Council opinion

of 27 February 2007

on the updated stability programme of Italy, 2006-2011

(2007/C 70/05)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1], and in particular Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 27 February 2007 the Council examined the updated stability programme of Italy, which covers the period 2006 to 2011.

(2) The macroeconomic scenario underlying the programme envisages that real GDP growth will initially decline from 1,6 % in 2006 to 1,3 % in 2007. Afterwards, economic growth will gradually pick up, to reach 1,7 % in 2011. Assessed against currently available information, this scenario appears to be based on plausible growth assumptions. The programme's projections for inflation appear to be on the low side in the outer years.

(3) The 2006 stability programme update projects the 2006 deficit at 5,7 % of GDP [2]. This contrasts with the 4,7 % of GDP in the Commission services' autumn 2006 forecast. The Commission scenario does not take account of the 0,9 % of GDP slippage due to the cancellation of railway company's debt related to the high speed project (Ferrovie dello Stato ‘�RFI/TAV) [3], following a decision taken in the final phase of the budgetary process. In turn, the Commission services' autumn forecast for the general government deficit is higher than the 3,5 % of GDP set in the previous update of the stability programme. The 1,2 % of GDP difference is essentially explained by the different impact of one-offs (0,8 % of GDP) and the permanent negative impact of the European Court of Justice's ruling on VAT on company cars (around 0,4 % of GDP).

(4) The budgetary strategy in the programme aims at correcting the excessive deficit in 2007 (the deficit is planned to decline to 2,8 % of GDP) largely with measures of a permanent nature. Thereafter, the government balance is planned to continue improving steadily over the programme period, to turn into a positive 0,1 % of GDP in 2011. The primary balance is planned to improve from -0,9 % of GDP in 2006 [2] to 5 % in 2011. Until 2007, the adjustment is essentially revenue-based. Beyond 2007, the information is limited to the size of the correction required to achieve the budgetary targets relative to trends. Compared with the previous programme, the targets from 2007 onwards are broadly unchanged against a less favourable macroeconomic scenario but, due to the much higher 2006 deficit starting point, the adjustment in 2007 is much higher.

(5) The structural balance (i.e. the cyclically-adjusted balance net of one-off and other temporary measures) calculated according to the commonly agreed methodology is planned to improve from a deficit of around 4 % of GDP in 2006 to a surplus of 14 % at the end of the programme period (2011). As in the previous update of the stability programme, the medium-term objective (MTO) for the budgetary position presented in the programme is a balanced budget in structural terms, which the programme aims to achieve by the end of the programme period. The previous update of the programme did not plan to reach the MTO within the programme period (which stopped in 2009). As the MTO is more demanding than the minimum benchmark (estimated at a deficit of around 112 % of GDP), achieving it should fulfil the aim of providing a safety margin against the occurrence of an excessive deficit. The MTO lies within the range indicated for euro-area and ERM II Member States in the Stability and Growth Pact and the code of conduct and adequately reflects the debt ratio and average potential output growth in the long term.

(6) The budgetary outcomes could be better than projected in the programme in 2006 and worse than projected in the programme after 2007. For 2007 the risks to the budgetary projections in the programme appear broadly balanced. On the positive side, in view of the developments of cash data, the 2006 deficit could turn out lower than the projected 5,7 % of GDP, implying a better-than-projected base effect for 2007. However, risks are attached to the effectiveness of some measures included in the 2007 budget. Risks to public finances in the medium term cannot be excluded, in particular stemming from the repeated overruns in health care expenditure. In addition, after 2007, no details are given on the adjustment strategy, increasing the risks attached to the planned fiscal consolidation.

(7) In view of this risk assessment, the budgetary stance in the programme seems broadly consistent with a correction of the excessive deficit by 2007 as recommended by the Council, provided the budget measures are fully and effectively implemented. Overall, there are negative risks to the 114 % of GDP planned structural adjustment in 2007. However, available data pointing to a better-than-projected structural adjustment in 2006 (14 % of GDP) could imply a better carry-over into 2007. The budgetary stance may not provide a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations before 2010. Furthermore, it may not be sufficient to ensure that the MTO is achieved within the programme period, as envisaged in the programme. In the years following the correction of the excessive deficit, the pace of the adjustment towards the MTO implied by the programme is broadly in line with the Stability and Growth Pact, which specifies that, for euro-area and ERM II Member States, the annual improvement in the structural balance should be 0,5 % of GDP as a benchmark and that the adjustment should be higher in good economic times and could be lower in bad economic times.

(8) Government gross debt is officially estimated to have reached 107,6 % of GDP in 2006, far above the 60 % of GDP Treaty reference value. The programme projects the debt ratio to gradually decline to reach around 98 % of GDP in 2011. The evolution of the debt ratio is likely to be more favourable than projected in the programme in 2006 given cash data developments. The risks to the projected evolution of the debt appear to be broadly balanced in 2007. After 2007, the lack of details on the adjustment strategy increases the risks attached to the planned debt reduction. In view of this risk assessment, the debt ratio be may not be sufficiently diminishing towards the reference value over the programme period.

(9) The long-term budgetary impact of ageing in Italy is lower than the EU average, with pension expenditure showing a more limited increase than on average in the EU, thanks to the pension reforms adopted, assuming they are fully implemented, notably including the planned periodical actuarial adjustment in line with life expectancy. Increasing the employment rate, notably of older workers, would improve workers' pensions in the future and contribute to the success of the pension reforms. The initial budgetary position, albeit slightly improved compared with 2005, constitutes a risk to sustainable public finances even before the long-term budgetary impact of an ageing population is considered. Moreover, the current level of gross debt is well above the Treaty reference value and reducing it will require high primary surpluses to be achieved and maintained over a long period. Overall, Italy appears to be at medium risk with regard to the sustainability of public finances.

(10) The stability programme contains a qualitative assessment of the overall impact of the October 2006 implementation report of the national reform programme within the medium-term fiscal strategy. It provides some information on the direct budgetary costs or savings of the main reforms envisaged in the national reform programme and its budgetary projections seem to take into account the public finance implications of the actions outlined in the national reform programme. The measures in the area of public finances envisaged in the stability programme seem consistent with those foreseen in the national reform programme. In particular, both programmes address the issue of fiscal sustainability and envisage the implementation of a cut in the labour tax wedge over 2007-2008.

(11) The budgetary strategy in the programme is broadly consistent with the broad economic policy guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has gaps in the required and optional data [4] which need to be closed in the future programmes.

The Council considers that the programme is consistent with a correction of the excessive deficit by 2007, subject to the full and effective implementation of the 2007 Budget. After 2007, the planned adjustment is in line with the requirements of the Stability and Growth Pact and would allow reaching the MTO by the end of the programme period. However, no details are given on the adjustment strategy, which itself represents a risk for the achievement of the budgetary targets after 2007 and hinders a proper assessment of the consolidation strategy.

In view of the above assessment and also in the light of the recommendation under Article 104(7) of 28 July 2005, the Council invites Italy to:

(i) achieve the planned fiscal consolidation in 2007 so as to correct the situation of excessive deficit in line with the Council recommendation under Article 104(7);

(ii) take advantage of better than expected budgetary developments for deficit reduction and ensure, after the excessive deficit has been corrected, adequate progress towards the MTO so as to achieve it by the end of the programme period at the latest and ensure that the debt-to-GDP ratio is reduced accordingly;

(iii) in view of the very high level of debt, fully implement the adopted pension reforms including the planned periodical actuarial adjustment in line with life expectancy so as to avoid significant increases in age-related spending; and

(iv) improve the budgetary process by increasing its transparency, specify in greater detail the budgetary measures with a longer time perspective and effectively implementing mechanisms to monitor and control expenditure, especially health care expenditure;

Comparison of key macroeconomic and budgetary projections

Notes:

Source:

Stability programme (SP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations

| | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 |

Real GDP (% change) | SP Dec 2006 | 0,0 | 1,6 | 1,3 | 1,5 | 1,6 | 1,7 | 1,7 |

COM Nov 2006 | 0,0 | 1,7 | 1,4 | 1,4 | n.a. | n.a. | n.a. |

SP Dec 2005 | 0,0 | 1,5 | 1,5 | 1,7 | 1,8 | n.a. | n.a. |

HICP inflation (%) | SP Dec 2006 | 2,2 | 2,2 | 2,1 | 1,7 | 1,5 | 1,5 | 1,5 |

COM Nov 2006 | 2,2 | 2,3 | 2,0 | 1,9 | n.a. | n.a. | n.a. |

SP Dec 2005 | 2,3 | 2,3 | 2,2 | 2,0 | 2,0 | n.d. | n.d. |

Output gap (% of potential GDP) | SP Dec 2006 [5] | ‘�1,3 | ‘�0,9 | ‘�0,9 | ‘�0,8 | ‘�0,7 | ‘�0,5 | ‘�0,5 |

COM Nov 2006 [9] | ‘�1,4 | ‘�1,0 | ‘�1,0 | ‘�1,1 | n.a. | n.a. | n.a. |

SP Dec 2005 [5] | ‘�1,5 | ‘�1,2 | ‘�1,0 | ‘�0,8 | ‘�0,6 | n.a. | n.a. |

General government balance (% of GDP) | SP Dec 2006 [11] | ‘�4,1 | ‘�5,7 | ‘�2,8 | ‘�2,2 | ‘�1,5 | ‘�0,7 | 0,1 |

COM Nov 2006 | ‘�4,1 | ‘�4,7 | ‘�2,9 | ‘�3,1 | n.a. | n.a. | n.a. |

SP Dec 2005 | ‘�4,3 | ‘�3,5 | ‘�2,8 | ‘�2,1 | ‘�1,5 | n.a. | n.a. |

Primary balance [10] (% of GDP) | SP Dec 2006 [11] | 0,7 | ‘�0,9 | 2,2 | 2,8 | 3,4 | 4,2 | 5,0 |

COM Nov 2006 | 0,5 | ‘�0,1 | 1,8 | 1,7 | n.a. | n.a. | n.a. |

SP Dec 2005 | 0,6 | 1,3 | 1,9 | 2,6 | 3,2 | n.a. | n.a. |

Cyclically-adjusted balance (% of GDP) | SP Dec 2006 [5] [11] | ‘�3,5 | ‘�5,3 | ‘�2,3 | ‘�1,8 | ‘�1,2 | ‘�0,4 | 0,3 |

COM Nov 2006 | ‘�3,4 | ‘�4,1 | ‘�2,4 | ‘�2,5 | n.a. | n.a. | n.a. |

SP Dec 2005 [5] | ‘�3,5 | ‘�2,9 | ‘�2,3 | ‘�1,7 | ‘�1,2 | n.a. | n.a. |

Structural balance [6] (% of GDP) | SP Dec 2006 [5] [7] | ‘�4,0 | ‘�3,9 | ‘�2,5 | ‘�1,9 | ‘�1,2 | ‘�0,4 | 0,3 |

COM Nov 2006 [8] | ‘�3,9 | ‘�3,6 | ‘�2,5 | ‘�2,6 | n.a. | n.a. | n.a. |

SP Dec 2005 [5] | ‘�4,1 | ‘�3,2 | ‘�2,3 | ‘�1,7 | ‘�1,2 | n.a. | n.a. |

Government gross debt (% of GDP) | SP Dec 2006 | 106,6 | 107,6 | 106,9 | 105,4 | 103,5 | 100,7 | 97,8 |

COM Nov 2006 | 106,6 | 107,2 | 105,9 | 105,7 | n.a. | n.a. | n.a. |

SP Dec 2005 | 108,5 | 108,0 | 106,1 | 104,4 | 101,7 | n.a. | n.a. |

[1] OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

[2] The tables in the 2006 Stability Programme do not incorporate the 0,9 % of GDP higher one-off government expenditure due to the cancellation of the railway company's debt, which the programme text refers to. This additional expenditure brings the targeted deficit for 2006 to 5,7 % of GDP, from the 4,8 % reported in the tables, and also affects other budgetary data.

[3] Following a Eurostat decision of 23 May 2005 (see Eurostat News Release No 65/2005), according to which this railway company's debt was already booked as government liability, the government decision has no impact on the debt.

[4] In particular, there is no breakdown of the budget consistent with the deficit targets for the years 2008-2011.

[5] Commission services calculations on the basis of the information in the programme

[6] Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures

[7] One-off and other temporary measures taken from the programme (0,5 % of GDP in 2005, 0,1 % in 2007 and 2008; deficit-reducing. In 2006, 1,4 % of GDP deficit-increasing)

[8] One-off and other temporary measures taken from the Commission services' autumn 2006 forecast (0,5 % of GDP in 2005, 0,1 % in 2007 and 2008; deficit-reducing. In 2006, 0,5 % of GDP deficit-increasing).

[9] Based on estimated potential growth of 1,2 %, 1,3 %, 1,4 % and 1,5 % respectively in the period 2005-2008.

[10] Data on the primary balance in the programme and in the Commission services' forecasts are not directly comparable because of a different treatment of FISIM. Data in the programme follow the definitions required by the code of conduct. To be comparable with data in the programme, Commission data on the primary balance need to be adjusted by around + 0,2 % of GDP.

[11] The budgetary data in the programme for 2006 have been amended to include 0,9 % of GDP of expenditure due to the cancellation by the State of the railway company's debt related to the high-speed project, announced in the stability programme and approved with the final amendment to the 2007 Budget Law.

--------------------------------------------------