ITALY: 4-YEAR FINANCIAL PLAN 2003-2006

UNCLAS SECTION 01 OF 03 ROME 003551 SIPDIS DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA LABOR FOR ILAB PARIS ALSO FOR USOECD UNCLASSIFIED PAGE 02 ROME 03551 01 OF 03 180615Z TREAS FOR OASIA -HARLOW, JONES STATE PASS CEA STATE PASS FRB FOR GUST FRANKFURT FOR WALLAR USDOC 6800/ITA/TD/OTEA/TISD/HSCHULTZ AND 4212/ITA/MAC/OEURA/CPD/DDEFALCO E.O. 12958: N/A TAGS: ECON EFIN ELAB EFIN ELAB EFIN ELAB IT KPRP ITECON KPRP ITECON KPRP SUBJECT: ITALY: 4-YEAR FINANCIAL PLAN 2003-2006 REF: A) ROME 2958; B) ROME 2794 ¶1. SUMMARY. ITALY IS UNLIKELY TO ELIMINATE ITS DEFICIT BEFORE 2005, ACCORDING TO THE GOI'S RECENTLY RELEASED FOUR-YEAR BUDGET PLAN (DPEF). GOI PLANS FOR SUBSTANTIAL TAX CUTS AND INFRASTRUCTURE INVESTMENT, COMBINED WITH LESS OPTIMISTIC ECONOMIC ASSUMPTIONS, LIKELY RULE OUT A BALANCED BUDGET BEFORE 2005. AN EU OFFICIAL EXPRESSED CONCERN, AS DID SOME ITALIAN ECONOMISTS, THAT ITALY HAD POSTPONED THE BALANCED BUDGET BY ONE YEAR. NONETHLESS, THE GOI EXPECTS THE TAX CUTS AND INVESTMENT TO GENERATE ECONOMIC GROWTH, AND ANTICIPATES STEADY IMPROVEMENT IN FISCAL AND OTHER ECONOMIC INDICATORS OVER THE NEXT SEVERAL YEARS. END SUMMARY. ¶2. THE GOVERNMENT OF ITALY'S FOUR-YEAR BUDGET PLAN (DPEF),WHICH OUTLINES BUDGET PRIORITIES AND ASSUMPTIONS, WAS APPROVED BY THE COUNCIL OF MINISTERS ON JULY 5 AND PRESENTED TO PARLIAMENT ON JULY 10. THE DOCUMENT MUST BE REVIEWED BY PARLIAMENT BEFORE THE UNCLASSIFIED PAGE 03 ROME 03551 01 OF 03 180615Z SUMMER RECESS IN LATE JULY OR EARLY AUGUST. THE DPEF PREVIEWS THE 2003 FINANCIAL LAW THAT WILL BE PRESENTED TO PARLIAMENT IN LATE SEPTEMBER. ¶3. ITALY WILL NOT REACH ITS BALANCED BUDGET TARGET BY 2004, BUT INSTEAD IN 2005. PRIME MINISTER BERLUSCONI RECENTLY ANNOUNCED GOVERNMENT PLANS TO REDUCE CORPORATE AND PERSONAL INCOME TAXES BY SEVEN BILLION EURO IN 2003. THE DPEF DOES NOT INDICATE SPECIFIC SPENDING CUTS TO OFFSET THIS LOSS IN TAX REVENUE, BUT MENTIONS A DEFICIT REDUCTION PACKAGE "AROUND ONE PERCENT OF GDP", EQUAL TO EURO 12.5 BILLION. THE GOI EXPECTS THE DEFICIT/GDP RATIO TO BE 1.1 PERCENT AT THE END OF 2002 AND TO DECLINE TO 0.8 PERCENT AT END-2003. DPEF 2003-1006 -------------- ¶4. THE KEY ECONOMIC ASSUMPTIONS IN THE DPEF ARE: -- REAL GDP GROWTH OF 1.3 PERCENT IN 2002, 3 PERCENT IN 2003-2004 AND 3.1 PERCENT IN 2005-2006; (NOTE: THIS MAY BE TOO OPTIMISTIC. THE LATEST CONSENSUS FORECAST ASSUMES 1.2 PERCENT GROWTH IN 2002. A HIGHER LEVEL WOULD REQUIRE A STRONG RECOVERY IN THE SECOND HALF OF 2002.) -- DEBT FALLING STEADILY FROM 109.4 PERCENT OF GDP IN 2001 TO 95 PERCENT IN 2006, AS PART OF A LONG-TERM PLAN TO REACH THE EMU TARGET OF 60 PERCENT BY 2011; (NOTE: THE 2001 DPEF, FOR 2002-2005, ASSUMED A 95 PERCENT TARGET IN 2004.) UNCLASSIFIED PAGE 04 ROME 03551 01 OF 03 180615Z -- TAX BURDEN FALLING, AS A PERCENT OF GDP, FROM 42.4 PERCENT IN 2001 TO 39.8 PERCENT IN 2006, MOSTLY IN FAVOR OF LOWER INCOME HOUSEHOLDS AND SMALL AND MEDIUM-SIZED COMPANIES. -- TAX CUTS, THE FIRST TRANCHE OF WHICH EXEMPTS FROM TAXES INCOMES BETWEEN 6,197 EURO (3,098 EURO FOR SELF- EMPLOYED) TO 10,329 EURO, AND REDUCES TAX RATES FROM 24- 32 PERCENT TO 23 PERCENT (FOR INCOMES RANGING FROM 10,329 TO 30,987 EURO). -- INFLATION BELOW 2 PERCENT PER YEAR, DECELERATING FROM 2.7 PERCENT IN 2001, TO 1.7 PERCENT IN 2002, 1.4 PERCENT IN 2003 AND 1.2 PERCENT IN 2006; (NOTE: A 1.7 PERCENT INFLATION RATE FOR 2002 WOULD BE 50 BASIS POINTS BELOW THE JUNE LEVEL OF 2.2 PERCENT, 70 BASIS POINTS BELOW THE 2.4 AVERAGE FOR THE FIRST HALF OF 2002 AND 60 BASIS POINTS BELOW THE LATEST CONSENSUS ESTIMATES OF 2.2 PERCENT FOR 2002.) -- INFRASTRUCTURE INVESTMENT INCREASING, PRIMARILY IN UNCLASSIFIED UNCLASSIFIED PTQ1434 PAGE 01 ROME 03551 02 OF 03 180615Z ACTION EUR-00 INFO LOG-00 AID-00 CIAE-00 CTME-00 DODE-00 ITCE-00 WHA-00 EAP-00 EB-00 EXME-00 E-00 UTED-00 FOE-00 VC-00 FRB-00 H-01 TEDE-00 INR-00 ITC-01 VCE-00 AC-01 NSAE-00 OMB-01 OPIC-01 ACE-00 SP-00 SSO-00 STR-00 TEST-00 TRSE-00 USIE-00 FMP-00 DRL-02 G-00 SAS-00 /007W -------------- CCD00A 180615Z /20 P 180531Z JUL 02 FM AMEMBASSY ROME TO DEPT OF TREASURY WASHDC PRIORITY SECSTATE WASHDC 4945 INFO USDOC WASHDC DEPT OF LABOR WASHDC EU MEMBER STATES COLLECTIVE AMEMBASSY OTTAWA USEU BRUSSELS 2745 AMEMBASSY TOKYO AMCONSUL MILAN AMCONSUL FLORENCE AMCONSUL NAPLES AMCONSUL FRANKFURT UNCLAS SECTION 02 OF 03 ROME 003551 SIPDIS DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA LABOR FOR ILAB PARIS ALSO FOR USOECD UNCLASSIFIED PAGE 02 ROME 03551 02 OF 03 180615Z TREAS FOR OASIA -HARLOW, JONES STATE PASS CEA STATE PASS FRB FOR GUST FRANKFURT FOR WALLAR USDOC 6800/ITA/TD/OTEA/TISD/HSCHULTZ AND 4212/ITA/MAC/OEURA/CPD/DDEFALCO E.O. 12958: N/A TAGS: ECON EFIN ELAB EFIN ELAB EFIN ELAB IT KPRP ITECON KPRP ITECON KPRP SUBJECT: ITALY: 4-YEAR FINANCIAL PLAN 2003-2006 THE SOUTH; PUBLIC INVESTMENT SPENDING WILL BE ACCOUNTED OFF BUDGET THROUGH A NEWLY-ESTABLISHED AUTONOMOUS CONTRACTING FIRM FOR LARGE INFRASTRUCTURE PROJECTS. -- UNEMPLOYMENT, RESULTING FROM ECONOMIC RECOVERY COMBINED WITH MEASURES TO INCREASE FLEXIBILITY IN THE LABOR MARKET; FALLING FROM 9.5 PERCENT IN 2001 TO 9.1 PERCENT IN 2002 AND TO 6.8 PERCENT IN 2006. THE GOI ALSO EXPECTS AN INCREASE IN THE LABOR MARKET PARTICIPATION RATE FROM 56.3 PERCENT IN 2002 TO 59.6 PERCENT IN 2006. -- DEFICIT/GDP RATIO FALLING TO 1.1 PERCENT AT THE END OF 2002 AND TO 0.8 PERCENT AT END-2003. RE-DOING THE BOOKS -------------- ¶5. A RECENT RULING IN BRUSSELS MAY CHANGE GROWTH ESTIMATES. IN EARLY JULY, EUROSTAT (THE EUROPEAN BUREAU UNCLASSIFIED PAGE 03 ROME 03551 02 OF 03 180615Z OF STATISTICS) DECLARED THAT ITALY MAY NOT USE BORROWINGS AGAINST FUTURE PROPERTY SALES AND LOTTERY REVENUES TO REDUCE THE DEFICIT FIGURE. AS A RESULT, THEY STATED, THE GDP DEFICIT FOR 2001 MUST BE REVISED UPWARD - FROM 1.6 TO 2.2 PERCENT OF GDP. THE RULING AGAINST THESE ACCOUNTING METHODS ALSO PUTS PRESSURE ON FUTURE TARGETS. ¶6. ACCORDING TO MARCELLO MESSORI, ECONOMIST AND PRESIDENT OF MEFOP (THE GOI INSTITUTION FOR PENSION FUNDS),THE EUROSTAT DECISION WILL MAKE IT MORE DIFFICULT FOR THE GOI TO SELL SECURITIES BACKED BY FUTURE INCOME. MESSORI TOLD US THAT THE EUROSTAT DECISION HAD BEEN EXPECTED, BUT THAT MOST ITALIAN ANALYSTS EXPECTED THAT IT WOULD BE LIMITED TO THE SECURITIZATION OF LOTTERY PROCEEDS. ¶7. FINANCE MINISTER TREMONTI HAS AFFIRMED THAT THE GOI WILL CONTINUE TO SELL ASSET-BACKED BONDS, VALUED AT CLOSE TO SEVEN BILLION EURO, TO REDUCE THE DEFICIT. THE GOI WILL MODIFY THE WAY IT SELLS ASSET-BACKED DEBT, WHICH WILL LIKELY BE BACKED BY FEWER PROPERTIES. (NOTE: PREVIOUSLY, THE FACE VALUE OF ASSETS WAS LOWER THAN THE VALUE OF THE COLLATERAL-BACKING SUCH ASSETS. FOR EXAMPLE, IN 2001, THE GOI RAISED 2.3 BILLION EURO BY SELLING A BOND BACKED WITH 3.2 BILLION EURO IN REAL ESTATE.) PRIVATIZATIONS -------------- UNCLASSIFIED PAGE 04 ROME 03551 02 OF 03 180615Z ¶8. THE GOI WILL PROCEED WITH PRIVATIZATIONS TO OFFSET THE BUDGET SHORTFALL. ACCORDING TO THE DPEF AND GOVERNMENT STATEMENTS, THE FIRST TO BE PRIVATIZED WILL BE THE RESIDUAL STAKE OF TELECOM ITALIA (3.46 PERCENT), ETI (ENTE TABACCHI ITALIANI - ITALY'S NATIONAL TOBACCO COMPANY) AND 85 PERCENT OF TIRRENIA (MARITIME TRANSPORTATION),AS WELL AS ANOTHER TRANCHE OF ENEL (ELECTRICITY CONGLOMERATE),TERNA (100 PERCENT ENEL- OWNED ELECTRICITY TRANSMISSION COMPANY) AND GESTORE DELLA RETE (100 PERCENT ENEL-OWNED ELECTRICITY NETWORK MANAGEMENT COMPANY). THE GOI ALSO PLANS TO REDUCE ITS STAKE IN ALITALIA OVER THE NEXT 18 MONTHS, "BUT NOT BELOW 30 PERCENT". THE FINANCE MINISTRY OWNS 67.58 PERCENT OF ENEL AND 62.4 PERCENT OF ALITALIA. ¶9. UNCERTAIN MARKET CONDITIONS HAVE, HOWEVER, RAISED QUESTIONS ABOUT BOTH HOW FAST THE GOI WILL PROCEED WITH THESE PRIVATIZATIONS AND THE REVENUES THAT WILL BE REALIZED. WHEN THE MARKET RECOVERS, THE GOVERNMENT HOPES SALES OF GOVERNMENT-OWNED ENTITIES AND SHARES WILL BRING IN 20 BILLION EURO. UNCLASSIFIED UNCLASSIFIED PTQ1423 PAGE 01 ROME 03551 03 OF 03 180613Z ACTION EUR-00 INFO LOG-00 AID-00 CIAE-00 CTME-00 DODE-00 ITCE-00 WHA-00 EAP-00 EB-00 EXME-00 E-00 UTED-00 FOE-00 VC-00 FRB-00 H-01 TEDE-00 INR-00 ITC-01 VCE-00 AC-01 NSAE-00 OMB-01 OPIC-01 ACE-00 SP-00 SSO-00 STR-00 TEST-00 TRSE-00 USIE-00 FMP-00 DRL-02 G-00 SAS-00 /007W -------------- CCCFD6 180613Z /20 P 180531Z JUL 02 FM AMEMBASSY ROME TO DEPT OF TREASURY WASHDC PRIORITY SECSTATE WASHDC 4946 INFO USDOC WASHDC DEPT OF LABOR WASHDC EU MEMBER STATES COLLECTIVE AMEMBASSY OTTAWA USEU BRUSSELS 2746 AMEMBASSY TOKYO AMCONSUL MILAN AMCONSUL FLORENCE AMCONSUL NAPLES AMCONSUL FRANKFURT UNCLAS SECTION 03 OF 03 ROME 003551 SIPDIS DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA LABOR FOR ILAB PARIS ALSO FOR USOECD UNCLASSIFIED PAGE 02 ROME 03551 03 OF 03 180613Z TREAS FOR OASIA -HARLOW, JONES STATE PASS CEA STATE PASS FRB FOR GUST FRANKFURT FOR WALLAR USDOC 6800/ITA/TD/OTEA/TISD/HSCHULTZ AND 4212/ITA/MAC/OEURA/CPD/DDEFALCO E.O. 12958: N/A TAGS: ECON EFIN ELAB EFIN ELAB EFIN ELAB IT KPRP ITECON KPRP ITECON KPRP SUBJECT: ITALY: 4-YEAR FINANCIAL PLAN 2003-2006 THE DPEF DEBATE -------------- ¶10. THE EU COMMISSION HAD BEEN KEEPING A CLOSE EYE ON ITALY'S BUDGET AND HAD SAID REPEATEDLY THAT IT EXPECTED A GOI BUDGET CLOSE TO BALANCE IN 2003 AND IN BALANCE IN ¶2004. THUS, EU REACTION TO THE DPEF ECONOMIC PLAN WAS GENERALLY NEGATIVE. THE SPOKESPERSON FOR EU COMMISSIONER FOR ECONOMIC AFFAIRS PEDRO SOLBES SAID THAT THE GOI'S 0.8 PERCENT DEFICIT/GDP TARGET FOR 2003 WAS TOO HIGH TO BE CONSIDERED "CLOSE TO BALANCE" AS AGREED IN THE LAST EU MEETING IN SEVILLE. ¶11. FINANCE MINISTER TREMONTI RESPONDED UNEQUIVOCALLY THAT "WE ARE ABSOLUTELY IN CONFORMANCE WITH THE STABILITY PACT." PRIME MINISTER BERLUSCONI AGREED, DECLARING THAT "I DO NOT BELIEVE THAT THERE IS ANY CONCERN REGARDING MINISTER TREMONTI'S DPEF, WHICH I BELIVE RESPECTS COMPLETELY THE MAASTRICHT PARAMETERS, AS WELL AS A FLEXIBLE INTERPRETATION OF THE LIMITS UNCLASSIFIED PAGE 03 ROME 03551 03 OF 03 180613Z INDICATED BY ECOFIN IN MADRID AND THE EUROPEAN COUNCIL IN SEVILLE." ¶12. ON JULY 15, DURING THE PARLIAMENTARY REVIEW OF THE DPEF, THE PRESIDENT OF THE "CORTE DEI CONTI" (ITALY'S SUPREME AUDIT COURT) STATED THAT THE GOI WOULD NEED A DEFICIT REDUCTION PACKAGE OF E19 BILLION TO BRING THE DEFICIT/GDP RATIO TO 0.8 PERCENT IN 2003. THIS IS WELL ABOVE THE E12.5 BILLION LEVEL GIVEN BY DEPUTY FINANCE MINISTER BALDASSARRI. ¶13. FORMER TREASURY MINISTER VISCO, OF THE OPPOSITION CENTER-LEFT, ECHOED THE CRITICISM, STATING "IT WILL BE A HUGE MANEUVER, ALMOST 2 PERCENT OF GDP". ¶14. CENTRAL BANK GOVERNOR ANTONIO FAZIO ALSO COMMENTED TO PARLIAMENT ON THE DPEF. FAZIO AGREED WITH THE GOI THAT TAX CUTS WERE ESSENTIAL AND THAT A GOI PUBLIC WORKS PROGRAM SHOULD BE IMPLEMENTED IMMEDIATELY. HOWEVER, HE ALSO DECLARED THAT THE GOI NEEDED TO ACT URGENTLY TO CUT HEALTH AND SOCIAL SECURITY EXPENDITURES, INCREASE THE RETIREMENT AGE AND, DEVELOP SUPPLEMENTAL PENSION FUNDS. FAZIO ALSO CALLED FOR THE REPLACEMENT OF ONE-TIME BUDGET MEASURES (SUCH AS ASSET SALES) WITH DURABLE BUDGET MEASURES TO CONTROL SPENDING AND ASSURE STABLE REVENUES. REGARDING THE DPEF'S MACRO ASSUMPTIONS, FAZIO SAID THAT THE 1.3 PERCENT GROWTH THIS YEAR ASSUMES A DRAMATIC FOUR PERCENT ACCELERATION DURING THE LAST TWO QUARTERS OF ¶2002. SUCH GROWTH RATES ARE POSSIBLE ONLY IF A FIVE BILLION EURO INFRASTRUCTURE INVESTMENT PROGRAM IS IMPLEMENTED DURING THE SECOND HALF OF 2002. UNCLASSIFIED PAGE 04 ROME 03551 03 OF 03 180613Z COMMENT -------------- ¶15. THE DPEF ASSUMPTIONS OF HIGHER GROWTH AND LOWER INFLATION DURING 2002 MAY BE OPTIMISTIC, AND SOME SUPPLEMENTAL SPENDING CUTS MAY BE NECESSARY, BUT FINANCE MINISTER TREMONTI HAS CREATED A REASONABLY REALISTIC DOCUMENT IN HIS 2002 DPEF. FACED WITH A CHOICE BETWEEN BALANCING THE BUDGET BY 2003 OR IMPLEMENTING PROMISED TAX CUTS AND INFRASTRUCTURE INVESTMENT, TREMONTI HAS CHOSEN THE LATTER. HE INSISTS, AND CENTRAL BANK PRESIDENT FAZIO AGREES, THAT THESE MEASURES ARE NECESSARY FOR LONG TERM ECONOMIC GROWTH AND A FISCAL BALANCE THAT CAN BE SUSTAINED ONCE REACHED. FAZIO IS ON TARGET WITH HIS CALL FOR FURTHER MEASURES, INCLUDING PENSION REFORM, AND DEEPER SPENDING CUTS. MINISTER TREMONTI HAS TOLD US THAT HE AGREES AND HOPES TO CARRY THESE OUT IN THE LONGER TERM. SEMBLER UNCLASSIFIED > 2002ROME03551 - Classification: UNCLASSIFIED