Italy—Background Economic Developments and Issues

This paper reviews developments in the Italian economy during 1994 with some special attention to some specific issues. It describes trends in the real economy, with special annexes focusing on the outlook for inflation and the response of employment to cyclical and structural factors. The paper discusses fiscal developments, and summarizes developments in the monetary sector. It also reviews empirical evidence on money demand in Italy, and the combination of cyclical and structural factors impinging on the banking system.


This paper reviews developments in the Italian economy during 1994 with some special attention to some specific issues. It describes trends in the real economy, with special annexes focusing on the outlook for inflation and the response of employment to cyclical and structural factors. The paper discusses fiscal developments, and summarizes developments in the monetary sector. It also reviews empirical evidence on money demand in Italy, and the combination of cyclical and structural factors impinging on the banking system.

III. Public Finances

1. The 1994 budget and outcome

The 1994 budget was based on the three-year plan for 1994-96. That plan had been approved in July 1993, in the midst of the recession. In these conditions, the authorities had decided to accept a “pause” in the process of primary adjustment: the central government (settore statale) primary surplus in 1994 was targeted to remain at about its 1993 level (Lit 32 trillion, just under 2 percent of GDP). At the same time, because interest rates were falling at the time, the overall deficit was projected to decline from Lit 154 trillion, or 9.9 percent of GDP in 1993 to Lit 144 trillion, or 8.7 percent of GDP in 1994. 1/ The target date for debt stabilization was postponed from 1995—as earlier planned—to 1996.

To achieve the objective for the primary surplus, given that the underlying “no-measures” (tendenziale) fiscal position was projected to deteriorate as a result of the expiration of the one-off measures taken in 1993 and of the economic cycle, the 1994 budget included new measures (manovra) relative to baseline equivalent to Lit 31 trillion (about 1.9 percent of GDP) on both revenues and primary expenditures. The emphasis was put on expenditure savings, which were supposed to contribute the bulk (about Lit 26 trillion) of the total. 2/

In early 1994, as the full extent of the 1993 downturn became evident while the signs of recovery were still weak, the authorities took the view that the 1994 central government targets could not be achieved without additional measures. According to the March 1994 quarterly budget report, in the absence of additional measures, the primary surplus in 1994 would reach only Lit 9.9 trillion and the overall deficit Lit 159 trillion, compared with the targeted Lit 32 trillion and Lit 144 trillion, respectively. The new government that came to office in May 1994 decided to take Lit 5 trillion of measures to offset this shortfall only partly, and the revised target was set at Lit 154 trillion (9.4 percent of GDP). This implied a reversal of the process of primary adjustment, instead of the “pause” envisaged in the 1994-96 plan.

Developments in the course of the year affected the fiscal accounts in opposite directions. On the positive side, the economic recovery revealed itself to be much stronger than expected early in the year. However, interest rates stopped declining and then—especially after August—increased substantially. Furthermore, floods hit the North-west of the country in October, causing considerable damage to private and public property. The government’s immediate response to the floods was a postponement by six months of the direct and indirect tax payment due in November 1994 by business and professionals in the affected regions (an amount estimated at about Lit 4.5 trillion, including social security contributions); and an extension of a line of credit of Lit 3 trillion for reconstruction (of which only about Lit 1.2 trillion was expected to be drawn in 1994). Additional relief measures were to be taken in 1995 (see below).

In addition to these exogenous factors, the government delayed taking the supplementary measures intended to partly offset the shortfall from the original budget target, and when these measures were finally taken in September their yields amounted to less than the Lit 5 trillion originally announced: when implemented, the measures, consisting of summary procedures for the closing of outstanding tax court cases, and an amnesty on illegal construction, were designed to yield only Lit 3.5 trillion.

Nonetheless, the government left the revised 1994 budget target unchanged at Lit 154 trillion. The cost of higher interest rates (which would anyway be contained in 1994) and of the floods, as well as the smaller size of the corrective measures, were expected to be broadly offset by lower-than-budgeted VAT refunds and the positive effects of the stronger economic cycle on the primary balance—although these effects would be muted as the recovery had not yet resulted in higher employment. The latest staff estimates show the central government overall deficit close to the government’s revised target at about Lit 157 trillion (9.5 percent of GDP), 3/ and the primary surplus at Lit 15.4 trillion (0.9 percent of GDP). These estimates are still subject to some uncertainty arising primarily from the possible impact on the central government’s cash financing need of transactions among government agencies (such as transfers to public sector entities, deposits of local authorities in the Treasury account, etc.). They are, however, broadly in line with the authorities’ own estimates. After privatization receipts accruing to the Treasury of Lit 7.2 trillion, the central government debt is estimated at 123.1 percent of GDP at end-1994.

The main reason for the difference between the estimated outcome and the original budget was a significant shortfall in revenues: instead of the budgeted decrease of 1 percentage point of GDP, central government revenue fell by almost 2 percentage points relative to 1993 (despite the corrective measures taken in September) to reach an estimated 32.5 percent of GDP in 1994. This shortfall, which affected both direct and indirect tax revenue, was only partly due to the cycle. Pending the official data on the budget outcome, it appears that the shortfall was also partly due to the ineffectiveness of the revenue measures included in the 1994 budget. Expenditures, on the other hand, were kept broadly in line with the target: small overruns in primary current spending (an estimated 27.7 percent of GDP instead of an original budget target of 27.3 percent) and interest payments were offset by lower capital (an estimated 2.5 percent of GDP instead of an original budget target of 3.1 percent). The latter was due to the decision to renegotiate existing suppliers’ contracts, as well as the effects on public investment of the corruption investigations of recent years; although these factors had been taken into account in the 1994 budget, their effects went beyond the budget estimates.

2. The 1995-97 three-year plan and the 1995 budget

In July 1994, the government presented its new three-year plan for the period 1995-97. Although this plan was based on a projected 1994 outcome that was considerably worse than envisaged in the previous three-year plan, it maintained that plan’s key objective of stabilizing the central government debt-to-GDP ratio in 1996. In addition, it spelled out the broad strategy to achieve this objective: the budgets for 1995-97 would be designed so as to keep the tax pressure at about its 1994 level, while primary current expenditure would increase every year by the rate of projected inflation.

The plan targeted an increase of the central government’s primary surplus to 2 percent of GDP in 1995, and to a further 3 percent and 4 percent of GDP, respectively, in 1996 and 1997. Relative to a baseline “no-measures” projection, this implied a cumulative primary adjustment of some 4½ percentage points of GDP over the three-year period, to compensate for the expiration of one-off measures taken in the past. The plan was front-loaded: about half of the planned primary adjustment relative to the baseline (Lit 45 trillion, or 2½ percent of GDP) was targeted for 1995. These primary surpluses were expected, according to the plan, to enhance confidence and thereby bring about a substantial reduction in interest rates, with the benchmark interest rate on 12-month Treasury bills declining from over 9 percent at the time of the plan to 8 percent by end-1994 and remaining there through the end of the three-year period. This would facilitate fiscal adjustment and debt reduction. The overall central government deficit was projected to decline to 8 percent of GDP in 1995, 6.6 percent in 1996, and 5.6 percent in 1997. With the contribution of privatization receipts (expected to amount to Lit 10 trillion per year during 1995-97), the debt-to-GDP ratio was projected to start declining in 1996, and reach 121.6 percent at end-1997 (Chart 24).


ITALY: State Sector Finances and Debt 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 1995, 036; 10.5089/9781451819687.002.A003

Source: Data provided by the authorities.1/ Starting in 1986, data exclude operations of the Railways, Tobacco Monopolies, and Telephone Agencies.

The 1995 budget, approved by Parliament in December 1995, reflected these targets. Because interest rates and hence interest payments at the time of budget preparation were projected to be higher than at the time of the plan, the budget included a slightly larger primary adjustment than the plan (Lit 48 trillion) to achieve the same overall deficit target.

The budget included measures on both revenues (Lit 21 trillion) and expenditures (Lit 27 trillion). The bulk of the revenue measures were one-off and, although they would raise the revenue-to-GDP ratio slightly to 32.6 percent, were not interpreted as increasing tax pressure. In particular, more than half (Lit 11.5 trillion) of the yield of the revenue measures was expected from the application of new assessment procedures for outstanding tax liabilities for 1989-93 (concordato); another Lit 7 trillion was expected from the amnesty on illegal construction; and Lit 0.6 trillion was expected from clearing outstanding court cases with simplified procedures. Most of the remaining increase in revenue would come from reductions in tax exemptions and from increases in excises on tobacco and spirits.

In contrast, most of the expenditure measures included in the budget were permanent cuts. A reform of the pension system, together with a postponement of some compensatory pension payments (pensioni d’ annata) and indexation payments, as well as an amnesty on overdue social security contributions, was projected to yield savings of Lit 12.5 trillion in transfers to the social security agencies. 4/ Health spending cuts, including ceilings on spending by local health agencies, the closure of small uneconomic hospitals (subject to certain criteria) and ceilings on drug spending were projected to generate Lit 6 trillion in savings. Finally, the budget included cuts to transfers to local authorities, wider public sector entities, and the State Railway Company equivalent to almost Lit 7 trillion. The remaining expenditure savings would come from a central government hiring freeze for the first nine months of 1995 and reductions in other government consumption.

On December 19, 1994, the government passed decree-law 691/1994 specifying extraordinary measures (in addition to those taken earlier in 1994) to cover the costs of the floods. This decree-law includes three measures:

  • a one-time personal income tax (Irpef)surcharge for medium and high incomes (Lit 100,000 for incomes between Lit 100-200 million; Lit 300,000 for incomes between Lit 200-500 million; and Lit 1 million for incomes higher than Lit 500 million);

  • a one-time corporate tax (Irpeg) surcharge equal to 1 percent of taxable corporate income; and

  • an increase of 50 percent in stamp duty on financial transactions.

The one-time personal and corporate income tax surcharges would not apply to taxpayers in the areas affected by floods.

These measures are expected to generate about Lit 1.3 trillion of resources in 1995. Together with another Lit 1 trillion of diverted budgetary resources (from the Cassa dei Depositi e Prestiti), they would cover the expected additional financial burden on the central government for flood relief and rehabilitation in 1995. Nonetheless, other overruns—notably on interest payments—remained. The program of the new government that took office in January 1995 included the early implementation of corrective measures (which it estimated at about 1 percent of GDP) to safeguard the overall budget target. The package of measures was still in the process of definition at the time of writing.


The official definition of interest payments (and hence the overall deficit) does not include interest accruing on outstanding tax refund liabilities not yet replaced by government bonds (the process of issuing bonds to gradually replace these liabilities started in 1993). This accrued interest is estimated by the staff at about 0.3-0.4 percent of GDP annually, and is projected to decline rapidly in the coming years as these liabilities are replaced by bonds. Thus, if the government accounts figures were to be corrected by this amount, the overall deficit would be 10.3 percent of GDP in 1993, and the 1994 target would be 9.0 percent of GDP. In what follows, the official presentation of interest payments and the overall balance is used, unless otherwise indicated.


The 1994 budget was described in SM/94/39, 2/11/94.


About Lit 162 trillion (9.8 percent of GDP) including estimated interest accruing on tax refund liabilities not yet replaced by bonds.


While the original draft budget included specific standard measures in the area of pension reform, trade union protests led to the removal of these measures from the budget law, and to a negotiated agreement on the principles of pension reform to be implemented by June 1995. Instead, the final 1995 budget included—in addition to the postponement of compensatory payments and the amnesty on social security contributions—a freeze on seniority pensions until June 1995.

Italy: Background Economic Developments and Issues
Author: International Monetary Fund