IMF Concludes 2022 Article IV Consultation with Italy

Washington, DC: On July 27, 2022, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Italy.

The Italian economy rebounded vigorously from the COVID-related drop in output and has avoided economic scarring. Employment and labor force participation have fully recovered, and banks’ nonperforming loans have continued to decline and their capital positions have strengthened. Nevertheless, the economy is now facing major new challenges. The war in Ukraine and COVID-related disruptions to global supply chains have pushed up energy prices and inflation more broadly and intensified shortages of key products, even as global demand is slowing. Ensuring an adequate supply of energy is a priority. A severe drought across the Northern part of the country will further pressure food prices and exacerbate energy security challenges. Yields on Italian government bond have risen and spreads have widened on the prospective tightening of monetary policies and political uncertainty amid a weakened global outlook. Reinvigorating trend growth is essential to strengthen public finances in order to meet social, climate and other goals, while also moderating the high level of public debt .

Growth is projected to moderate sharply and remain subdued owing to the war in Ukraine, monetary policy tightening, continued supply chain disruptions and higher and more persistent inflation. In all, the economy is forecast to expand by 3 percent in 2022, mostly on strong carryover from last year, with a further slowdown to around ¾ percent in 2023. Annual average inflation is expected to peak in 2022 at 6¾ percent and to moderate gradually thereafter. In subsequent years, as energy prices moderate, growth is forecast to pick up, reinforced by public investment spending under the National Recovery and Resilience Plan (NRRP).

Uncertainty surrounding the baseline forecast is high, and downside risks could materially affect the outlook, complicating the task of reducing public debt. A further spike in energy prices and/or a rapid tightening of financial conditions could compress growth, and weigh on fiscal consolidation efforts. Difficulties delivering NRRP investments and reforms would reduce support for demand, weaken longer-term productivity enhancements and delay EU financing. Sustained high inflation could erode recent external competitiveness gains. A complete suspension of Russian energy imports in the coming months could reduce output significantly this year and next relative to the baseline.

Executive Board Assessment[2]

Executive Directors commended the authorities’ effective pandemic policy response, which delivered a robust and full recovery. However, major new challenges brought about by elevated energy prices related to Russia’s invasion of Ukraine, as well as tightening financial conditions, global supply chain disruptions, and political uncertainty have considerably dimmed the economic outlook. Together with longstanding weak productivity, these factors bring to the fore risks associated with Italy’s high public debt.

Directors underscored the need for sustained, decisive improvements in fiscal balances, commencing this year by saving part of revenue overperformance. They commended the authorities’ pre-emptive efforts to strengthen the security of energy supplies and recommended that compensation for higher energy prices be temporary and targeted, and that price signals be retained. Rationalizing current spending, broadening the tax base, strengthening tax compliance, and implementing growth-enhancing reforms-including public administration, civil justice, and competition-are needed to achieve and maintain a sizable primary surplus to keep public debt on a firmly downward path.

Directors welcomed the resilience of the banking sector to the pandemic shock but suggested caution given the highly uncertain outlook. Banks should prepare for severe downside scenarios and temporary capital conservation may be warranted in specific cases, including to cope with potential weakening of asset quality. Continued close monitoring, including of smaller and weaker banks, will be important. More efficient debt restructuring to help firms avoid financial distress would also be necessary. Directors commended the progress in implementing the FSAP recommendations and encouraged prioritizing key remaining recommendations.

Directors welcomed the authorities’ commitment to their National Recovery and Resilience Plan and commended the timely implementation of Next Generation EU-related targets and milestones. They recommended continued steadfast progress to lift labor productivity, investment, and potential growth, as well as accelerate the green transition. Efficient execution of public investment and strong reform momentum will be essential for success. Improving carbon tax design, making green investment incentives more cost-effective, and streamlining approval procedures for investments in renewables would help accelerate decarbonization and strengthen energy security. A number of Directors saw merit in a coordinated EU approach on carbon taxation. Directors encouraged a continued strengthening of the anti-corruption and AML/CFT frameworks.