes open-ended and apprenticeship contracts for young workers, makes unemployment insurance more universal, and facilitates hiring by reducing the cost of dismissal. Progress has also been made on strengthening the anti-corruption legal framework.
Executive Board Assessment Executive Directors commended the Italian authorities for launching an ambitious policy agenda to secure fiscal sustainability and promote growth. The economic and financial situation nevertheless remains challenging, with downside risks to the outlook. Directors emphasized the importance of maintaining strong policies and the momentum for reforms. To revive growth, priority should be given to raising productivity and labor participation, pursuing growth-friendly fiscal consolidation, and promoting a more dynamic and resilient banking system. Sustained implementation of this agenda needs to be supported by continued progress at the European level in strengthening the currency union.
Directors acknowledged the important steps taken towards deregulating the service sector and making the labor market more flexible and inclusive. They welcomed the passage of the labor market reform bill which promotes open-ended contracts and makes unemployment insurance more universal. Further action will be necessary to bridge the gap between permanent and temporary workers, raise female labor participation, and better match wages to productivity via greater wage setting decentralization. In the area of product markets, priority should be given to accelerating reforms in the energy and services sectors. Directors also encouraged the authorities to take steps to improve the investment climate and reduce the cost of doing business. They welcomed efforts to enhance the efficiency of the judicial system.
Directors commended the authorities for initiating a sizeable fiscal adjustment. They welcomed the increased focus on targeting a structural balance to ensure flexibility in fiscal policy. Directors encouraged the authorities to rebalance the adjustment towards expenditure cuts and lower taxes. The recently announced package of spending cuts is a step in the right direction. Directors looked forward to the swift follow-up on the ongoing spending review to help reduce the overall level of government spending and improve its quality. They saw scope for cutting the public sector wage bill, reducing tax expenditures, and stepping up efforts against tax evasion. This would create space for growth-supporting measures to reduce the labor tax wedge and encourage investment.
Directors emphasized that locking in prudent medium-term policies to reduce the high level of public debt would further improve confidence. They welcomed the important progress in the pension reform, the introduction of a new constitutional structural balanced budget rule, and the creation of the fiscal council. Directors saw the recent plan to sell public assets to reduce public debt as a positive first step and stressed the need to pursue more comprehensive privatization.
Directors recognized the strengths of the Italian banking system but concurred that banks need to maintain adequate capital and liquidity buffers to remain resilient to the downturn.
They noted that reducing impaired loans would free up resources for new lending and strengthen banks’ balance sheets. In this context, they saw scope for improving the efficiency of bankruptcy proceedings and out-of-court workouts to support corporate restructuring.
Statement by the Staff Representative on Italy Executive Board Meeting
July 9, 2012
This statement provides additional information on policy actions
in Italy since the Article IV mission complementing the staff
report (SM/12/152). The additional information does not change
the thrust of the staff appraisal.
Recent macroeconomic developments. Recent macroeconomic data point
to continued contraction in Q2 2012, in line with staff’s
projections. The unemployment rate came down from 10.2 percent in
April to 10.1 percent in May, reflecting a 0.3 percent increase
in employment. However, retail sales fell significantly in April,
bringing the annual decline to about 7 percent, and business and
consumer confidence indicators remained at low levels through June.
Bankruptcy and civil justice reforms and other growth measures.
A decree law on growth measures entered into effect on June 26.
It includes modifications to the bankruptcy regime, such as a new
tax provision on deductibility of losses which would facilitate
financing of companies in distress. In civil justice, the decree
aims to speed up the judicial process by streamlining appeals
procedures. In addition, the decree provides for favorable tax
treatment for project bonds to promote private-public partnerships,
extends tax incentives in infrastructure and construction, amends
the VAT regime for real estate leases and sales, and introduces
new debt financing instruments for non-listed companies to improve
their access to capital markets.
Bank recapitalization. On June 26, the Council of Ministers
approved measures to increase the capital base of Banca Monte
dei Paschi (MPS), Italy’s third largest commercial bank.
The state support of up to €3.9 billion, which includes a
replacement of €1.9 billion provided in 2009, will help MPS
meet the target of 9 percent core Tier 1 ratio as determined
by the European Banking Authority (EBA).
Labor market reform. On June 27, the parliament approved the
labor market reform law, largely in line with the government’s
proposal submitted in April. Among the modifications introduced
is the extension of tax incentives for firm-level bargaining,
a minimum remuneration for some temporary contracts, and some
increase in flexibility for firms to use temporary and
Statement by Arrigo Sadun, Executive Director for Italy July 9, 2012 1. Recent Developments Facing intensive pressure from financial markets as the European debt crisis intensified in the middle of last year, Italy had no choice but to enact multiple rounds of austerity measures that have impacted negatively growth and employment. Against this background, the top priorities of the new government are achieving a lasting consolidation of public finances and restoring growth by addressing its structural weaknesses. The domestic strategy founds its necessary complement in relentless efforts to promote an effective response to the debt crisis at the European level. The structural reforms introduced in the past few months and those planned will produce tangible benefits in the years ahead, but in the short term could hardly be expected to spur aggregate demand. Economic activity continued to contract throughout the first quarter of 2012, while a modest recovery is expected in the second part of the year. The recovery will be led by exports as domestic demand will continue to lag behind the business cycle.
Private consumption and investments should contribute positively to GDP growth in 2013 as the growth-dampening effects of the austerity measures wear off and real disposable income recovers.
Inflation in the first half of the year was somewhat higher than the European average; this reflected mostly the spike in energy prices and the increase in the VAT. However, core inflation remains at 2.2 percent because of sluggish demand and restrains in wage rates.
Wages in the public sector have been frozen for the past two years and have been significantly reduced for senior officers.
2. A Balanced Budget On fiscal policy, the goal is to balance the budget in structural terms and to put the debt on a declining path by 2013. The measures enacted in the last 12 months represent a fiscal adjustment of about 5 percent of GDP and they aim to reduce the deficit from 3.9 percent in 2011 to 1.7 percent this year and to 0.5 percent in 2013. In structural terms, the deficit is expected to decline from 3.6 percent in 2011 to 0.4 percent this year and to achieve a surplus of 0.6 percent in 2013. The principle of a balanced budget has been enshrined in the Italian Constitution, in line with the commitments undertaken in the framework of the European Fiscal Compact.
In the short term, the bulk of the fiscal adjustment is taking place through tax increases; however, efforts were made to make fiscal consolidation as growth friendly as possible.
Thus, the burden has been placed on consumption and property taxes. VAT rates were increased and a real estate tax abolished by the previous governments has been reinstated.
Conversely, taxes have been reduced for companies hiring new employees and on capital investments in order to support economic growth.
Further fiscal consolidation measures are expected through spending cuts; a comprehensive spending review has been launched with the objectives of reducing the overall level of government spending and improving its quality. The spending review broadens the efforts made in the past few years to curb current expenditures. Wages in the public sector have been frozen since 2010, while those of senior officials were cut by 10 percent.
Debt Reduction Despite challenging economic conditions, the government remains firmly committed to reducing public debt to a more manageable level through the achievement of consistent primary surpluses. A structural primary surplus of more than 1 percent was reached last year; this year, the authorities expect it to increase to well above 4 percent and to stabilize around 6 percent from 2013 onward. Accordingly, the debt should start to decline as of next year, one year ahead of the staff projections, and should reach the 114.4 percent level by 2015. It would not be the first time that the country managed to reduce the Debt to-GDP ratio despite very slow growth, thanks to sizeable primary surpluses. To accelerate the path of debt reduction, the government is also looking at the possibility of disposing of some of its most liquid assets, including stocks of state-owned companies.
New initiatives are also scheduled to establish companies, trusts, or real estate funds for the development and sale of public real estate properties. Obviously, its high debt level makes the country vulnerable to external shocks. However, the debt sustainability is ensured even under the relatively pessimistic assumptions used in the sensitivity analysis in the Stability Programme. In fact, assuming a 0.5 percent reduction in GDP growth or higher interest rates of 100 b.p. with respect to the baseline, the debt-to-GDP ratio is projected to decline by 2014 at the latest. It would take rather extreme assumptions such as the staff scenario of permanent no-growth and an increase in interest rates of 100 b.p. to push the debt toward 140 percent of GDP.
The Spending Review The need to frontload the fiscal adjustment has led to an increase in fiscal pressure; however, in the medium term, the goal of reducing public debt will rely increasingly on the reduction of current expenditure. Accordingly, the government has embarked on a comprehensive spending review that aims to reduce the overall level of government spending and to improve its quality, focusing on key areas. Thus, the previous approach of imposing linear cuts across the board has been replaced by an analytical assessment of needed resources. All areas of government spending are under review, with top priorities identified in the budget of key central agencies and local governments.
The Reforms Agenda Since the Reforms Agenda is supported by all major political forces, the government has been able to move expeditiously on a wide range of areas, starting with the completion of the Pension System reform. This will increase the retirement age to the highest level in Europe and it will ensure its sustainability in the long term. In June, Parliament approved a long-delayed reform of the labor market aimed at increasing productivity, creating more jobs, and ultimately boosting growth. The reform reduces some of the rigidities of the labor market as well as the disparities between overprotected traditional jobs and limited benefits for new entrants while providing for a universal unemployment insurance system. It also provides greater flexibility to employers to adjust working hours and employment levels according to the business cycle. These changes are balanced by the introduction of a universal unemployment insurance benefit to which all companies will contribute. Under the new scheme, unemployment benefits will be extended to a much larger segment of the workforce, including workers with relatively shorter tenures. The reform also introduces a faster, out-of-court procedure to handle labor disputes in case of dismissal for economic or other objective reasons. The reform also strengthens active labor market policies by facilitating youngsters to enter the labor force, by widening the use of apprenticeship contracts, and by retraining those who have lost their jobs.
Restoring Growth and Competitiveness Even before the global crisis hit hard the Italian economy, its performance had been lagging behind those of other European countries for more than a decade, as a result of a slow adjustment to the new international specialization of labor brought about by the globalization and deep-seated structural rigidities. Economic activity was hampered by deteriorated competitiveness and low productivity growth. The current government came to power last winter with the double mandate of addressing the fiscal crisis with urgent measures and of implementing long-delayed structural measures necessary in order to boost both growth and employment. Some of the reforms that aim to streamline and modernize the Pension, Judicial and Administrative Systems are also expected to improve the efficiency of the economy. Specific measures to boost growth have recently been submitted to Parliament in the so-called “Sviluppo Italia” package. These include initiatives to improve the business environment (a reduction of the tax wedge on labor, notably in the case of employment of women and young workers; the re-funding of the guarantee fund for SMEs; the simplification of the incentives scheme for enterprises; the redesign and extension of tax incentives on building renovations and energy efficiency investments; and the introduction of substantial tax benefits for companies’ recapitalization).
A wide array of measures has been introduced to increase competition in key product and services markets, including the liberalization of professional services, the distribution sector, the transportation sector, and the network industries. Of particular importance are the planned liberalizations in the energy sector with the breaking-up of the vertically integrated cartel in the gas and electricity sectors.
The government is seeking to expedite investment in key infrastructure projects by facilitating the participation of private capital in public investment, by reducing the administrative burden, and by coordinating regional programs co-financed by EU structural funds. Furthermore, in order to ease the financial pressures of government suppliers, measures have been taken to accelerate the disbursement of approved payments.
The Financial Sector Throughout the global and debt crisis, the Italian banking system has remained broadly resilient, reflecting a sound business model (retail funding accounts for about 85 percent of the total bank loans), prudent risk management practices, and effective supervision. Italian banks faced the crisis without the over-extended leveraging of most of their peers and without large exposure to inflated real estate markets or Program countries. However, two recessions in three years and the intensification of the European debt crisis last summer have taken their toll; access to wholesale markets deteriorated and funding costs rose in the second half of last year. Credit growth declined and the quality of loans worsened.
Funding pressures have eased considerably in recent months as result of the ECB LTRO operations. For the 32 banking groups covered by the weekly liquidity monitoring by Banca d’Italia, LTRO funding is sufficient to meet in full those bonds held by institutional investors that come due in the next two years.
During 2011 Italian banks have significantly strengthened their capital base, mostly by tapping private markets. For the five largest banking groups (covering about 70 percent of total consolidated assets), the core tier 1 capital ratio increased from less than 6 percent in 2007 to 9.5 percent by March 2012; this compares to an average of slightly above 10 percent for the euro area.
To meet the EBA Recommendations, four of the largest banks have strengthened their capital position by about €15 billion by the end-June. Half of this amount has been raised by the largest bank through the issuance of new equity; the rest by a combination of measures, including asset disposal, retained earnings and, in one case, by issuing recapitalization bonds subscribed by the government.
SOURCE: International Monetary Fund
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