Italian Parliament Approves New Austerity Measures Worth EUR48 Bil.
IHS Global Insight Perspective
The Italian parliament has given its final approval to another layer of austerity measures worth EUR48 billion, most of which are expected to take effect in 2013 and 2014. Furthermore, the general government budget deficit is projected to narrow from 4.6% of GDP in 2010 to an estimated 3.9% in 2011 and 0.2% by 2014.
The new austerity measures are an attempt to deflect the increasing contagion felt by Italy from Greek sovereign debt default fears. This has been demonstrated by Italian 10-year bond yields on the secondary bond market rising sharply in the past week.
The new budget deficit consolidation measures appear to be credible, but may need to take effect sooner in order to calm private investors and rating agencies. Another concern is the omission of reform initiatives to bolster Italy's indifferent productivity performance in recent years, thereby to lift its medium-term growth potential.
The Italian parliament has given its final approval to another layer of austerity measures worth EUR48 billion in order to eliminate the budget deficit by 2014, while trying to soften the scale of the contagion hitting Italy from the Eurozone debt crisis. The measures were passed in record time, with the government and opposition parties setting aside their differences to pass the new fiscal plan within a week. The final vote in the lower house was 314 in favour and 280 against. Most of the budget consolidation measures are expected to take effect after the general election in 2013, while less than EUR10.0 billion is planned to be implemented before 2013. The government is already activating fiscal savings totalling EUR25 billion over 2011 and 2012. Therefore, the general government budget deficit is now projected to narrow from 4.6% of GDP or EUR71.0 billion in 2010 to an estimated 3.9% in 2011 and 0.2% by 2014. A key assumption is that the austerity measures will allow the primary surplus (general government budget minus interest expenditure) to rise to 5.2% of GDP by 2014 from less than 1.0% in 2011, thereby allowing the government to reduce the public debt ratio from an estimated 120% of GDP in 2011 to 112.8% by 2014.
The main measures on the spending side include trimming central and regional government spending between 2012 and 2014. Central government ministry budgets will be cut by EUR1 billion in 2012, EUR3.5 billion in 2013 and EUR5 billion in 2014. The salary increase and recruitment freeze for public-sector workers will be extended to 2014. Central government transfers to town councils and provinces will be cut by EUR3.2 billion in 2013 and EUR6.4 billion in 2014. The healthcare budget will be trimmed by EUR2.5 billion in 2013 and EUR5.0 billion in 2014.
The government is also looking to accelerate potential savings from Italy's pension system. The measures include delayed retirement for some workers, coupled with a tax on pensions above EUR90,000 per year. The official retirement age for women working in the private sector will be raised from 60 to 65 years, but this will start from 2032. Finally, the introduction of automatic increases to the retirement age on the basis of regular assessments of life expectancy will be brought forward to 2013 from 2015.
On the revenue side, the government will start to consider privatisations of local authority assets and of state holdings in big corporations. The Economy Minister will be required to approve the sale of at least one public enterprise by the end of 2013. "Ticket" payments for certain hospital and medical visits will also be introduced from today (18 July). The government will increase taxes on holders of financial instruments, which is expected to generate EUR0.725 billion in 2011, EUR1.3 billion in 2012, EUR3.8 billion in 2013 and EUR2.5 billion in 2014. Additional changes include a higher tax rate on banks, financial companies and Insurers, plus another layer of taxation to capture variable compensation for managers, particularly stock options and bonuses. There will be a limit on tax deductions that toll road operators can claim on sums paid into a so-called "clean-up fund" to 1% from 5% at present, under budget rules on the amortization of infrastructure assets. The austerity measures also include higher taxes on petrol and diesel that will raise an additional EUR1.7 billion, and on betting and lotteries income which could bring in an additional EUR1.9 billion between 2011 and 2014. The government has also inserted a "safeguard clause" in the new fiscal package that implements curbs on tax breaks for families and companies if savings from the above tax reform plan fail to materialise. The clause will permit a cut in tax breaks of up to EUR4 billion in 2013 and EUR20 billion in 2014.
Outlook and Implications
Italy Faces Stronger Contagion from Greek Sovereign Debt Crisis
The new austerity measures are an attempt to deflect the increasing contagion felt by Italy from Greek sovereign debt default fears in the past week. This has been demonstrated by Italian 10-year bond yields on the secondary bond market spiking up to 5.7% on 15 July, compared to below 4% towards the end of 2010. Furthermore, the average yield spread on Italian and German 10-year bonds stood at 3.0% on 15 July, a record high since the introduction of the euro. The more aggressive austerity drive appears to be credible, particularly with the government's growth forecasts roughly in line with consensus. However, we are concerned that the impact on the budget deficit reduction plan is not sooner in order to calm private investors and rating agencies. The Greek debt crisis has ramped up pressure on Italy to face up the challenges of reducing its excessive debt levels, particularly with growth continuing to disappoint. A key risk is that Italy faces significant financing needs in the next few years. According to the International Monetary Fund (IMF), Italy's gross financing needs (the new overall borrowing requirement, plus debt maturing during the year) is expected to stand at 22.8% of GDP in 2011 and 23.1% of GDP in 2012. The IMF concludes that relatively short average debt maturities and continued budget shortfalls point to significant financing needs in the next few years for Italy.
More Needed on Reform to Lift Italy's Growth Potential
Another concern is that the new austerity measures do not appear to be accompanied by much-needed reform initiatives to improve Italy's indifferent productivity performance in recent years, thereby helping to lift its medium-term growth potential. This could entail dismantling excessive regulation in key sheltered service sectors, like electricity and gas, retail and professional services sectors. The government also needs to address the steady loss of international competitiveness since the inception of the euro. This is a serious problem for Italy, especially when a large slice of its exports are labour-intensive, lower value-added goods such as textiles, apparel, shoes, light manufacturing and so on. Italy will need a real exchange-rate adjustment to improve its underlying competitiveness, which cannot be achieved through nominal currency devaluation given its membership of the Eurozone. Consequently, a favourable shift in the real exchange rate requires a downward adjustment in inflation, which could be achieved by nominal wage restraint stemming from improvements to the wage bargaining system, increased competition among enterprises in the sheltered sectors, or the fostering of improved productivity growth. In more general terms, Italy still needs to adjust more fully from the competitive devaluation model that existed before it joined the euro to a model based on productivity gains and on higher value-added production and services.
Structural Fiscal Reforms Need to Bolster Primary Surplus in Medium Term
The government has grasped the importance of accumulating ever larger primary budget surpluses in the medium term, thereby allowing the public debt ratio to fall steadily. This can be reinforced by deep-rooted structural fiscal reforms, targeting the state's substantial pension and wage commitments, which dominate public expenditure landscape. This is an acute challenge to the government for two reasons. First, the state is a large employer, with the wage bill accounting for around 10% of GDP. Second, pension expenditure, which accounts for most of the social protection budget, is likely to be determined primarily by demographics as the "baby boom" generation retires, and the continued availability of pensions is linked to average earnings. Pension expenditure is expected to remain a heavy burden on the state, at just over 14% of GDP between 2005 and 2025, according to the latest calculations from the Ministry of Economy and Finance.
Low Private Debt Levels Make Italy Less Vulnerable than SpainA major difference between Italy and the other "Club Med" economies and Ireland is that Italy displayed greater fiscal prudence during the global economic crisis, with its overall public-sector budget deficit peaking at 5.3% of GDP in 2009, compared to 11.2% in Spain, 13.6% in Greece and 9.4% in Portugal. Despite excessively high levels of public debt, Italy is still deemed less risky than Ireland, Greece, Portugal and Spain. There appear to be several factors that have helped to deflect some of the contagion following the events in Greece, Ireland and Portugal. First, the markets have been appear to be less demanding of Italy, which is seen as a country with a long tradition of managing high debt and modest growth. Second, the outlook for the Italian banking system is less daunting than most of the Eurozone, partly due to the traditional character of many Italian banks, which are based on a higher dependence on retail deposits for funding than many other European banks. Importantly, the Italian banking system did not oversee a property bubble or even a credit explosion. This is highlighted by the level of household borrowing in Italy being significantly lower than other European countries. Third, the high level of household savings in Italy provides an extra layer of protection. This is borne out by the relatively low share of Italian public debt held by overseas investors, with Italian investors continuing to show an appetite for Italian bonds. Given that more than half of the Italian bonds are held by domestic investors, Italy is less exposed to huge sell-offs by foreign investors.
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