OECD Economic Outlook, Volume 2023 Issue 2

Italy

GDP growth is expected to slow to 0.7% in both 2023 and 2024, before picking up modestly to 1.2% in 2025. Low wage growth and high inflation have eroded real incomes, financial conditions have tightened, and most of the exceptional fiscal support related to the energy crisis has been withdrawn, weighing on private consumption and investment. The projected decline of inflation, targeted income tax cuts and the pick-up in public investment related to New Generation EU (NGEU) funds will only partly offset these headwinds. Risks are tilted to the downside. The main downside risk is a larger-than-expected tightening of financial conditions due to tighter euro area monetary policy or an increase in the risk premium on Italian government securities. On the upside, a significant pick-up in public investment related to the National Recovery and Resilience Plan (NRRP) could boost growth in 2024 and 2025.

The effects of monetary policy tightening have started to kick in, while fiscal support to households and businesses to tackle the energy crisis has been scaled back, although the latter is broadly offset by targeted income tax cuts and higher NRRP spending. The broadly neutral stance of fiscal policy will limit the slowdown in growth, but there is room to improve the budget balance more rapidly than currently planned to put the public finances on a more prudent path. Public spending needs to be contained, including by looking for options to reduce pension expenditure and raising the ambition of spending reviews. The speedy implementation of public investment plans and structural reforms in the NRRP will be key to sustain growth and reduce the debt ratio.

Activity is slowing

GDP was flat in the third quarter, following the contraction of 0.4% in the second quarter that was partly due to exceptionally weak housing investment in the wake of tighter rules for house improvement tax credits. Recent high frequency indicators point to continued weakness in the near term. While industrial production appears to have bottomed out over the past few months, retail sales and confidence indicators remain weak. Despite the slowdown in activity, the unemployment rate remains historically low, employment continues to grow robustly, and nominal wage growth has picked up to around 3%, which should support household incomes and private consumption in the fourth quarter of 2023.

Italy: Economic growth and investment indicators

1Annualised quarterly rate.

Source: OECD Economic Outlook 114 database.

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Italy: Demand, output and prices

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Italy: Fiscal indicators

Source: OECD Economic Outlook 114 database.

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Declines in international energy prices in the first half of 2023 have been transmitted rapidly to consumer price inflation, which declined from more than 12% in November 2022 to 1.8% in October 2023. However, increases in oil prices since the end of June are expected to slow the decline of inflation in the near term. Gas inventories are close to capacity and there has been significant progress in the geographical diversification of gas supply over the past year, limiting the risk of shortages. The tightening of global financial conditions has so far had limited negative spillovers on the banking sector, which has benefited from increased profitability due to higher net interest margins.

Higher interest rates have had a strong impact

Borrowing costs for households and businesses have increased significantly over the past year following the tightening in euro area monetary policy, with rates reaching 4.2% on mortgages and 5.3% on loans to non‑financial corporations in September. Lending standards have also tightened and lending growth has turned negative. Higher interest rates have raised debt servicing costs for the government, which are expected to reach about 4.2% of GDP in 2025.

Abstracting from the impact of a change in the accounting treatment of tax credits for home improvements, the stance of fiscal policy will be broadly neutral in 2024. The recent tightening of the rules for those tax credits will improve the government budget balance in 2024 on an accrual basis, but not on a cash basis, which is largely determined by tax credits granted over 2021-23 that are claimed in later years. Energy crisis support has been scaled back in the course of 2023, but some measures were extended to the fourth quarter, including targeted income support for low-income households, the suspension of fixed charges on gas bills and the reduction in value added taxes on gas. The government plans to phase out these measures over the course of 2024, which should provide fiscal savings of around 1% of GDP. These savings will be broadly offset by targeted income tax cuts for low and middle-income households and the expected ramp-up of spending related to Next Generation EU (NGEU). In 2025, the targeted income tax cuts introduced in 2024 and the targeted social security contribution cuts introduced in 2023 are scheduled to expire under current legislation, implying a mild fiscal tightening and an improvement in the primary fiscal balance of about ½ per cent of GDP. Overall, tight financial conditions and a broadly neutral fiscal policy in 2024 should lead to a gradual easing of inflationary pressures, while growth will remain modest.

Growth will remain weak in the near term and inflation will recede

Real GDP is projected to grow 0.7% in 2023 and 0.7% in 2024, despite lower energy prices and the expected strengthening of NGEU-related spending, before picking up modestly in 2025. The tightening of financial conditions, the erosion of real incomes due to subdued wage growth and high inflation, and the scaling back of exceptional fiscal support related to the energy crisis will weigh on private consumption and investment. In 2024, these headwinds are only partly offset by spending financed from the remaining household savings accumulated during the pandemic, targeted income tax cuts and the expected pick-up in public investment related to Next Generation EU funds. Private consumption and private investment will remain weak. Inflation is expected to come down gradually over 2024-25 on the back of lower energy prices and moderate nominal wage growth. In 2025, the support to real household incomes from higher real wage growth, continued support from public investment and the strengthening of net exports due to recovering external demand will drive a modest pick-up.

Risks to growth are tilted to the downside. The main downside risk is a larger-than-expected tightening of financial conditions, which could arise from tighter euro area monetary policy or a higher premium on Italian government securities. On the upside, a significant pick-up in public investment related to the National Recovery and Resilience Plan (NRRP) could boost growth in 2024 and 2025.

Fiscal adjustment and structural reforms are needed to put the debt ratio on a more prudent path

The government deficit will narrow but remain above 3% over 2024-25. The public debt ratio is high and there are substantial spending pressures from investment needs and ageing costs, which will increase by about 2½ per cent of GDP over 2023-2040. A sustained fiscal adjustment will be required over a number of years to put the debt ratio on a more prudent path, meet future costs and comply with proposed EU fiscal rules. This should include decisive action to tackle tax evasion, limit the growth of pension spending and ambitious spending reviews. The full implementation of the public investment and structural reform plans in the NRRP could durably lift Italy’s GDP, which would have the added benefit of putting further downward pressure on the debt-to-GDP ratio. Progress with structural reforms has been substantial, but spending of NGEU funds is behind the original schedule, which mainly reflects delays in the implementation of public investment projects. The priorities should be to swiftly reallocate implementation to the highest-capacity public administrations, focus on growth-enhancing infrastructure projects, and abandon unviable projects.