Council Opinion

of 14 March 2006

on the updated stability programme of Italy, 2005-2009

(2006/C 82/06)

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 14 March 2006 the Council examined the updated stability programme of Italy, which covers the period 2005 to 2009.

(2) Between 1995 and 2004, Italian GDP grew at an average rate of 1,5 % per year, below the 2 % of the euro area. Over the last decade, Italy has experienced a marked slowdown in productivity growth, a progressive deterioration in competitiveness leading to a steady loss of export market shares and, since 2000, a significant contraction in manufacturing activity. Italy undertook significant fiscal consolidation efforts during the 1990s, reducing the government deficit from almost 12 % of GDP in 1990 to below 2 % at the end of the decade. However, the deficit rose again above 3 % of GDP in 2001, 2003 and 2004, remaining close to it only thanks to significant one-off measures [2]. The primary surplus, from 5 % of GDP in 1999, fell to 1,8 % of GDP in 2004, and the decline in the debt-to-GDP ratio, which had peaked at 125 % in 1994, slowed down considerably. At the end of 2004, the debt was 106,5 % of GDP.

(3) In its opinion of 17 February 2005 on the previous update of the stability programme, the Council invited Italy to: ensure the achievement of the 2005 deficit target, achieve a budgetary position of close to balance by 2008 and ensure that the debt-to-GDP ratio diminishes at a more rapid pace, paying particular attention to debt-increasing factors other than net borrowing. On 28 July 2005 the Council decided that Italy was in excessive deficit. According to the Council recommendation under Article 104(7) of the same date, the excessive deficit has to be corrected by 2007. On 22 February, the Commission adopted a communication concluding that the actions taken by Italy before the 12 January 2006 deadline set by the Council, if fully implemented, would be consistent with the consolidation path contained in the Council recommendation.

(4) The 2005 deficit is estimated at 4,3 % of GDP, against a target of 2,7 % of GDP set in the previous update. The target was missed due to: (i) a shortfall in GDP growth; (ii) slippages in primary expenditure and sale of real estate, not fully compensated by higher revenues and lower interest expenditure; and (iii) carry-over effects from 2004, essentially due to statistical revisions.

(5) The programme broadly follows the model structure, but deviates on some material points from the data provision requirements for stability and convergence programmes specified in the new code of conduct [3]. The update was submitted three weeks beyond the 1 December deadline set in the code of conduct, reflecting the authorities' wish to incorporate the final version of the 2006 budget.

(6) The macroeconomic scenario underlying the programme envisages that real GDP growth will pick up from zero in 2005 to slightly above 1,5 % on average over the rest of the programme period. Assessed against currently available information, this scenario appears to be plausible. The programme's projections for inflation also appear to be realistic.

(7) The budgetary strategy outlined in the programme aims at reducing the deficit below 3 % of GDP by 2007, pursuing further fiscal consolidation towards a balanced budget in subsequent years. The primary balance is planned to improve from 0,6 % of GDP in 2005 to 3,2 % in 2009. The budgetary correction in 2006 is largely expenditure driven. For the years 2007-2009, the information is limited to the size of the correction required to achieve the budgetary targets relative to trend deficits based on unchanged legislation. Compared with the previous programme, the new update frontloads the planned adjustment against a less favourable macroeconomic scenario. However, the new deficit target for 2008 is 1,2 % of GDP worse than in the previous update, as the frontloading does not fully offset the effect of a much weaker 2005 starting position.

(8) Over the programme period, 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 on average by about 0,75 % of GDP per year. The programme sets the medium-term objective (MTO) for the budgetary position as meant in the Stability and Growth Pact at a balanced budget, which it does not aim to achieve within the programme period. As the programme's MTO is more demanding than the minimum benchmark (estimated at a deficit of around 1,5 % of GDP), its achievement should fulfil the aim of providing a safety margin against the occurrence of an excessive deficit. However, the minimum benchmark would only be achieved in 2009. The programme's MTO is at an appropriate level because it 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.

(9) The budgetary outcomes could be worse than projected in the programme. There are significant uncertainties regarding the implementation of the 2006 budget, in particular of the sizeable expenditure savings. Beyond 2006, there is no information on the measures envisaged, and the size of the needed fiscal correction may be underestimated.

(10) Taking into account the balance of risks, the correction of the excessive deficit by the 2007 deadline set by the Council crucially relies upon a full and effective implementation of the 2006 budget and the specification and implementation of substantial corrective measures for 2007 [4]. The achievement of the safety margin in 2009 also hinges on these risks and on the specification and implementation of corrective measures for the years beyond 2007. In the years following the correction of the excessive deficit, the pace of the adjustment towards the programme's MTO implied by the programme is 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.

(11) The debt ratio is estimated to have reached 108,5 % of GDP in 2005, well above the 60 % of GDP Treaty reference value, and amongst the highest in the EU. The programme projects the debt ratio to decline by 7 percentage points over the programme period. The evolution of the debt ratio might be less favourable than projected in the programme given the risks to the budgetary targets mentioned above and uncertainty about the stock-flow adjustment. In view of this risk assessment, a further strengthening of the budgetary position would be necessary to guarantee a sufficiently diminishing debt ratio towards the reference value.

(12) With regard to the sustainability of public finances, Italy appears to be at medium risk on grounds of the projected budgetary costs of an ageing population. Past reforms have helped to contain future rises in public expenditure and their full implementation, notably of the 2004 pension reform, will be crucial to obtain the expected results. The currently high level of gross debt and the weak budgetary position indicate the necessity for strong consolidation of public finances over the medium-term to reduce risks to public finance sustainability [5].

(13) The envisaged measures in the area of public finances are broadly consistent with the broad economic policy guidelines included in the integrated guidelines for the period 2005-2008. In particular, Italy is taking action to correct the excessive deficit and is committed to ensure an average annual structural adjustment, net of one-off measures, in line with the Stability and Growth Pact. However, it would be appropriate to envisage a more rapid pace of government debt reduction.

(14) The National Reform Programme of Italy, submitted on 14 October 2005 in the context of the renewed Lisbon strategy for growth and jobs, identifies five challenges: extending the area of free choice for citizens and companies (by opening up energy and services markets); granting incentives for scientific research and technological innovation; strengthening education and training; upgrading infrastructure; and protecting the environment. With regard to public finances, a sixth priority, long-term fiscal sustainability, is addressed in the Economic and Financial Planning Document (DPEF) of July 2005. The measures in the area of public finance envisaged in the NRP and the DPEF are broadly in line with the actions foreseen in the stability programme. The update outlines measures to reduce social contributions, encourage private pension savings and reduce health care deficits.

In view of the above assessment, the programme can be considered as consistent with a correction of the excessive deficit by 2007, subject to a full and effective implementation of the 2006 budget and the specification and adoption of further substantial measures for 2007. In the light of the recommendations made by the Council under Article 104(7) of the Treaty on 28 July 2005, and in order to strengthen the sustainability of public finances, the Council invites Italy to:

(i) achieve the structural efforts envisaged in the programme for 2006 and 2007 in order to ensure the correction of the excessive deficit by 2007 in a credible and sustainable manner;

(ii) spell out the broad measures underlying the adjustment path in 2007 and the outer years of the programme and ensure that the adjustment towards the medium-term objective remains in line with the Stability and Growth Pact requirements;

(iii) ensure that the debt-to-GDP ratio is declining towards the 60 % of GDP Treaty reference value at a more rapid pace including by paying particular attention to factors other than net borrowing which contribute to the change in debt levels; and

(iv) improve the budgetary process by increasing its transparency and by an effective implementation of the past and new mechanisms to monitor, control and report expenditure.

Comparison of key macroeconomic and budgetary projections [6]

Notes:

Source:

Stability programme (SP); Commission services' autumn 2005 economic forecasts (COM); Commission services' calculations.

| 2004 | 2005 | 2006 | 2007 | 2008 | 2009 |

Real GDP (% change) | SP December 2005 | 1,2 | 0,0 | 1,5 | 1,5 | 1,7 | 1,8 |

COM Nov 2005 [11] | 1,2 | 0,2 | 1,5 | 1,4 | n.a. | n.a. |

SP November 2004 | 1,2 | 2,1 | 2,2 | 2,3 | 2,3 | n.a. |

HICP inflation (%) | SP December 2005 | 2,3 | 2,3 | 2,3 | 2,2 | 2,0 | 2,0 |

COM Nov 2005 | 2,3 | 2,2 | 2,1 | 1,9 | n.a. | n.a. |

SP November 2004 | 2,2 | 1,6 | 1,5 | 1,4 | 1,4 | n.a. |

Output gap (% of potential GDP) | SP December 2005 [7] | ‘�0,4 | ‘�1,5 | ‘�1,2 | ‘�1,0 | ‘�0,8 | ‘�0,6 |

COM Nov 2005 [12] | ‘�0,5 | ‘�1,5 | ‘�1,2 | ‘�1,2 | n.a. | n.a. |

SP November 2004 [7] | ‘�1,6 | ‘�1,2 | ‘�0,8 | ‘�0,3 | 0,0 | n.a. |

General government balance (% of GDP) | SP December 2005 | ‘�3,2 | ‘�4,3 | ‘�3,5 | ‘�2,8 | ‘�2,1 | ‘�1,5 |

COM Nov 2005 | ‘�3,2 | ‘�4,3 | ‘�4,2 | ‘�4,6 | n.a. | n.a. |

SP November 2004 | ‘�2,9 | ‘�2,7 | ‘�2,0 | ‘�1,4 | ‘�0,9 | n.a. |

Primary balance (% of GDP) | SP December 2005 | 1,8 | 0,6 | 1,3 | 1,9 | 2,6 | 3,2 |

COM Nov 2005 | 1,8 | 0,6 | 0,6 | 0,3 | n.a. | n.a. |

SP November 2004 | 2,4 | 2,4 | 3,3 | 4,0 | 4,7 | n.a. |

Cyclically-adjusted balance (% of GDP) | SP December 2005 [7] | ‘�3,0 | ‘�3,5 | ‘�2,9 | ‘�2,3 | ‘�1,7 | ‘�1,2 |

COM Nov 2005 | ‘�3,0 | ‘�3,5 | ‘�3,6 | ‘�4,0 | n.a. | n.a. |

SP November 2004 [7] | ‘�2,1 | ‘�2,1 | ‘�1,6 | ‘�1,2 | ‘�1,0 | n.a. |

Structural balance [8] (% of GDP) | SP December 2005 [9] | ‘�4,4 | ‘�4,1 | ‘�3,2 | ‘�2,3 | ‘�1,7 | ‘�1,2 |

COM Nov 2005 [10] | ‘�4,4 | ‘�4,0 | ‘�4,0 | ‘�4,0 | n.a. | n.a. |

SP November 2004 | n.a. | n.a. | n.a. | n.a. | n.a. | n.a. |

Government gross debt (% of GDP) | SP December 2005 | 106,5 | 108,5 | 108,0 | 106,1 | 104,4 | 101,7 |

COM Nov 2005 | 106,5 | 108,6 | 108,3 | 107,9 | n.a. | n.a. |

SP November 2004 | 106,0 | 104,1 | 101,9 | 99,2 | 98,0 | n.d. |

[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 budgetary impact of one-off measures amounted to 0,6 % of GDP in 2001, 1,9 % in 2003 and 1,4 % in 2004. In 2002, the deficit was at 2,7 % of GDP, with 1,3 % of GDP of one-offs.

[3] In particular, the optional chapter on "institutional features of public finance" is missing, and the programme also has gaps in the compulsory data and does not provide all optional data prescribed by the new code of conduct (especially, there is no breakdown of the budget consistent with the deficit targets for the years 2007-2009).

[4] An amnesty on unpaid social contributions of the agricultural sector currently debated in the Italian Parliament, if eventually approved and subject to statistical verification, might produce a limited upward revision for the deficit and/or the debt ratio.

[5] Details on long-term sustainability are provided in the technical assessment of the programme by the Commission services(http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm).

[6] The Commission services' autumn 2005 forecast was based on information available up to the cut-off date of 7 November 2005. Therefore, it was based on a draft version of the 2006 budget.

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

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

[9] One-off and other temporary measures as calculated by the Commission services (1.4% of GDP in 2004, 0.6% in 2005 and 0.3% of GDP in 2006; deficit-reducing).

[10] One-off and other temporary measures taken from the Commission services' autumn 2005 forecast (1.4% of GDP in 2004, 0.5% in 2005, and 0.4% in 2006; all deficit-reducing).

[11] The Commission services' interim forecast of 21 February 2006 projects growth of 1.3% in 2006.

[12] Based on estimated potential growth of 1.4%, 1.2%, 1.2% and 1.3% respectively in the period 2004-2007.

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