Italy: Government more upbeat on growth developments – ING

The updating Note to the DEF projects higher growth and a lower debt profile, also courtesy of the latest revision to national accounts yearly data and the lack of requests for extra fiscal flexibility could earn the government the Commission’s greenlight, according to Paolo Pizzoli, Senior Economist at ING.

Key Quotes

“Last Saturday, the Italian government approved the updating Note to the 2017 DEF, the economic and financial document which sets the macro framework for the following stability (budget) law.”

“The new set of forecasts is more upbeat about the economy than the April version. GDP growth is now expected to reach 1.5% YoY in 2017 (was 1.1% in the DEF) and to continue at the same pace in 2018 and 2019 (was +1.0% for both years in the DEF). Over the three-year horizon, economic growth is expected to be fully driven by domestic demand net of inventories, with the positive contribution of exports fully compensated by imports. Concentrating on 2018, the domestic demand drive builds on the assumption that the planned increase in VAT rates, the so-called safeguard clauses, will be entirely sterilized once more, avoiding an inflation blip which could have weighed on real disposable income and, ultimately, on private consumption.”

“On the investment front, the underlying assumption is that the so far tentative recovery in the machinery and plant component will eventually play out in full. Year to date, extremely upbeat sectoral confidence and order book indicators from the industrial surveys have not been matched by national account data, but the gap is expected to fill already in 2H17. In the government’s view, the projected partial confirmation of investment-enhancing tax incentives in the 2018 budget should help sustain the machinery investment recovery next year.”

“In the document the government incorporates the latest yearly national accounts estimate updates released by Istat last Friday. The upgraded nominal GDP profile and deficit estimates have affected relevant public finance ratios. According to the new data, in 2016 the debt/GDP ratio was 132% (down from the previous estimate of 132.6%) while the deficit/GDP ratio was 2.5%.”

“The Note makes explicit that the Italian government will not ask for extra fiscal flexibility over that what was already requested by Finance Minister Padoan in his letter to the EU Commission. Italy will target a 0.3% structural adjustment for 2018 (vs 0.8% as originally agreed with the Commission) and continues to aim for a quasi-balanced budget (both in nominal and in structural terms) by 2019. In nominal terms, this translates to a headline deficit target of 2.1% in 2017 and 1.6% in 2018. The general government debt /GDP ratio is seen declining to 131.6% of GDP in 2017 and to 130% in 2019, on the back of an improvement in the primary surplus from an upwards revised 1.7% of GDP in 2017 to 2% in 2018 and thanks to the recovery in the GDP deflator expected in 2018.”

“The Note clearly states that the fiscal flexibility assumed in the new numbers will be used for specific aims, namely to finance incentives for private investments, to strengthen public investment, to finance the cut to the tax wedge on youth employment, and to provide some revenue integration for the poor. The sterilisation of VAT hikes and the measures above will be covered by a manoeuvre worth some 0.5% of GDP, a third of which should come from expenditure cuts and two-thirds from the revenue side. All of these measures will have to be detailed in the forthcoming budget, with a draft to be submitted to the EU Commission by mid-October.”

“What is our take-away from the new government numbers?

We expected an upwards revision to 2017 forecasts and both the 1.5% GDP growth and the 2.1% deficit/GDP numbers seem reasonable. A marginal reduction in the debt/GDP ratio is also possible this year and looks set to continue in 2018, even under less upbeat growth forecasts. However, we are a bit sceptical about the continuation of growth in 2018 and 2019 at the 1.5% clip. A strong euro will hardly help to maintain the current momentum in export growth, even though the positive international growth backdrop might remain supportive.

We agree that domestic demand will be the main driver of growth, but believe that the scarce resources available in the budget might not be enough to propel employment and private investment enough to meet the government’s forecasts. While acknowledging that the composition is a positive note, the determination of PM Gentiloni and Finance Minister Padoan to stick to their word as far as fiscal flexibility is concerned should earn them the Commission’s greenlight, helping to create the conditions for an orderly end to the current legislature. This is a valuable asset in view of a highly uncertain political election round.”