OECD Economic Outlook, Volume 2022 Issue 2

Italy

Real GDP growth is projected at 3.7% in 2022, slowing to 0.2% in 2023, before picking up moderately to 1% in 2024. High energy prices will act as a brake on production in energy-intensive industries, while falling real incomes due to high inflation, increasing interest rates and subdued export market growth will moderate demand growth. Unemployment will rise and labour market participation decline, with employment shrinking in 2023. Consumer price inflation is expected to come down only gradually from about 10% at the end of 2022, as energy price caps are phased out in 2023 and recent increases in energy and food prices are triggering wider price pressures.

Monetary policy tightening will partly be offset by higher public investment related to the National Recovery and Resilience Programme. Timely implementation of new investments, reform of the competition law and the effective targeting of energy crisis support measures will be paramount to sustain activity in the short term and to lay the ground for sustainable growth in the medium term.

Activity is slowing

Following strong growth over the first three quarters of 2022, recent high-frequency indicators point to a decline in activity. Industrial production has been resilient, but retail sales and confidence indicators have been weakening. Employment has been trending down recently, although unemployment has continued to recede. Overall, the recent weakness of activity indicators, rising borrowing costs and the erosion of real household incomes related to high inflation are driving a turning point in activity.

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1. Gross public debt, Maastricht definition.

Source: OECD Economic Outlook 112 database; OECD Economic Outlook 110 database; OECD Economic Outlook 111 database; and OECD calculations.

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Italy: Demand, output and prices

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1. 10-year interest rates.

Source: OECD Economic Outlook 112 database; and OECD calculations.

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Large price increases for energy and agricultural commodities on international markets are being passed on to domestic inflation, which approached 13% in October. The substitution of Russian natural gas has been rapid but increases in energy and food prices have triggered wider price pressures, with core inflation around 5½ per cent in October.

Monetary policy is tightening, but fiscal policy remains supportive

The tightening of euro area monetary policy is having significant effects on financial conditions in Italy. This implies higher borrowing costs for the government, households and businesses even though the risk premium on long-term Italian government bonds over German bonds is projected to remain constant.

In order to cushion the impact of inflation on households and businesses, the government has taken fiscal measures amounting to around 3½ per cent of GDP in 2022. This includes tax credits for firms with large increases in gas and electricity bills, reductions of fixed charges on gas and electricity, as well as targeted income support for low-income households. These measures are likely to continue, although the Budget for 2023 has been delayed by the elections. It is assumed that fiscal measures in 2023 will strike a balance between supporting the economy and fiscal prudence, with current measures being extended over the winter months and then gradually withdrawn by mid-2023, resulting in fiscal savings of about 2% of GDP over the full year relative to 2022. At the same time, the expected ramp-up of spending related to Next Generation EU by 1½ per cent of GDP relative to 2022 will boost public investment. Overall, the combination of tighter financial conditions and mildly supportive fiscal policy in early 2023 is expected to limit the risks of second-round effects on inflation from higher wage growth and help prevent a persistent contraction of activity over 2023. Public sector wage growth, which will be a key determinant of inflation and the fiscal position, is expected to remain contained over 2023 and 2024.

Growth will pick up only slowly, with risks tilted to the downside

Real GDP is anticipated to contract in late 2022, before picking up moderately over 2023 and 2024. On the supply side, increases in input prices are expected to curtail production, especially in energy-intensive sectors. On the demand side, high inflation and declining employment are eroding real incomes despite significant energy crisis support, while the sharp slowdown in export market growth and increasing interest rates are weighing on private investment. As public investment increases strongly in 2023 and inflation gradually recedes on the back of stabilising commodity prices, real income growth and activity should gradually pick up over 2023 and 2024. However, the upturn may remain modest, with energy crisis support measures gradually phased out despite energy prices remaining exceptionally high, and the full effects of higher real interest rates on activity starting to kick in.

Risks and uncertainties are larger than usual and tilted to the downside. While energy rationing is unlikely even in the event of a complete cut-off of Russian natural gas, delays in implementing the National Recovery and Resilience Programme could weigh on public investment and larger-than-expected monetary policy tightening in the euro area could further push up the risk premium on Italian long-term government securities. This would not only lead to a further tightening of financial conditions in the private sector but also raise debt-servicing costs on high public debt. Even though short-term public debt dynamics have been favourable over the past year – largely reflecting higher-than-anticipated nominal GDP growth – and the average maturity of public debt is long, this could lead to a deterioration in debt dynamics in the long term. On the upside, the effective implementation of structural reforms related to the National Recovery and Resilience Programme could have a larger‑than‑anticipated positive effect on productivity in the short term.

Efficient spending of Next Generation EU funds will be key to support growth

Improving the effectiveness of public administration will be a key priority to support demand in the short term and boost productivity in the long term. This is particularly the case for the Next Generation EU funds, where efficient implementation, management and prioritisation of public investment will be paramount for a timely delivery of quality projects. To reap the full benefits of the National Recovery and Resilience Programme, public investment should be coupled with effective implementation of structural reforms, especially the recent competition law reform. While the diversification of natural gas supplies away from Russia over the past year is welcome, accelerating the transition to renewable energies would have the added benefit of making Italy less dependent on fossil fuel supply from abroad and making growth more sustainable. Effectively targeting energy crisis support measures and reducing the recourse to broad‑based price caps would encourage energy savings while preserving the incomes of the most vulnerable households.