KEY ISSUES Seizing the Window of Opportunity for Reform and Growth Context: Euro area-wide policies and national efforts have supported a turnaround in market sentiment and real activity. Italy’s performance since the crisis, however, has been among the weakest in the euro area. Real activity and investment are still far from their precrisis levels; unemployment is high; and public debt, at 130 percent of GDP, is a source of risk. Low productivity and impaired balance sheets continue to weigh on the recovery and cloud medium-term growth prospects. Policies: There is now a window of opportunity to push ahead with deeper reforms to re-ignite growth. This requires actions on multiple fronts, which are mutually reinforcing: • Tackling the long standing productivity problem. A wide-ranging reform to raise the efficiency of public services at all levels of government would not only provide better quality and cheaper services but would also raise private sector productivity. The implementation of the Annual Competition law would further liberalize product and service markets, benefiting producers and consumers. Completing the Jobs Act would create better incentives to hire and train workers, while greater firm-level wage bargaining will make labor more responsive to economic conditions. • Supporting balance sheet repair. A broad-based strategy to strengthen bank and corporate balance sheets will support recovery. More provisioning and write-offs, a revived distressed debt market, and enhanced insolvency regime would accelerate the reduction of NPLs. Establishing standard criteria for bank assessments of the viability of SMEs and introducing guidelines for creditor-led restructuring would accelerate the process of dealing with distressed SMEs. • Rebalancing fiscal adjustment and reducing public debt. Fiscal rebalancing is needed to reduce the high taxes on labor and capital, through savings from past and ongoing spending reviews. The planned small fiscal adjustment is appropriate in the near term, given the still-weak growth and high debt. In the medium term, a modest structural surplus would reduce debt faster, providing valuable insurance against changes in market sentiment, and helping comply with EU fiscal rules. More ambitious privatization targets would also help.
We thank staff for fruitful discussions during the 2015 Art. IV Consultations with Italy. The Selected Issues Papers (SIPs) deal with critical issues and are of excellent quality, particularly the analysis of the link between public sector efficiency and productivity. We broadly concur with the thrust of the staff appraisal.
This said, the Staff Report sometimes gives the impression that the structural reforms Italy needs in its labor and product markets, as well as in its public administration and finances, are still in the planning stage including by frequent references to the “ambitious government agenda” (ambitious, yes, but still an agenda).1 No, these are not just plans: during the last year several key actions have been undertaken to implement these reforms.
Thus, this statement starts by clarifying what has been already fully legislated and implemented, what is in the implementation phase, and what is in the planning stage. Of course the lists of what is still in the implementation and planning stages are also long. But what has already been achieved bodes well for the future.
One additional remark before proceeding: the Staff Report presents various indicators of the efficiency of the Italian economy to illustrate the need for reform, including the World Bank Doing Business Indicators and the World Economic Forum (WEF) perception-based indexes. There is no doubt that there are bottlenecks and inefficiencies in the Italian economy but, for the reasons that we explain below, the way these indicators are used in the Report conveys only a partial representation of the country to the detriment of the effectiveness of the Report.
Where Italy stands in the implementation of the ambitious government reform agenda
Since the last Article IV Consultation the following structural reforms have been implemented:
Probably the most important reform was the enactment of the Jobs Act, which deeply changes the working of the labor market by introducing more flexibility in laying off and hiring workers, reforming labor contracts and introducing a better protection for the unemployed. This part of the labor market reform—its core component—is fully legislated, including the necessary implementation decrees, and is thus fully operational. Only two components of the reform—the reform of the wage supplementation scheme and the reform of active labor market policies—still require the implementation decrees, but they have already been sent to Parliament (for comments, not for approval, which is not needed) in the first of these two areas.
Labor taxes have been cut and to an extent somewhat larger than suggested by staff (close to one per cent of GDP, rather than 0.7), taking into account the 3-year reduction of labor taxation for new permanent contracts. Based on our own estimates, this cut has almost halved the gap between Italy’s tax wedge and that of the euro area. The initial results are encouraging: permanent hirings increased sharply in the first quarter of this year (+104,000); in April the unemployment rate decreased more than expected, though remaining at high levels also on the back of increased labor supply.
Primary spending has been cut by about ½ percent of GDP (and more net of spending increases that were necessary to implement some structural reforms such as the strengthening of unemployment benefits).2 This decline in spending is not only the effect of “austerity measures” but also of deep reforms, including the reform of procurement, which does not require any further legislative action. It implies setting up 35 procurement agencies that will replace the over 30,000 offices that currently manage procurement activities in Italy. This is expected to be completed in July 2015.
New rules for the mobility of public sector employees have been legislated and are now being used to reallocate personnel from the reformed Provinces to other parts of the public administration. The 2014 law on the reform of the public administration (not to be confused with the new law now in Parliament to complete the reform process, which is the one mentioned in the Staff Report) introduced other simplification and streamlining measures.
Thanks to the reform of the Treasury management system introduced during 2014, the repayment of government arrears has been accelerated and payment delays have been dramatically reduced with the introduction of the electronic invoice system. According to the most recent data, €36.5 billion were paid to creditors, and the total resources provided by central government to local governments – the firms’ debtors – totaled €42.8 billion. This is assessed to broadly match overdue commercial debt.
New measures have been adopted to improve the functioning of the civil justice, along the lines of the numerous provisions enacted since 2011. A paperless process for civil court cases (processo telematico) was introduced. Two new modalities for the extra-court resolution of disputes have been added. The possibility for judges to resort to fast-track procedures has been widened. These and earlier reforms are already having an impact: in June 2014 the backlog of pending cases was down by 18 percent from the peak of 2009.
A new anti-corruption law was approved in May 2015 which criminalized false accounting, lengthened the punishment for corruption cases, changed the statute of limitations and increased the powers of the Anti-Corruption Authority established in 2014. The crime of self-laundering has been introduced in January 2015.
The cooperative banking sector (banche popolari) has been profoundly reformed with the aim of improving its corporate governance and its ability to access capital markets and enhancing investors’ assessment. Measures on the portfolio management (diversification of investments, limits and conditions for debt, derivatives and investments in instrumental entities) and governance arrangements of banking foundations have also been introduced; they guarantee that foundations fully comply with the ban on investee banks’ control (also jointly or de facto).
On June 23 the government adopted a set of new measures to overhaul the insolvency regime, reduce the length of recovery procedures and, consequently, speed-up the write-off of non-performing loans (NPLs) from banks’ balance sheets. Moreover, loan loss provisions will be immediately deductible for tax purposes. These newly-adopted measures, which are in line with staff recommendations, will facilitate the development of a market for NPLs in Italy.
More generally, the issuance of implementation decrees to enact laws approved in the past has been accelerated with the current government reducing by 70 percent the backlog of implementation decrees arising from previous legislation.
Other elements of the government reform agenda are in progress but have not yet been completed:
A key element is the enabling law on the reform of public administration. We will not delve further into this as it is already discussed in the Staff Report. Its approval is expected before the summer break. The implementation decrees are being drafted already and are expected to be issued within a month after the approval of the law.
Early this year the Parliament approved the new electoral law, which has been designed with the aim of enhancing the stability of the political system. It is part of a broader strategy, including a constitutional reform whose discussion has further advanced in Parliament and that will simplify the legislative process and rationalize the attribution of competences between central and local governments.
In February 2015 the Government presented an Annual Competition Law aimed at enhancing competitiveness in several sectors (professional services, telecommunications, banking and insurance services, fuel distribution), meeting for the first time the requirement introduced in 2009.
In March a draft enabling law to reform the civil procedure code was presented to the Parliament with the aim of simplifying the procedures and widening the case-management powers of judges.
In May, the government draft bill to reform education was approved by the House and is now under evaluation by the Senate. It aims at enhancing meritocracy of teachers, fostering transparency in the management of schools, and strengthening training in professional schools.
The government adopted a multi-year privatization program, which includes the listing of major State controlled companies such as Poste, ENAV and Ferrovie. Revenues from privatization are by law earmarked to the reduction of public debt. In early 2015 the government sold on the market a 5 percent stake of ENEL, reducing its stake to 25 percent. The IPO of Poste Italiane is scheduled for the fall. Incentives have been provided to local authorities to privatize utilities under their control. In parallel, the reorganization, restructuring and, when appropriate, sale of public real estate continues, including by setting up several specific funds by Invimit, the government real estate management company.
Finally, some steps are still in the planning stage, including, among others, proposals to: reduce the appeal rate in civil justice and develop court performance indicators; improve the provision of public services; strengthen the governance and resilience of the mutual bank sector (banche di credito cooperativo); address the high stock of non-performing loans with targeted actions (in addition to those introduced on June 23).
Doing Business and other indicators
These reforms are critical for addressing what is perhaps the most severe problem affecting the Italian economy: its low productivity growth. The authorities’ tangible reform achievements are a testament of how seriously this problem is acknowledged.
This said, we would caution against taking at face value some of the indicators presented in the Staff Report which—like the Doing Business and WEF indicators—suggest that Italy is at the bottom of OECD countries in virtually all respects. Indeed this is the impression that one gets in reading the Staff Report, given the selection of the indicators presented. In this regard, the list of the variables for the chart at page 10 excludes all the dimensions of the World Bank indices along which Italy is performing relatively better, such as: “Starting a business” (18th position among OECD countries); “Registering a property” (14th); “Protection of minority shareholders” (10th).
Furthermore, some of the indicators the Staff Report put a lot of emphasis on are probably not very revealing of actual conditions. Drawing from the Doing Business database, the Staff Report notes that it takes 120 days (for a business) to get electricity connection in Italy. The Staff Report does not say that, according to the same database, it would take 126 days to get a connection in the UK, 132 days in Los Angeles and 142 days in Canada. Admittedly, the Netherlands and Japan would be in a better position, but not by much (respectively 117 and 105 days). These data cast doubts on the quality of the reported indicator.
But the problems with these indicators are more general in the case of Italy for three reasons:
The Doing Business indicators refer to central Italy, whose efficiency, for example in terms of public services, is not representative of the national average weighted by regional GDP (whose production is skewed toward the most efficient regions). It is strange that staff does not acknowledge this problem, as the Staff Report does underscore the major differences in the efficiency of public services across the country.
The WEF indexes are typically based on perceptions and, for Italy (to a much larger extent than for other countries, based on econometric estimates) there is a wide gap between perceptions and more objective information. For example, according to a Eurobarometer survey, while a very large proportion of respondents (97 percent) argue that corruption is widespread in Italy, the proportion of those who personally know anyone who takes or has taken bribes in Italy is only 9 percent, at the lowest among the EU countries. Econometric evidence shows that, while there is in general a statistical relationship between perception of corruption and its direct evidence across countries, in the case of Italy the fit is very poor and the relationship does not hold. Therefore, while perception indicators are useful for many countries, for Italy they may not be so useful, and hence should not be overemphasized.
Third, the reported indicators typically give a snapshot of the current situation but do not describe the trends. This may miss important developments. For example, OECD PISA surveys do indeed show that Italian pupils’ competences are below the OECD average, but Italy is one of the countries which over recent years recorded one of the most marked improvements in competences in mathematics and science. Furthermore, between 2003 and 2012, Italy reduced the share of “low performers” by 7 percentage points, and increased that of the “top performers” by 3 percentage points.
Finally, it is difficult to square the image of the country conveyed by the indicators included in the Staff Report with some hard data. The Report appropriately underscores the disappointing productivity and GDP performance of the Italian economy over the last decade. It would have been more balanced to mention also some points of strength. Italy has the second largest manufacturing industry in Europe and the seventh in the world. While it is true that the productive system features a portion of small firms which are less innovative and able to compete, it also includes a large share of highly productive and competitive enterprises. According to WTO data, Italian firms are among the top-rank exporters in a wide range of industries (textiles, basic manufactures, transport equipment, machinery, clothing, electronic components). According to a 2013 SIP produced by staff, “In an era dominated by the dramatic expansion of emerging-market exporters, Italy’s tradable sector continues to rank among the world’s leaders – in contrast to many other European countries.” This is confirmed also by the fact that, after the trade collapse in 2009, the volume of Italian goods exports not only has kept up with, but has slightly outpaced potential demand (the weighted average of trade partners’ imports). Against this background, competitiveness indicators based on unit labor costs may underestimate Italian firms’ capacity to compete in international markets. We reiterate our suggestion that the consideration of a broader set of both price and non-price indicators would be more appropriate.
We concur with staff that the improvement in growth prospects is the result not only of the actions of the government but also of more favorable external conditions. The improved macroeconomic outlook has been reflected in the upward revision of earlier staff projections: GDP is now expected to grow by 0.7 percent in 2015 and 1.2 in 2016 (as against, respectively, 0.4 and 0.8 in the January 2015 WEO Update). Over the medium term staff has a somewhat less sanguine outlook than the authorities’, but not by much as the latter have adopted a cautious approach, not including in the projections the likely effect of the structural reforms that have already been and are being implemented.
The improved macroeconomic outlook and the reform already introduced over the last few years have led to an improvement in companies’ financial structure and to a more diversified access to financing for Italian business, particularly SMEs. The introduction in 2011 of the Allowance for Corporate Equity (ACE) scheme, and its recent enhancements, virtually cancelled out the tax advantage of debt finance. Positive results are emerging: in 2014 the gradual strengthening of firms’ risk capital continued, also favored by increased foreign capital inflows and by a wave of new stock-exchange listings. Tax incentives have been introduced for venture capital and other measures have been taken to liberalize credit markets. The re-composition of firms’ financial liabilities towards less reliance on bank funding has proceeded on the back of a greater recourse to bond emissions, including by new issuers and small unlisted firms benefitting from the provisions on the so-called mini-bonds adopted in 2012. Overall, corporate financial debt and leverage have decreased; firms’ liquidity is high. This said, the authorities are well aware that more efforts are needed to enhance capital markets, whose weaknesses reflect long-standing structural features of the Italian productive system.
The banking system continues to be sound and resilient, as it has been throughout the crisis, even without receiving any significant state support. The results for the Italian banks of the Comprehensive Assessment conducted last year at the euro area level have been generally positive. They confirmed the system’s overall resilience to extreme shocks. The two banks showing capital shortfalls under the adverse stress test scenario have presented recapitalization plans and already successfully completed substantial rights issues. At the end of 2014 Italian banks’ common equity tier 1 ratio (CET1) was at 11.8 percent, with a sizeable rise from 10.5 percent the year before; the coverage ratio of the NPLs increased to 44.4 percent. Markets’ assessment of the soundness of the Italian banks improved. Financial supervision remains attuned to the highest standards, as acknowledged by the 2013 FSAP.
However, the effects of the prolonged recession continue to unfold. In 2014, banks’ overall profitability remained weak, but improved with respect to 2013, thanks to continued efforts to enhance efficiency and cut costs. Operating profits were almost completely absorbed by loan loss provisioning as a consequence of the worsening in credit quality. The sharp rise of NPLs mainly reflected the impact of the recession on firms’ capacity to generate income and thus service their debt, despite the corporate debt-to-GDP ratio being one of the lowest among the large euro area countries. The weaknesses of the insolvency regime and the unfavorable tax treatment of loan-loss provisioning have been impediments to the reduction of the stock of NPLs. In order to reduce it, targeted actions may be required, particularly by helping to develop a secondary market for this kind of assets. As previously mentioned, the authorities have recently adopted measures going in these directions.
Looking ahead, signs of improvement in the credit market are emerging, extending also to the business sector. Credit conditions are reported as gradually easing. Exposure to interest rate risk, even in the case of a prolonged period of low yields, is limited for both banks and insurances. Italian insurers benefit from balanced cash flows, with good matching of yields and duration between assets and liabilities.
As staff underscores, the fiscal stance, which continues to be guided by SGP rules, strikes the right balance between the need to strengthen the fiscal accounts and the need to support economic activity. The authorities remain well aware of the need to lower the public debt ratio. However, we would complement the information included in this respect in the Staff Report with two relevant points that are omitted:
According to the Fund’s structural fiscal indicators (see Table A.23 of the Fiscal Monitor most recent issue), Italy has one of the lowest pension and health care debt among advanced countries (26 percent against an average of almost 134 percent for advanced economic, measured by the NPV of projected increases in pension and health care spending over the next 40 years).
The dynamic of the debt ratio in the last few years has been negatively affected by the above mentioned payment of arrears and, especially, by the support to the euro-area financial assistance mechanisms (for a total of 6.2 percentage points of GDP).
Italy is undertaking simultaneous reforms in multiple critical areas, consistent with the IMF policy advice. The implementation pace has significantly accelerated over the last year, and efforts are paying off: together with improved external conditions, they have favored the turning point of the business cycle.
It is now critical to consolidate the recovery. The stable return to a balanced and solid growth is essential to support the efforts to deleverage public and private balance sheets, reduce the unacceptable levels of unemployment (particularly among the young), and fully unleash the benefits of structural reforms. As argued earlier, the policy agenda is clearly defined and works are advanced on a number of fronts, in a context of continued prudence for fiscal policy. The authorities are determined to keep momentum and to continue delivering. They look forward to further constructive interactions with IMF staff.
In terms of presentation, it is also unfortunate that some of the actions already adopted are often listed in the sections on the “Authorities’ views” – rather than in the sections describing the current situation – leaving the reader wondering whether staff shares the view that the actions were indeed implemented.
The reduction in spending to GDP ratios is not evident in the headline statistics because the cut in labor taxation of €80 per month for lower income dependent workers is not classified as a tax cut according to the methodology followed by the Statistical Institute. However, from an economic perspective, it has all the features of a tax cut, increasing the incentive to work.