OREANDA-NEWS. On July 21, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Italy.

The Italian economy is in the third year of a moderate recovery. Supported by exceptionally accommodative monetary policy, fiscal easing, low commodity prices, and the government’s reform efforts, the economy grew by 0.9 percent in 2016 and continued to expand in the first quarter of 2017. Unemployment and nonperforming loans have declined somewhat from their crisis-driven peaks. Public debt appears to be stabilizing at about 133 percent of GDP. However, weak productivity and low aggregate investment remain key challenges for faster growth, held back by structural weaknesses, high public debt, and impaired bank balance sheets. A decade after the global financial crisis, real disposable incomes per capita remain below pre-euro accession levels, while the burden of the crisis has fallen disproportionately on younger generations.

The recovery is expected to continue, but risks ahead are significant. Growth is projected at about 1.3 percent this year and around 1 percent in 2018–20 as favorable tailwinds-terms of trade, fiscal and monetary policies-become less supportive. Growth could surprise on the upside in the near term, including from a stronger European recovery. However, downside risks are significant, related among others to political uncertainties, possible setbacks to the reform process, financial fragilities, and re-evaluation of credit risk during monetary policy normalization. Uncertainty about U.S. policies and Brexit negotiations add to these risks. This moderate growth path would imply a return to pre-crisis per capita income levels only by the mid-2020s and a widening of Italy’s income gap with the faster growing euro area average.

The authorities have advanced important reform initiatives, which have succeeded in supporting the recovery and broadly stabilizing imbalances. Further progress in reducing imbalances, narrowing competitiveness gaps, raising productivity and supporting incomes of the most vulnerable will require more ambitious policy efforts and broad and sustained political support. The current backdrop of cyclical recovery and exceptional monetary accommodation provides a favorable, if narrowing, window to press ahead with structural, fiscal, and financial reforms.

Executive Board Assessment

Executive Directors noted that the Italian economy has been recovering steadily in recent years, supported by accommodative policies, a favorable global environment, and the authorities’ reform efforts. Notwithstanding the progress made, long-standing structural weaknesses, high public debt, and impaired bank balance sheets continue to pose challenges.

Directors commended the authorities for their ongoing efforts to reform the economy. They stressed that the current backdrop of cyclical recovery and exceptional monetary accommodation provides a favorable, if narrowing, window to advance structural reforms, accelerate the repair of bank balance sheets, and carry out the needed fiscal adjustment. Decisive implementation of such a comprehensive strategy can support the economy in the near term, put public debt on a firm downward path, narrow competitiveness gaps, and yield notable output gains in the medium term. Directors agreed that broad and sustained political support will be essential in this regard.

Directors agreed that structural reforms are essential to raise potential growth and improve competitiveness. In this context, they welcomed the passage of decrees on public administration reform. They also encouraged the authorities to press ahead with ambitious product and service market reforms, modernize the wage bargaining system to better align wages with productivity at the firm level, strengthen active labor market policies, accelerate insolvency and civil justice reforms, and broaden and complete public administration reforms.

Directors noted that progress is underway to safeguard financial stability. They called for additional measures to enhance banks’ operational efficiency and materially reduce NPLs. Directors highlighted that banks’ NPL reduction and restructuring strategies should be ambitious, and credible, aided by supervisory assessments. Undertaking an asset quality review of all emerging consolidated banking groups and ensuring robust governance and risk management structures will also be important going forward. While acknowledging the reduction in tail risks related to the recent decisions to liquidate two weak banks and recapitalize another institution, Directors emphasized the importance of prompt actions to address problems in banks, with appropriate burden sharing involving banks’ shareholders and creditors, and protection as needed for the most vulnerable retail bondholders. This is especially important in view of Italy’s limited fiscal space to minimize costs to taxpayers.

Directors considered that the ongoing recovery and favorable financial conditions provide an opportunity for a credible and sizable fiscal consolidation strategy to reduce the public debt ratio. They supported a gradual but substantial fiscal adjustment in 2018-19 toward a structurally balanced budget. For the medium term, many Directors thought that targeting a small structural surplus would provide valuable insurance for a declining debt path against shocks. At the same time, many other Directors felt that a balanced budget was appropriate. Directors underscored that the adjustment effort should be underpinned by permanent, growth-friendly, and inclusive measures, including so as to not jeopardize the recovery. The focus should be mainly on further cutting current primary spending, including reducing pension spending over the medium term, expanding the income inclusion program into a universal anti-poverty scheme, increasing capital spending, broadening the tax base, and gradually lowering tax rates on productive factors.