Italy’s economy has recovered from the impacts of the COVID-19 pandemic and energy price shocks as tourism recovered. However, growth has moderated despite substantial policy support. The latest International Monetary Fund (IMF) review of Italy’s economy reveals that despite contributing to Italy’s recovery, expansionary fiscal policy has also kept the deficit and public debt very high, raising the country’s risk premium and impacting private sector investment.
Economy expands
Italy’s economic activity expanded 0.9 percent in 2023 and 0.6 percent in Q1 of 2024. Significant spending on home renovations from tax credits and the increase in utilization of the EU’s National Recovery and Resilience Plan (NRRP) contributed to Italy’s strong performance. Therefore, in 2024 and 2025, the IMF expects Italy’s economy to expand by 0.7 percent as growing NRRP spending offsets the phasing out of superbonus-boosted residential investment.
The IMF also expects Italy’s headline inflation to decline to 1.7 percent in 2024 before increasing to the 2 percent target in 2025. Meanwhile, it expects wage growth to pick up this year and the next.
Primary deficit to narrow
This year, Italy’s government forecasts a primary deficit of 0.4 percent of GDP, narrowing from a primary deficit of 3.4 percent in 2023. The IMF also reveals that the primary deficit has decreased, “but the gap with the 1.75 percent primary surplus that prevailed prior to the pandemic remains very large on the slow removal of temporary crisis-era policies despite the economy’s strong cyclical position”.
Therefore, Italy needs a much larger primary surplus of almost 3 percent of its GDP to ensure a gradual decline in its debt ratio. Moreover, the inability to complete NRRP spending and effectively implement reforms amidst a large deficit could further impact investor confidence in the country’s economy, which will further weaken public finances.
Read: Stress in home loans manageable despite high rates: ECB
IMF’s policy recommendations
The IMF outlines four efforts that Italy needs to enhance investment and productivity, ease spending pressures and prepare for severe shock. Italy needs to implement the following measures to achieve financial growth including:
- Replacing tax wedge cuts and hiring subsidies with measures that permanently boost labor productivity.
- Streamlining pension spending by raising the effective retirement age and avoiding costly early retirement schemes.
- Rationalizing tax expenditures to broaden the base, increase progressivity, and reduce complexity.
- Improving control and oversight of tax credits.
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