IMF NEWS

Two businessmen shake hands over a table. To lift potential growth, Italy needs to improve its business climate. (photo: Bob Burkany Cultura/Newscom)

Italy: Toward Growth, Social Inclusion, and Sustainability

February 6, 2019

A new government took office in Italy in June 2018 with the goals of jumpstarting growth, fostering social inclusion, and securing financial stability. To achieve these goals, the country needs a comprehensive reform package, alongside modest and balanced fiscal consolidation, the IMF advised in its annual review of the economy.

IMF Country Focus interviewed Rishi Goyal, the head of the IMF team for Italy, to discuss some of these reforms, the risks facing the economy, and the report’s overall findings.

The Italian economy shrank in the second half of 2018. How do you see Italy’s growth prospects going forward?

We project Italy’s economy to grow by 0.6 percent in 2019; the economy faces obstacles from slowing euro zone growth as well as from greater domestic policy uncertainty. This is reflected in the increase over the past year of sovereign borrowing costs. Beyond that, we project annual growth below 1 percent.

To lift potential growth and enable Italy to narrow the income gap with its euro area peers, as well as to facilitate a reduction in its high public debt, it needs to tackle long-standing structural impediments to productivity growth. This includes decentralizing the wage bargaining regime, liberalizing service markets, and improving the business climate.

The government intends to raise growth and assist the poor. What is your assessment of their initiatives?

The authorities’ intentions to lift growth and social inclusion are welcome, as real incomes per person are still at the levels of two decades ago, living standards of the middle-aged and young have eroded, and emigration of Italian citizens is near a five-decade high. They have recently reformed the insolvency regime and are seeking to raise public investment and improve the business climate. These are needed initiatives.

The government is also partially reversing past pension reforms by easing early retirement rules and introducing a new “citizenship income program.” On pensions, we are concerned that this would raise the number of pensioners, add to an already high pension bill, and lower labor force participation and potential growth.

The new citizenship income program is aimed at alleviating poverty and facilitating integration of beneficiaries into the labor market. Italy needs a modern social safety net targeted at the poor. We are concerned, however, that the level of benefits provided is very high when compared to international good practice. This could discourage participation in the formal workforce and increase welfare dependency.

Concerns about fiscal policy appear to have abated, following an agreement between Italy and the European Commission. Have fiscal policy concerns been addressed?

Late last year, the Italian government lowered its fiscal deficit target for 2019 to 2 percent of GDP, in part by delaying slightly the implementation of the reversal of pension reform and the citizenship income program. This contributed to assuaging market concerns. The government also committed to further reducing deficits going forward, but their strategy relies on large hikes to value-added tax rates that have been difficult to implement in the past.

Unless there is broad political support to adopt credible compensatory fiscal measures, deficits could increase, public debt would remain high, and the debt dynamics would be vulnerable to adverse shocks. Putting to rest concerns about debt sustainability will require modest, growth-friendly fiscal consolidation, alongside structural and financial sector reforms.

What specific policies do you recommend?

Faster potential growth is the only durable way to improve economic outcomes and enhance resilience. This requires a package of structural reforms, alongside credible fiscal consolidation and bank balance sheet strengthening:

• Structural reforms: the priority is decentralizing wage bargaining to align wages with productivity at the firm level, product and service market liberalization, and reforming public administration. These would lower Italy’s high structural unemployment and boost investment.

• Fiscal policy: undertaking a credible, growth-friendly, and balanced consolidation is essential to ensure debt declines firmly—by cutting current spending while modernizing the social safety net, increasing public investment, broadening the tax base, and lowering taxes on labor.

• Financial sector policies: the focus should be on continuing to reduce nonperforming loans, restructuring operations and improving profitability; consolidating and rationalizing smaller banks; building capital buffers that are effective in resolution; and improving governance.

Speaking of the banking system, how vulnerable are banks?

Considering the strong links between banks and the government, safeguarding fiscal stability is a pre-requisite for banking sector stability. As market action has shown over the past year, the cost of accessing wholesale funding by banks and their valuations have suffered as sovereign yields have risen.

That said, commendable progress has been made in reducing nonperforming loans and building capital buffers. Nonperforming loans have fallen from 16½ percent of loans in 2015 to below 10 percent. This is a notable reduction, although nonperforming loans remain high compared to the European average. Progress needs to continue in this area, as well as in improving profitability, so that the banking sector can fully play its role in supporting the economy.