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
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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.)
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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

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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
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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
--------------

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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
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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.
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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

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2002ROME03551 - Classification: UNCLASSIFIED