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DEF 2017

April 12, 2017

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Economic and Financial Document - Analyses and Trends in Public Finances

Economic and Financial Document (DEF 2017)

SECTION I

SECTION II

SECTION III

Annexes to the DEF

Introduction

Route Taken and Results Achieved

The 2017 Economic and Financial Document (DEF) is the fifth presented during the current legislature; it offers an opportunity to evaluate past experiences and the results achieved so far, as a basis to guide future economic policy choices. After a profound and lengthy crisis, in 2014 the Italian economy started on a path of gradual recovery which strengthened little by little in the following two years. GDP for 2014 was revised upwards by nearly Euro 10 billion in nominal terms, and 2015 GDP by over 9 billion compared to estimates from a year ago.
This is a more gradual recovery than in previous economic cycles following less deep and prolonged crises, but it is extremely significant, in particular given the boost to the labour market: according to the most recent data available the number of people in work has exceeded by 734,000 the low point reached in September 2013. Partly resulting from the measures included in the Jobs Act, this improvement in labour market conditions saw a drop in the number of inactive people, the unemployment rate and the use of IGC; household consumption has benefited too, growing by 1.3% in 2016, this being an area the government has addressed through various economic policy measures.
Several lines of evidence also indicate a recovery in the competitiveness of the Italian economy, long undermined by a stagnation in productivity that was especially evident in the decade preceding the crisis: in the last two years the trade surplus has reached historically high levels and is among the most substantial in the European Union. The prospects for exporters remain favourable for 2017.
The strengthening of growth and competitiveness has benefited from the expansionist measures adopted by the Government, always bearing in mind the need to continue pursuing fiscal consolidation. The deficit decreased from 3.0% of GDP in 2014 to 2.7% in 2015 and to 2.4% in 2016; the primary surplus (i.e. the difference between income and expenditure net of interest on the public debt) amounted to 1.5% of GDP in 2016.
To fully appreciate the efforts made by the country in terms of fiscal adjustment in past years, it should be noted that between 2009 and 2016 Italy was the Eurozone country which together with Germany maintained the highest average primary surplus and was among the few countries to have a positive balance, whereas most other Member States saw their position deteriorate over that period.
Fiscal policy has given priority to interventions that promote investment, productivity and social cohesion. Using the increased revenues resulting from the fight against tax evasion to reduce taxes and the strengthening of growth are factors that have made way for a significant reduction in fiscal pressure. The sum of the various tax reductions or equivalent measures, starting with the monthly reduction of Euro 80 in income tax for employees with low and average incomes, already brought the tax burden down to 42.3% in 2016 (net of the income tax reduction of Euro 80) from 43.6% in 2013. In addition to relief for families, the overall tax burden for businesses has been significantly lowered through changes to IRAP (2015), IMU (2016) and IRES (2017).
the sustainability of public finances: after rising by more than 32 percentage points between 2007 and 2014, this indicator has substantially stabilised in the last two years, an achievement that is all the more significant in the light of the limited changes in prices in the period.

The outlook for growth and public finances in the wake of the strategy adopted thus far

The top priority of the government - and of the fiscal policy outlined in the DEF - remains to increase growth and employment steadily, while respecting the sustainability of public finances; in this sense, the forecasts are based on the principles of prudence that have led to the high reliability of estimates and projections in recent years, in order to ensure confidence in the planning of public finances.
The Italian economy is moving in a favourable direction. In the second half of 2016 growth accelerated, benefiting from the rapid increase in industrial production and, on the demand side, from investment and exports. The confidence of Italian companies is increasing significantly in a European context that is becoming more solid.
There are background concerns relating to geopolitical risks and the consequences of any protectionist trade policies espoused by the new US administration. Among the various factors underlying the increased uncertainty has been growing concern about the results of referenda and elections in Europe and the USA: at this stage these appear not only to promise transitions between opposing political views but also to risk triggering systemic instability.
Compared to previous forecasts, today's outlook benefits from the expansion of Italy's export markets and the lower exchange rate. The improvement in economic data and expectations in advanced economies, including Italy, could justify a significant upward revision of the GDP growth forecast for 2017. However, conservative estimates have been chosen, making the programmed growth forecast for 2017 1.1% (only a tenth higher than the 2016 DEF Update).
It is the intention of the Government to continue following the economic policies adopted since 2014, aimed at freeing the country's resources from an excessive burden of taxation and at the same time boosting investment and employment within the constraints of the need for fiscal consolidation. The plan foresees paying net debt down to 2.1% in 2017, then to 1.2% in 2018 and to 0.2% in 2019 until it reaches a zero balance in 2020; these forecasts incorporate the fiscal policy and expenditure control measures, still being finalised, which will reduce the net debt of the public administration by 0.2% of GDP in 2017. The change in the structural balance is in line with the Stability and Growth Pact rules for the full three-year period 2018-2020. Structural budget balance is to be fully achieved in 2019 and 2020.
With regard to the existing commitment not to increase VAT rates and excise duties, the Government intends to replace these with measures on both the expenditure and revenue fronts, including additional moves to combat tax evasion. This objective will be pursued in the 2018 Budget to be defined in the coming months; it will benefit from a reform of financial reporting procedures that will facilitate the spending review. The forecast debt/GDP ratio calculated for 2017 amounted to 132.5%; it incorporates any precautionary recapitalisation of banks as well as income from disposals of real estate and of shares in public companies. Following the stabilisation achieved in recent years, this would be the first slight decrease in the indicator since the start of the crisis.
The Government considers it a priority to give new impetus to public investment; in this regard the public finance manoeuvres adopted between 2008 and 2013 weigh heavily: the time needed to complete the works has held back the growth of expenditure for investment in subsequent years. To achieve greater efficiency and rationalisation of investment spending it is necessary to reactivate a proper process for planning and evaluating works, providing the procedural and financial certainties that are essential to investment. Given the lack of evaluation and planning capacity of the contracting entities and of the Administrations that plan and finance the construction of public works, the Government intends to establish centralised organisations to carry out technical evaluation and support activities on behalf of local governments.
Alongside the revival of public investment the Government intends to pursue actions to strengthen the competitiveness of Italian companies, following up on operations undertaken in the last three years. The measures taken to support all industrial inputs have channelled the energies of Italian entrepreneurs toward growth in size and internationalisation, opening up the Italian system to attract capital, people and ideas from abroad. The 'Finance for Growth' measures are helping companies to improve their governance and to access capital markets; the recent reform of Individual Savings Plans provides, for the first time, a tool that helps channel private savings into the real Italian economy.
Incentives for labour productivity have complemented the effects of the Jobs Act, while facilitation measures for depreciation are supporting the recovery in private investment, particularly in technology. Tax credits for research and development and the patent box which have also recently been introduced are further incentives for Italian companies to position themselves in the high end of the value chain. In addition, the tax cut has allowed Italian companies to improve their competitive position, in particular compared with the main European countries; more generally, interventions on corporate taxation have favoured capital formation, making taxation neutral with respect to the legal form chosen.
For the support of business investment and Italian families the banking system will continue to play a crucial role, although the introduction and promotion of new channels and financing instruments should reduce dependence on banks as the only financial intermediaries. To promote the adaptation of the banks' business model to the opportunities offered by the new environment, since 2015 various measures have renewed and deeply strengthened the sector, removing some of the constraints that have held back the lending system in the past; for example, excessive fragmentation of the market and the excessive time needed for recovery of bad loans.
The reform of the “people's” banks [banche popolari], the self-reform of the banking Foundations with the Government's help and the reform of the cooperative banks (BCC) contribute to the consolidation of the banking sector: the new aggregations have resulted in larger, stronger and more transparent banks that are capable of enhancing and protecting savings and supporting the recovery with more modern and efficient services to households and businesses. The reforms promoted with the aim of raising the quality of corporate governance of banks and strengthening their ability to raise capital in the market also facilitate the disinvestment of non-performing loans; in this context, the introduction of guarantee mechanisms on securitisation of bad debt and the speeding up of credit recovery times, particularly high in Italy, reduce the costs of recovery, improving the worth of the positions in the event of disposal. The most recent data show some positive trend reversals in the sector.
The measures to push growth, investment and employment complement the efforts undertaken in recent years to remove structural impediments to growth on many fronts, such as the labour market, the banking sector, the capital markets, the tax rules, schools, the public administration and civil justice. The 2017 National Reform Program aims to continue action on the ambitious reforms initiated in 2014 for structural change in the economic and social fabric of the country; a significant part of the initial program of interventions has been completed, as was also recognised by the recent Report on Italy drawn up by the European Commission.
The main actions undertaken over the last year include: laying the foundation for a more efficient public administration, simple, digital, cost-effective and transparent; identifying operational tools to address the mountain of non-performing loans resulting from the crisis; furnishing the banking system with the tools to maximise market solutions with the support of State guarantees; completing reform of the labour market, which is encouraging the growth of employment and quality of work; and for the first time the country has adopted a national structural tool for combating poverty - Assistance for Active Inclusion that will be replaced by the Inclusion Income - which aims to promote the reintegration into society and the labour market of those who have been excluded.
Industry Plan 4.0 - based on actions in support of productivity, flexibility and the competitiveness of our products – is designed to promote productive technological change aiming for strong growth in competitiveness. Much progress has been made in the area of civil justice and there has been a substantial reduction in the backlog of administrative procedures. Further work has been done in simplification and plans for infrastructure and logistics, and the revival of the slum areas of the big cities. Reform of the budget process has been completed with the unification of the Budget Law and the Stability Law into one integrated measure. Tax administration reform has been fully implemented at a formal level and is now producing substantial effects with the introduction of attitudes and behaviours that are improving relations with the taxpayer and consequently increasing the rate of spontaneous fulfilment. Finally, measures have been strengthened to reverse the brain-drain and attract human capital.
Despite the number and weight of the reforms adopted we must carry on along this path without delay: the interventions on the structure of the economy need time to produce their full effects and, by mutually supporting each other, raise the growth potential.
The priorities of the Government include the need for further opening up of different sectors to market forces, with the aim of delivering tangible benefits to the public in terms of increased choice, investment, productivity and growth: from professional services to retail trade to local public services. To this end, quick approval of the annual competition law is an essential objective, together with the immediate definition of an appropriate legislative instrument to govern the next steps in liberalisation.
On the labour market, the Jobs Act must be followed by a strengthening of active employment policies, those intended to boost skills and to support family welfare measures. On the other hand, actions relating to employment are also the basis for policies to stimulate growth and productivity. In this context, the Government sees as essential the role of second level wage bargaining which should be further enhanced by targeted interventions in the field of corporate welfare.
Efforts to combat poverty will focus on an innovative strategy outlined in the enabling act passed by Parliament last March and that the government has firm plans to implement in the coming months. It authorises the government to take action in three areas: i) the launch of the Inclusion Income, a universal measure of economic support for families in poverty that will take the place of the current Assistance for Active Inclusion, with a progressive widening of the base of beneficiaries (already in 2017 more than 400,000 households, for a total of 1,770,000 people), a redefinition of economic benefit that is conditional upon participation in projects of social inclusion and a strengthening of services to help people stand on their own feet; ii) the reorganisation of welfare benefits aimed at combating poverty (purchase cards for minors and the ASDI unemployment benefit); iii) the strengthening and coordination of activities in the field of social services, aimed at ensuring greater territorial uniformity in the provision of benefits. The resources allocated amount to approximately Euro 1.2 billion for 2017 and Euro 1.7 billion for 2018.
The coming months will see continuing implementation of the judicial reform measures that have already been started, particularly with regard to criminal trials, the efficiency of civil trials and statutes of limitations. The action of the Government is intended to reconcile the need to ensure adequate time for the investigation of criminal offences with the need to ensure a reasonable duration of the process. Increased resources will be available to the judiciary. The adoption of best practices will be further encouraged so as to make it possible to harmonise the performance of the courts in both qualitative and quantitative terms. Improvements to the legislative framework on insolvency will make the management of bankruptcy proceedings more effective, in order to establish a comprehensive governance of the matter and give more certainty to companies experiencing a crisis.
March 2017 saw completion of reporting for the 2007-2013 programming cycle. Despite the delay in spending through 2013, effective reprogramming, a renewed political impetus and innovative actions in administrative support for the managing authorities meant that the accounting report completed on 31 March 2017 showed full absorption of European funding. The new 2014-2020 program began both by strengthening institutional cooperation and programming, coordinated with the Regions through a central control function for the management of development and cohesion funds, and through a new policy for the South based on an active Government role and significant delegation of responsibility to local administrations, the whole being implemented through the Master Plan and Pacts for the South. Continuing on from the previous government's work, the central role of cohesion policy and the question of the South as a national issue has been re-emphasised. The immediate measures to strengthen the tax credit on private investment, the rebalancing of the ordinary capital expenditure of the central government in favour of the South, the institutional innovations for effective programming and planning of interventions and accelerated spending on cohesion programs, along with signs of economic vitality in the South over the last two years, confirm the target of a change in policies and the dynamics of the gap between the South and the rest of the country.
Measures for income support and modernisation of the system will continue to be complemented by a comprehensive strategy of public spending review; the continuation of the work to correct public finances will also be based on a new phase of the spending review which must be more selective and at the same time be consistent with the principles established by the budget reform. This objective also involves a more extensive use of tools for the rationalisation of the purchase of goods and services by the public administration.

Fair and Sustainable Wellbeing

The crisis, and globalisation before that, made clear the limits of economic policies oriented exclusively toward GDP growth. The increase in inequality in recent decades in Italy and in most developed countries and the continuing insufficient attention to environmental sustainability call for more intense public debate and rethinking of strategies in economic policy.
With this in mind, in August 2016 in the reform of the law on accounting and public finance, the parliament voted by a large majority to include fair and sustainable well-being among the objectives of the Government's economic policy. The DEF must give an accounting of the main factors of well-being in the past three years and, for the same variables, must predict future trends and the impact of policies. Italy is the first advanced country to give itself such a task.
The law mandates a Committee for fair and sustainable well-being to select and define the indicators that governments will be required to use to monitor the evolution of well-being and to assess the impact of policies; pending its conclusions, the Government has decided to introduce some provisional indicators of well-being already this fiscal year. Alongside the traditional targets – first of all GDP and employment which continue to be crucial indicators for assessing and promote the welfare of citizens – the DEF reports on changes in average disposable income, income inequality, lack of participation in the labour market, and emissions of CO2 and other climate-altering gases. The DEF also sets policy objectives for these variables.
For the 2014-2016 three-year period the data show a substantial improvement in the indicators considered with the exception of emissions which, of course, reflect the impact of the economic recovery. In particular, inequality shows a significant decrease as a result of growth in employment and the effectiveness of the measures put in place in recent years. The Government's objective is to continue to reduce inequality over the next three years.

Needed Reform in the European Union

The Italian Government considers it a priority to continue to promote its own strategy for reform of the European institutions. A new form of governance is needed which, along with monetary and financial integration, will have to set as its central points economic growth, employment and social inclusion, and it must introduce a means of risk-sharing among member countries alongside the means of risk reduction associated with each individual country. Increased sharing of risks improves the capacity and flexibility of the Member States to adjust to shocks and helps reduce any specific risks. The new governance of the area should promote budgetary policies that are favourable to growth, which should be better distributed among Member States.
Europe will need to adopt shared mechanisms that can alleviate the cost of reallocation of labour and of crises involving a sector or a territory; a common tool for macroeconomic stabilisation will also allow countries that are subject to strict budgetary constraints to adopt counter-cyclical policies to respond to an increase in unemployment in the case of asymmetric shocks. Greater risk-sharing between countries would not reduce the incentives to adopt national reforms. Instead, the non-sharing of efforts to meet common challenges risks jeopardising public European assets that are essential for the integration process.
The management of flows of migrants and asylum seekers to countries of the Union represents an unprecedented challenge that Europe is facing today in the field of freedom of movement of persons, respect for human rights and the security of Europe's citizens. This is a systemic crisis to which we must provide a common European response, through a common management of borders. Integration policies in national labour markets need to be planned and implemented; this would make it possible to reap the benefits traditionally associated with immigration which, in an ageing society, will in the medium to long term outweigh the short-term costs associated with the management of migration flows.
In parallel, a targeted and reinforced cooperation should be established with the countries of origin and transit of migrant flows that includes an investment plan to address the root causes of the phenomenon, the search for decent living conditions, for safety, for a job. Any offer of financial and operational support to partner countries must be conditional upon precise commitments in terms of effective border control, reduction of the flow of migrants, cooperation on repatriation/readmissions, and the strengthening of law enforcement against trafficking in human beings and terrorism.

***

In the light of the need for consolidation dictated by the high public debt accumulated in previous years, since 2014 the limited room for fiscal manoeuvre has been used to support growth and competitiveness. With a new focus on the composition of the budget, cutting unproductive expenditures to finance investment and a reduction in the tax burden, the country has embarked on a virtuous but narrow path between two opposing requirements, to reduce the deficit and to support growth. This has led to positive growth figures, while avoiding dangerous falls in prices, and has allowed us to contain the fiscal deficit and stabilise debt.
These are results that are not to be underestimated. Just as we must not underestimate the strict constraints that the public finances will continue to face in the future: these relate to a likely reduction in monetary stimulus, medium-term objectives that have not been achieved and high and widespread geopolitical risks. The tenor, composition and intensity of the economic policies the Government adopts will continue to be consistent with this defined pathway.
The intensity of fiscal consolidation, but also the various economic policy options, will therefore be evaluated not only based on short-term goals, but especially for their medium and long-term implications, considering that the march towards a solid public financial position is a necessary commitment to the new generations to come. Healthy public finances produce concrete effects on the budget by helping to reduce the interest burden which absorbs resources that otherwise could be directed to economic policy objectives such as reducing the tax burden, investment and social inclusion.
Careful reflection on the practical value of the country's credibility is particularly relevant in the light of the widespread expectation that the ECB will end its program of sovereign bond purchases by the end of 2018. Italy must not find itself unprepared.

The Main Numbers

TABLE I.3: PUBLIC FINANCE INDICATORS (in percentage of GDP)(1)
  2015 2016 2017 2018 2019 2020
PLANNING FRAMEWORK
Net debt  -2,7 -2,4 -2,1 -1,2 -0,2 0,0
Primary Balance  1,5 1,5 1,7 2,5 3,5 3,8
Interest  4,1 4,0 3,9 3,7 3,7 3,8
Net Structural Debt(2) -0,5 -1,2 -1,5 -0,7 0,1 0,0
Structural Variation  0,3 -0,7 -0,3 0,8 0,8 -0,1
Public Debt (inc. support loans)(3) 132,1 132,6 132,5 131,0 128,2 125,7
Public Debt (net of support loans)(3) 128,5 129,1 129,1 127,7 125,0 122,6
Objective for debt rule(4)           123,7
Proceeds of privatisations 0,4 0,1 0,3 0,3 0,3 0,3
TREND FRAMEWORK
Net debt  -2,7 -2,4 -2,3 -1,3 -0,6 -0,5
Primary Balance  1,5 1,5 1,5 2,4 3,1 3,4
Interest  4,1 4,0 3,9 3,7 3,7 3,8
Net Structural Debt(2) -0,5 -1,1 -1,6 -0,7 -0,2 -0,4
Structural Variation 0,3 -0,6 -0,5 0,9 0,5 -0,1
Public Debt (inc. support loans)(3) 132,1 132,6 132,7 131,5 129,3 127,2
Public Debt (net of support loans)(3) 128,5 129,1 129,3 128,2 126,0 124,1
MEMO: Draft Budgetary Plan 2017 (October 2016) 
Projected net debt    -2,4 -2,3 -1,2 -0,2  
Net Structural Debt(2)   -1,2 -1,6 -0,7 -0,2  
Public Debt(5)   132,8 132,6 130,1 126,7  
MEMO: UPDATE NOTE TO DEF 2016 (September 2016)
Net debt  -2,6 -2,4 -2,0 -1,2 -0,2  
Primary Balance  1,5 1,5 1,7 2,4 3,2  
Interest  4,2 4,0 3,7 3,6 3,4  
Net Structural Debt(2) -0,7 -1,2 -1,2 -0,7 -0,2  
Structural Variation  0,2 -0,5 0,0 0,5 0,6  
Public Debt(5) 132,3 132,8 132,5 130,1 126,6  
Trend of nominal GDP (absolute value in thousands) 1.645,4 1.672,4 1.709,5 1.758,6 1.810,4 1.861,9
Planned nominal GDP (absolute value in thousands)   1.645,4 1.672,4 1.710,6 1.757,1 1.809,3 1.860,6
  • (1) Discrepancies are due to rounding.
  • (2) Net of one-off items and the cyclical component.
  • (3) Including or net of Italy's share of EMU loans to Member States, bilateral loans or loans made through the EFSF, and of the contribution to the ESM's capital. At end 2016 these shares totalled about 58.2 billion, of which an amount of 43.9 billion represented bilateral loans and loans through the EFSF and 14.3 billion the ESM program (see the Bank of Italy's statistical bulletin 'Public Finance: Borrowing Requirements and Debt' of 15 March 2017). In 2015 and 2016, preliminary estimates of government debt published in March by the Bank of Italy slightly increased (about 200 million per year) as a result of ordinary statistical revisions. The estimates take into account privatisation proceeds and additional savings earmarked for the amortisation fund amounting to 0.3% of annual GDP over the period 2017-2020. The planning estimates are based on the hypothesis of a gradual exit from the Single Treasury only from 2021. Also assumed is a reduction of the MEF's cash balances of almost 0.7% of GDP in 2017, and over 0.1% of GDP in 2018 and 2019. The estimates assume increases in the harmonised index of consumer prices (HICP) of the Euro Area of 1.5% in 2017, 1.3% in 2018, 1.5% in 2019 and 1.7% in 2020; and increases in the index of consumer prices for families of blue- and white-collar workers (FOI) of 1.2 percent in 2017, 1.6 percent in 2018, 1.5 percent in 2019 and 2.0 percent in 2020. In the planning scenario increases in the FOI index are estimated at 1.5 percent in 2018, 1.4 percent in 2019 and 2.2 percent in 2020.The interest rates used for planning purposes are based on implicit forecasts derived from the forward rates on Italian government bonds as at the time of writing of this document.
  • (4) The debt/GDP ratio that would ensure compliance with the rule on the basis of forecasts for 2020 (forward-looking criteria). For more details see Section III.6.
  • (5) Including or net of Italy's share of EMU loans to Member States, bilateral loans or loans made through the EFSF, and of the contribution to the ESM capital. The estimates take into account privatisation proceeds and additional savings earmarked for the amortisation fund of 0.5% of GDP in the years 2017-2018 and 0.3% of GDP in 2019.

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