The mission concluded that the emphasis should continue to be on comprehensive structural reforms to boost productivity and labour participation, a supportive fiscal strategy that is both growth-friendly and sustainable, and on steps to promote a more dynamic and resilient banking system.
Italy’s success also depends on progress at the European level to resolve the crisis and promote growth.
The risks to the outlook are tilted to the downside. Renewed financial turmoil could push government bond yields higher, tighten bank credit, and weaken activity. Slow progress in implementing needed fiscal and structural reforms could undermine confidence and raise concerns about Italy’s fiscal position. On the upside, a more robust global recovery or faster progress in reforms could boost market sentiment and activity.
The potential gains to growth from deeper structural reforms are substantial. IMF staff estimates suggest that product and labour market reforms that bring Italy closer to OECD best practices could increase the level of GDP by about 6 per cent over the medium term. The government has embarked on important reforms to deregulate the service sector and make the labour market more inclusive and flexible. Accelerating these reforms, and locking in now the necessary legislative and administrative changes, would strengthen confidence and create momentum for further reforms. Greater coordination at the EU level, especially in strengthening the single market for energy, transportation, and services, would also support Italy’s efforts in these areas.
The government has enacted an impressive fiscal package to improve the primary surplus. The package features significant and front-loaded consolidation; pension reforms to strengthen long-term sustainability; a modest shift from direct to indirect taxes (in support of a so-called “fiscal devaluation”); and more aggressive action against tax evasion. As a result of these measures, the primary surplus of the general government is expected to rise significantly, to above 4 per cent of GDP by 2013, the highest in the euro area.
The fiscal adjustment this year and next is appropriate. The sizeable improvement in the structural primary balance in 2012–13 will weigh heavily on growth but is critical for fiscal sustainability. The mission welcomes the increased focus on targeting a structural balance which adjusts for the economic cycle and allows fiscal policy to remain flexible in a more severe downturn. To bolster the recovery, the mission welcomes the government’s efforts to identify and implement the needed expenditure cuts to avoid an increase in the VAT rate later this year.
Shifting further the composition of adjustment towards expenditure cuts and lower taxes would better distribute the burden of adjustment, thereby supporting growth. Cutting government expenditure, such as the public sector wage bill or other areas identified in the on-going spending review; reducing Italy’s sizeable tax expenditures; and stepping up efforts against tax evasion would create space for growth-supporting measures. These measures could include: reducing the labour tax wedge to boost employment; raising the allowance for corporate equity to encourage investment; or financing a modest, well-targeted increase in public infrastructure investment. Staff estimate that a sizeable shift in the composition of adjustment could raise the level of GDP by 1 per cent over the long term.
The newly-adopted constitutional fiscal rule is an important instrument for strengthening fiscal discipline and policymaking. Adopting a binding multi-year expenditure framework and unifying and enhancing the role of spending reviews in the budget process would buttress the credibility of the fiscal rule. The fiscal council will be important in assessing fiscal developments and improving accountability, and should be set up fully independent in terms of staffing, funding and work agenda.
Locking in prudent fiscal policies over the medium term would improve confidence and support growth. Looking beyond 2013, the ongoing spending review should expeditiously identify further cuts to unproductive expenditure, and use some of the savings to reduce debt. With the debt-to-GDP ratio projected to decline only gradually, the fiscal position will remain vulnerable to market distress or an economic slowdown. To raise the buffer against such shocks, targeting a 1 per cent of GDP structural surplus from 2014 onwards as the medium-term anchor for the fiscal rule would put the debt ratio on a more robust downward path, even under adverse conditions. The credibility gains from a faster pace of debt reduction could lower borrowing costs significantly, especially once European market conditions stabilise.
The stock of outstanding public payments needs to be addressed. Completing quickly the stocktaking exercise to determine the size of pending and overdue payments at the central and subnational levels, along with a strategy for improving the reporting and timeliness of public payments, would strengthen expenditure control and accountability. Such a strategy should be complemented by improved coordination among all levels of government and continued incentives for fiscal prudence also at the subnational levels.
© International Monetary Fund
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