EN Official Journal of the European Union C 142/13

COUNCIL OPINION

on the updated stability programme of Italy, 2009-2012

2010/C 142/03

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty on the Functioning of the European Union,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 26 April 2010 the Council examined the updated stability programme of Italy, which covers the period 2009 to 2012.

(2) While the low indebtedness of the household sector and a relatively solid financial sector have provided some shelter from the global financial crisis, deep-seated structural weaknesses giving rise to unsatisfactory productivity growth had weakened the Italian economy long before the global downturn. After having contracted for five quarters, GDP rebounded in the third quarter of 2009, but declined again slightly in the fourth quarter. The recession has taken its toll on the labour market with a lag: in 2009, its impact materialised more in terms of hours worked than of headcount employment, with many workers, in particular in the hardest hit manufacturing sector, accessing the wage supplementation fund to complement their salary for the fewer hours worked. The government's policy response to the crisis was adequate in view of the very high government debt, in a context of increased risk aversion. Since the last quarter of 2008, the government approved several measures to shore up the stability of the financial sector, restore confidence and offer relief to distressed firms and households. According to the government's estimates, the recovery measures were fully financed by redeploying existing funds and increasing revenues, with no effect on the deficit. Notwithstanding the government's prudent fiscal stance, the impact of the economic downturn on the Italian public finances has been significant. The government deficit ratio doubled between 2008 and 2009, to 5,3 % of GDP (confirmed in the statistical office's estimate released on 1 March 2010). This, in conjunction with the very high government debt ratio, led to the Council deciding that Italy was in excessive deficit on 2 December 2009, with a deadline for the correction of this situation by 2012. Besides fiscal consolidation, which is a condition to keep public finances on a sustainable path, the key challenge for Italy's economic policy in the coming years will be to foster a swift and durable recovery in productivity growth so as to restore competitiveness and raise the country's low potential GDP growth. Far-reaching structural reforms are key to addressing the productivity challenge. In addition, restoring competitiveness in the short term also requires ensuring that wage developments are better aligned with productivity developments.

(3) Although much of the observed decline in actual GDP in the context of the crisis is cyclical, the level of potential output has also been negatively affected. In addition, the crisis may also affect potential growth in the medium term through lower investment, constraints in credit availability and increasing structural unemployment. Moreover, the impact of the economic crisis compounds the negative effects of demographic ageing on potential output and the sustainability of public finances. Against this background it will be essential to accelerate the pace of structural reforms with the aim of supporting potential growth. In particular, for Italy it is important to undertake reforms in the areas of market competition, business environment, quality of public services and labour market functioning, including the reallocation of social expenditure towards a more comprehensive and uniform unemployment benefit system.

(4) The macroeconomic scenario underlying the programme envisages that real GDP will return to positive growth of 1,1 % in 2010, from – 4,8 % in 2009 (– 5 % according to the statistical office's estimate released on 1 March 2010), and accelerate to a rate of 2 % over the rest of the programme period. Assessed against currently available information (2), this scenario appears to be based on favourable growth assumptions. The programme's projections for inflation appear realistic. The projections for employment growth and the unemployment rate are more favourable than in the Commission services’ autumn 2009 forecast, consistent with the programme's higher real GDP growth projections.

(5) The programme estimates the general government deficit in 2009 at 5,3 % of GDP. The significant deterioration from a deficit of 2,7 % of GDP in 2008 reflects to a large extent the impact of the crisis on government finances. Several recovery packages were adopted in line with the European Economic Recovery Plan (EERP), together amounting to around 0,7 % of GDP in 2009 and, according to the authorities, fully financed by redeploying existing funds and additional revenues. According to the programme, fiscal policy is planned to turn mildly restrictive already in 2010, and more significantly so in 2011 and 2012, with a view to correcting the excessive deficit by 2012. This is broadly in line with the exit strategy advocated by the Council, also taking into account the very high government debt ratio.

(6) For 2010 the programme plans a 0,3 pp. of GDP reduction in the general government deficit, to 5,0 % of GDP, which taken at face value can be regarded as broadly in line with the Council recommendations under Article 126(7) of 2 December 2009. The revenue-to-GDP ratio is set to fall by 0,5 pp., also because of the expiry of the one-off revenue-increasing measures impacting on 2009. The expenditure-to-GDP ratio is planned to fall more significantly, by 0,8 pp. of GDP, mainly thanks to the expenditure restraint adopted with the fiscal package for 2009-2011 approved in summer 2008. This is visible in the slowing of primary expenditure growth, which is set to increase by just 0,6 % in 2010, also through the fall in public investment after the acceleration in 2009. The 2010 budget itself contains some measures beyond those planned in the fiscal package for 2009-2011 approved in 2008, and, according to the authorities, has a neutral impact on the budgetary position. It contains some new expansionary measures, amounting to around 0,4 % of GDP, directed at supporting low-income workers and ensuring the funding of additional health and social expenditure, as well as of military missions abroad. The main source of financing is represented by the one-off revenues from the extraordinary tax on illegally expatriated assets — ‘scudo fiscale’ — recorded in 2009 (0,35 % of GDP) as its positive outturn gave rise to the decision, made in the budget for 2010, to postpone from 2009 to 2010 the collection of some income taxes estimated at 0,25 % of GDP. The additional expansionary measures imply some deviation from the recommendations for 2010, although it has to be recognised that these are of a small amount and, according to the authorities’ estimate, fully financed thanks to the reshuffling of the one-off proceeds of the scudo fiscale. After worsening by 0,25 pp. of GDP in 2009, the structural balance, i.e. the cyclically-adjusted balance net of one-off and other temporary measures, according to the commonly agreed methodology is set to improve by 0,5 pp. of GDP in 2010 mainly thanks to expenditure restraint.

(7) The main aim of the programme's medium-term budgetary strategy is to reduce the deficit below the 3 % of GDP deficit reference value by 2012, the deadline for the correction of the excessive deficit set by the Council, with deficit targets set at 3,9 % of GDP in 2011 and 2,7 % of GDP in 2012. To reach the targets, the government envisages an additional consolidation effort, beyond that already adopted with the fiscal package for 2009-2011, amounting to 0,4 pp. of GDP in 2011 and a further 0,8 pp. in 2012. No information is provided on the broad measures behind this additional consolidation, which hampers the assessment of the overall composition of the planned adjustment. The primary balance is planned at 1,3 % of GDP in 2011, and 2,7 % in 2012. The planned annual consolidation amounts to 0,5 pp. of GDP in 2011 and 0,75 pp. in 2012 in structural terms. The budgetary adjustment over the programme period thus appears to be somewhat back-loaded. The programme confirms the commitment to the medium-term objective (MTO), which is a balanced budgetary position in structural terms. Given the most recent projections and debt level, the MTO reflects the objectives of the Pact; however, the programme does not envisage achieving it within the programme period.

(8) Overall, the budgetary outcomes could be worse than targeted in the programme. This possibility increases in the outer years of the programme period. First, real GDP growth could be lower than assumed in the programme for the whole period 2010-2012. In this context, the sensitivity analysis carried out in the programme indicates that a 0,5 % lower annual GDP growth over the programme horizon would imply a 0,7 pp. of GDP higher headline deficit by 2012 (3,4 % of GDP vs the 2,7 % target) and, due to the implications for potential growth, a 0,5 pp. smaller overall structural adjustment over the period 2010-2012. Second, the budgetary targets for 2011 and 2012 rely on the specification and implementation of further consolidation efforts but the programme does not spell out the broad measures behind this planned additional adjustment relative to the trend scenario based on unchanged legislation presented in the programme. The latter, moreover, tends to understate actual expenditure trends and thus the size of the consolidation measures needed to achieve the budgetary targets. Third, even before considering the required additional consolidation efforts, achieving the trend projections, which incorporate the summer 2008 fiscal package for the period 2009-2011, will be challenging because they already envisage a very significant degree of expenditure restraint. In this context, the track record indicates that expenditure overruns at the central and local level cannot be ruled out, particularly in current primary expenditure, which increased by around 4,5 % on average over the last decade. Respecting the tight expenditure targets that were set in the summer 2008 fiscal package will require an intensification of efforts to cut spending, increase efficiency and improve service quality.

(9) The general government gross debt-to-GDP ratio is well above the Treaty reference value and is projected to be on an increasing trend until 2010. After rising in 2008, the debt ratio is estimated in the programme to have increased by 9,3 pps, to 115,1 % of GDP in 2009 (115,8 % in the statistical office's estimate released on 1 March 2010), mainly due to the high interest burden and sharp contraction in real GDP, only partially offset by the still sizeable GDP deflator effect. A negative primary balance for the first time since 1991 also increased the debt, as did the stock flow adjustment, mainly because of the Treasury's precautionary accumulation of liquid assets. For 2010 the programme projects an additional 1,8 pps rise in the debt ratio as the debt-increasing effect of the interest burden is only partly offset by the assumed positive growth of real GDP and the GDP deflator. The debt ratio is then projected to follow a declining path in 2011 and 2012, to 114,6 % of GDP, mainly thanks to the planned positive primary balances and the assumed acceleration in real GDP growth. The evolution of the debt ratio could well be less favourable than projected in the programme, especially after 2010, in view of the risks identified for budgetary consolidation compounded by the possibility of less favourable real GDP growth than assumed in the programme.

(10) Medium-term debt projections that assume GDP growth rates to gradually recover to the values projected before the crisis, tax ratios to return to pre-crisis levels and that include the projected increase in age-related expenditure show that the budgetary strategy envisaged in the programme, taken at face value and with no further policy change, would be enough to stabilise the debt-to-GDP ratio by 2020.

(11) The long-term budgetary impact of ageing is clearly lower than the EU average, with pension expenditure showing a more limited increase than on average in the EU through the full implementation of the adopted reforms. Yet, pension expenditure as a share of GDP remains among the highest in the EU. The budgetary position in 2009 as estimated in the programme would not be sufficient to stabilise the current debt ratio. Achieving high primary surpluses would therefore contribute to limiting the risks to the long-term sustainability of public finances which were assessed in the Commission 2009 Sustainability Report (3) as medium.

(12) Fiscal governance in Italy has considerably improved since joining the euro area, prompted by the budgetary constraints imposed by the Treaty and the Stability and Growth Pact. However, there remains scope for improvement in several dimensions of its fiscal framework. A number of initiatives have been taken recently to improve fiscal governance in Italy. First, to address the traditional short-term orientation of the budgetary plans, in summer 2008 the government adopted a three-year package spelling out not only yearly targets for single expenditure and revenue items, but also the broad measures needed to achieve them. According to the authorities, this experience was not repeated with the budget for 2010 in view of the uncertainty connected to the economic downturn. However, the framework law on the reform of the budgetary process adopted in 2009 has enshrined in legislation the three-year budget horizon. A second improvement was the simplification of the structure of the State budget, allowing for a simpler and more policy-oriented allocation of resources. Third, some steps have been taken to improve monitoring of expenditure through detailed spending review exercises at the level of ministries. Also the two latter improvements were taken up in the framework law to become a permanent feature of the budgetary process. It remains to be seen whether the practical implementation of this reform, which will take some years, will deliver the planned results in terms of better expenditure control and fiscal governance. Going forward, a major challenge for fiscal governance is to specify and implement the new framework for fiscal federalism so as to ensure the accountability of local governments and foster efficiency.

(13) Although the implementation of pension reforms and the gradual increase of the retirement age for female civil servants introduced in 2009 are positive developments, the composition of social expenditure remains biased towards high pension spending. This takes its toll on other social spending and more productive expenditure aimed at supporting research and innovation, and in turn may have negative effects on growth potential. In addition, given that the consolidation strategy over the programme period relies on an expenditure-based adjustment, significant efficiency gains are needed to avoid compromising the level and quality of services provided. Recent efforts to improve the efficiency and cost-effectiveness of the public administration and to reform the organisation of upper-secondary school curricula could potentially deliver positive budgetary outcomes in the medium to long run.

(14) Overall, in 2010 the budgetary strategy set out in the programme is broadly consistent with the Council recommendations under Article 126(7). However, from 2011 on, taking into account the risks to the deficit targets, the budgetary strategy may not be consistent with the Council recommendations. In particular, the deficit targets for 2011-2012 need to be backed up by concrete measures and the plans for the entire period sufficiently strengthened to address the risks from possibly less favourable GDP growth and possible slippages on the expenditure side. The same conclusion holds for the structural effort planned in the programme, which may fall short of what was recommended by the Council. Unless these risks are adequately addressed, and the consolidation plans fully implemented, the budgetary strategy may not be sufficient to bring the very high government debt ratio back on a declining path in 2011-2012.

(15) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has some gaps in the required and optional data (4). In its recommendations under Article 126(7) of 2 December 2009 with a view to bringing the excessive deficit situation to an end, the Council also invited Italy to report on progress made in the implementation of the Council’s recommendations in a separate chapter in the updates of the stability programmes. Italy partly complied with this recommendation, as no information is provided on the broad measures required to achieve the additional consolidation planned in 2011-2012.

The overall conclusion is that the programme projects the deficit to narrow slightly, to 5 % of GDP in 2010, from 5,3 % in 2009, thanks to the expenditure-based adjustment adopted in summer 2008 and confirmed by the 2010 budget. Thereafter, the deficit ratio is planned to decline to below 3 % by 2012, the deadline set by the Council for the correction of the excessive deficit. The strategy is based on (i) the further implementation of the expenditure-based adjustment for the period 2009-2011 adopted in summer 2008; and (ii) an additional consolidation effort amounting to 0,4 pp. of GDP in 2011 and further 0,8 pp. in 2012, which is however not underpinned by broad measures. The gross debt ratio is set to increase from just above 115 % of GDP in 2009 to around 117 % of GDP in 2010. Thereafter, it is projected to fall towards 114,6 % of GDP in 2012, consistent with the planned budgetary targets and economic growth assumptions. However, the deficit and debt ratios could be higher than targeted. Overall, the programme's macroeconomic assumptions appear favourable. In addition, beyond the lack of broad measures underpinning the planned additional consolidation efforts, achieving the trend projections will be very challenging as they already envisage a very significant degree of expenditure restraint. In this context, the track record indicates that expenditure overruns cannot be ruled out. A major challenge for fiscal governance is the implementation of the budgetary process reform and of rules governing fiscal federalism in such a way to improve the accountability of local governments and ensure fiscal discipline. Besides fiscal consolidation, which is a condition to keep public finances on a sustainable path in view also of the very high debt ratio, a further key challenge for Italy's economic policy in the coming years will be to foster a swift and durable recovery in productivity growth so as to restore competitiveness and raise the country's low potential GDP growth.

In view of the above assessment and also in the light of the recommendation under Article 126(7) TFEU of 2 December 2009, Italy is invited to:

(i) rigorously implement the planned budgetary adjustment, in particular carry out the fiscal consolidation in 2010 as planned and back up the planned consolidation for 2011 and 2012 with concrete measures, standing ready to adopt the required consolidation measures in case the macroeconomic scenario underpinning the Article 126(7) Recommendation materialises; seize, as prescribed in the EDP recommendation, any opportunity beyond the fiscal efforts, including from better economic conditions, to accelerate the reduction of the gross debt ratio towards the 60 % of GDP reference value;

(ii) ensure that the implementation of the reform of the budgetary process improves the conditions for expenditure control and helps sustain the objective of sound public finances and that the rules governing fiscal federalism improve the accountability of local governments and foster efficiency.

Italy is also invited to improve compliance with the data requirements of the code of conduct in view of the indicative nature of revenue and expenditure projections in the outer years and to provide more information on the broad measures underpinning the envisaged consolidation in these years in the EDP chapter of the forthcoming updates of the stability programme.

Comparison of key macroeconomic and budgetary projections

2008 2009 2010 2011 2012 Real GDP (% change) SP Jan 2010 –1,0 –4,8 1,1 2,0 2,0 COM Nov 2009 –1,0 –4,7 0,7 1,4 n.a. SP Feb 2009 –0,6 –2,0 0,3 1,0 n.a. HICP inflation (%) SP Jan 2010 3,5 0,8 1,5 2,0 2,0 COM Nov 2009 3,5 0,8 1,8 2,0 n.a. SP Feb 2009 3,5 1,2 1,7 2,0 n.a. Output gap (5) (% of potential GDP) SP Jan 2010 1,1 –4,0 –3,5 –2,5 –1,6 COM Nov 2009 (6) 1,3 –3,6 –3,2 –2,5 n.a. SP Feb 2009 0,3 –2,3 –2,7 –2,5 n.a. Net lending/borrowing vis-à-vis the rest of the world (% of GDP) SP Jan 2010 –2,9 –1,8 –1,6 –1,3 –1,3 COM Nov 2009 –2,9 –2,3 –2,3 –2,3 n.a. SP Feb 2009 –1,6 –1,3 –1,1 –0,9 n.a. General government revenue (7) (% of GDP) SP Jan 2010 46,0 46,4 45,9 45,5 45,6 COM Nov 2009 46,0 46,3 45,5 45,4 n.a. SP Feb 2009 46,4 46,8 46,8 46,4 n.a. General government expenditure (7) (% of GDP) SP Jan 2010 48,8 51,7 50,9 49,9 49,5 COM Nov 2009 48,8 51,6 50,8 50,5 n.a. SP Feb 2009 49,0 50,5 50,0 49,5 n.a. General government balance (% of GDP) SP Jan 2010 –2,7 –5,3 –5,0 –3,9 –2,7 COM Nov 2009 –2,7 –5,3 –5,3 –5,1 n.a. SP Feb 2009 –2,6 –3,7 –3,3 –2,9 n.a. Primary balance (% of GDP) SP Jan 2010 2,4 –0,5 –0,1 1,3 2,7 COM Nov 2009 2,4 –0,5 –0,6 0,1 n.a. SP Feb 2009 2,5 1,3 1,9 2,6 n.a. Cyclically-adjusted balance (5) (% of GDP) SP Jan 2010 –3,3 –3,2 –3,2 –2,7 –1,9 COM Nov 2009 –3,4 –3,5 –3,7 –3,8 n.a. SP Feb 2009 –2,7 –2,6 –1,9 –1,6 n.a. Structural balance (8) (% of GDP) SP Jan 2010 –3,5 –3,8 –3,3 –2,7 –1,9 COM Nov 2009 –3,6 –3,7 –3,7 –3,7 n.a. SP Feb 2009 –2,9 –2,7 –2,0 –1,7 n.a. Government gross debt (% of GDP) SP Jan 2010 105,8 115,1 116,9 116,5 114,6 COM Nov 2009 105,8 114,6 116,7 117,8 n.a. SP Feb 2009 105,9 110,5 112,0 111,6 n.a. Stability programme (SP); Commission services’ autumn 2009 forecasts (COM); Commission services’ calculations.

(1) OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website: http://ec.europa.eu/economy_finance/sgp/index_en.htm

(2) The assessment notably takes into account the Commission services’ autumn 2009 forecast and February 2010 interim forecast, but also other information that has become available since then.

(3) In the Council conclusions from 10 November 2009 on sustainability of public finances ‘the Council calls on Member States to focus attention to sustainability-oriented strategies in their upcoming stability and convergence programmes’ and further ‘invites the Commission, together with the Economic Policy Committee and the Economic and Financial Committee, to further develop methodologies for assessing the long-term sustainability of public finances in time for the next Sustainability report’, which is foreseen in 2012.

(4) In particular, the programme does not indicate the broad measures underpinning the additional planned consolidation needed to achieve the budgetary objectives in the medium term. Accordingly, the expenditure and revenue ratios presented in the programme for 2011 and 2012 are not consistent with the budgetary targets. In addition, optional data on general government expenditure by function (table 3 in Annex 2 of the code of conduct) and on liquid financial asset and net financial debt (table 4 in Annex 2 of the code of conduct) are not presented.

(5) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes.

(6) Based on estimated potential growth of 0,4 %, 0,2 %, 0,3 % and 0,7 % respectively in the period 2008-2011.

(7) Revenue and expenditure data provided in the programme are trends based on unchanged legislation. The targeted general government balances incorporate additional measures with a positive impact of 0,4 % of GDP in 2011 and further 0,8 % in 2012.

(8) Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,2 % of GDP in 2008, 0,6 % in 2009 and 0,1 % 2010; all deficit-reducing according to the most recent programme. In the Commission services’ autumn 2009 forecast one-off and other temporary measures are 0,2 % of GDP in both 2008 and 2009 deficit-reducing; 0 % in 2010, and 0,1 % of GDP in 2011, deficit-increasing.

Source:

Stability programme (SP); Commission services’ autumn 2009 forecasts (COM); Commission services’ calculations.