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Italy Fiscal April 2021

Italy: Parliament approves growth-enhancing Covid-19 recovery package; raises deficit projections

At the end of April, Parliament approved Prime Minister Draghi’s plan for Italy’s post-pandemic recovery. Aiming to boost economic growth as well as address structural weaknesses, the package includes a total of EUR 235.1 billion in spending and reforms, with the large bulk being drawn from the EU’s Recovery and Resilience Plan. Earlier in April, accounting for the planned additional fiscal stimulus, the government hiked its projection for the fiscal deficit for this year. Looking at the longer term, its debt reduction path relies on a sustained pickup in economic growth amid successfully implemented reforms.

The plan—which had to be submitted to the European Commission for approval by 30 April—includes EUR 191.5 billion in loans and grants from the EU’s pandemic recovery pot and another EUR 13 billion from the React EU program, while the country is also planning to raise an additional EUR 30.6 from domestic resources. Moreover, reforms, particularly in the areas of justice and public administration—which have been seen as a longstanding hindrance to growth—have a vital part in the structure of the plan and will be key to the effective functioning of the investment program. Meanwhile, investments focus on six main areas: ecological transition, digitalization, infrastructure, education and research, social inclusion and healthcare—with more than half of the funding set to be spent on green projects and the digitalization of the economy. Overlapping this, around 40% of the total funding will be allocated to southern regions, in a bid to bridge the gap between the north and south. All in all, the government sees the measures boosting GDP by 3.6 percentage points by 2026.

Meanwhile, in mid-April, the Draghi cabinet updated its fiscal strategy for 2021 and beyond. It hiked its budget deficit forecast for this year by EUR 40 billion to 11.8% of GDP from 7.0% of GDP previously, mainly to continue providing subsidies and guarantees to the sectors worst hit by the pandemic. As a result, the government projects public debt to reach 160% of GDP by the end of this year (2020: 156% of GDP), and sees it gradually declining to 135.5% by 2032—close to pre-crisis levels—in a scenario where the recovery plan takes full effect.

Successful implementation of the ambitious recovery package could represent an important opportunity for the Italian economy, as noted by Paolo Pizzoli, senior economist at ING:

“If projects pass the Commission’s scrutiny and reforms are implemented effectively, the investment-driven push to GDP growth characterizing the first years will be eventually morph into productivity-enhanced higher potential growth over the remaining life of the 2021–2026 plan, helping to contrast the drag coming from poor demographics. The obvious, but not trivial, side effect of this would be fostering the sustainability of Italy’s public debt, a highly desirable outcome for a debt-laden country.”

Moreover, commenting on the increased fiscal stimulus and its impact on the debt stabilization path, Loredana Maria Federico, chief Italian economist at UniCredit, reflected:

“Given the fact that the low level of interest rates will leave the cost of servicing a higher public debt manageable, and that it is very difficult to see any discussion of a consolidation path for the budget deficit before 2023, we agree that higher fiscal stimulus (and hopefully investment and reforms) is the right road to making the public debt/GDP ratio sustainable.”

However, analysts at Scope Ratings warn that Italy’s public debt stock might not reach near pre-crisis levels by 2032:

“The risk to budget deficits is […] skewed to the upside—as many households and businesses may require extended support and growth expectations might prove optimistic. […] We expect the Italian debt ratio to remain on an upward trajectory longer term—looking through the cycle. In this respect, general government debt might reach meaningfully higher levels beyond 160% of GDP.”

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