In the 2016 DEF (economic and financial planning document), the Italian government has once again opted to postpone fiscal correction. While this will offer support to a still modest recovery of the economic cycle, it may spark a heated debate with the EU…….
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– As expected, in the DEF the Italian government has revised downwards its GDP growth forecasts compared to the previous targets, to 1.2% for 2016 and 1.4% for 2017 (from 1.6% previous). The new estimates are in line with our official forecasts, which date back to more than a year ago, and which we now consider to be exposed to downside risks. The deficit target is essentially confirmed for this year (at 2.3% from 2.4% based on the final version of the Stability Law), whereas it has been revised to 1.8% (from 1.1% previously) for next year. In light of the savings on interest expenditure of three-tenths of GDP a year (as we had expected), the new targets imply an easing of the primary balance of one point of GDP in 2017 (to 2% from 3% previously). The comparison between the government targets and the unchanged policies scenario shows that the government is considering new accommodative discretionary measures, with effects on the deficit of 0.4% in 2017, 0.6% in 2018, and 0.3% in 2019. The most delicate aspect is once again the forecast of the structural balance, which after dropping significantly in 2016 (-0.7%), is expected to correct by just one tenth in 2017 (to -1.1% from -1.2% in 2016, and from -0.6% in 2015), and by three tenths in 2018 (to 0.8%), compared to a “theoretical” adjustment required by EU rules of half a point a year. A balanced budget in structural terms would not be achieved in 2019, either (-0.2%). Also, the levels of structural deficit are estimated to be significantly different by the Commission and by the government: 1.7% vs. 1.3% in 2016, and 1.4% vs. 0.8% in 2017.
– Debt is confirmed on the decline starting this year, but only marginally (to 132.4% from 132.7% in 2015). Debt targets have been revised upwards by around one point for both 2016 and 2017. The level required by the European rule on debt is 123.6% in 2017, as opposed to 130.9% proposed by the government. In the last year of the forecasting horizon (2019), debt would again stay above 120% of GDP (123.8%). Targeted privatisation proceeds (ambitious, in our view) are confirmed at half a point of GDP a year in the 2016-18 period. In other words, the reduction of debt this year, considered especially important in order to achieve an improvement in Italy’s sovereign rating, seems too modest to be shielded from risks. Based on the growth-sensitivity analyses contained in the DEF itself, slower growth by 2-3 tenths (a scenario we do not see as particularly unlikely) could be enough to push debt up, rather than down, in 2016.
– The unchanged legislation scenario seems credible, because although downside risks to growth estimates still exist following the revision, they are balanced by further margins offered by interest expenditure savings. Our conservative forecast for the latter is around three tenths of GDP a year in the 2016-18 period (3 billion euros this year, 6-7 per year in the next biennium). However, based on our forecasts for the government bonds’ yield curve, savings could prove even greater (5 billion euros, i.e. 0.3% of GDP this year, and 12-15 billion. i.e. 0.7-0.9% of GDP in 2017-18). In other words, we suspect that interest expenditure is being used, once again, as has repeatedly been the case in public finance documents in the past few years, as a buffer capable of absorbing potential disappointments on other balance sheet items, as at least in the past few years the ex-post primary surplus has come in significantly lower than initial targets, due either to downside surprises from GDP growth, or to not fully effective funding measures.
– At the same time, the new targets will not meet the European rules on structural correction and debt, unless new, ample margins of flexibility are allowed (more than justified, in our view, but in theory not provided for by European rules for two consecutive years, until the Medium-Term Objective is reached).
– Furthermore, even in the event of such flexibility being conceded, significant spending cuts will be needed to cover the safeguard clauses (15 billion euros in 2017) and eventually the further tax cuts promised. The DEF confirms these targets, generically referring to “spending review measures” (including tax expenditure) and heightened fiscal compliance. The fiscal policy path is becoming increasingly narrow.
Appendix
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