Identifier
Created
Classification
Origin
04ROME3232
2004-08-20 14:57:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Rome
Cable title:  

SINISCALCO UNVEILS ITALY'S CONTROVERSIAL FOUR-YEAR

Tags:  ECON EFIN ELAB IT KPRP 
pdf how-to read a cable
This record is a partial extract of the original cable. The full text of the original cable is not available.
UNCLAS ROME 003232 

SIPDIS


SENSITIVE

DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA
PARIS ALSO FOR USOECD
TREAS FOR OASIA HARLOW, STUART
STATE PASS CEA
STATE PASS FRB FOR GUST
FRANKFURT FOR WALLAR
USDOC 4212/ITA/MAC/OEURA/CPD/DDEFALCO

E.O. 12958: N/A
TAGS: ECON EFIN ELAB IT KPRP
SUBJECT: SINISCALCO UNVEILS ITALY'S CONTROVERSIAL FOUR-YEAR
FINANCIAL PLAN: THE FIRST ACT OF THE POST-TREMONTI ERA

REF: ROME 2836

Summary
-------

UNCLAS ROME 003232

SIPDIS


SENSITIVE

DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA
PARIS ALSO FOR USOECD
TREAS FOR OASIA HARLOW, STUART
STATE PASS CEA
STATE PASS FRB FOR GUST
FRANKFURT FOR WALLAR
USDOC 4212/ITA/MAC/OEURA/CPD/DDEFALCO

E.O. 12958: N/A
TAGS: ECON EFIN ELAB IT KPRP
SUBJECT: SINISCALCO UNVEILS ITALY'S CONTROVERSIAL FOUR-YEAR
FINANCIAL PLAN: THE FIRST ACT OF THE POST-TREMONTI ERA

REF: ROME 2836

Summary
--------------


1. The July 29 release of Italy's four-year economic
blueprint opens Italy's annual budget process. The release
follows the political turmoil surrounding Finance Minister
Tremonti's resignation and the appointment of the new
Minister Siniscalco. The DPEF, which sets budgetary
guidelines for the next four years and makes projections
about economic performance, has, as usual, triggered
controversy - this year, over the enormous size of the
projected deficit reduction package for FY 2005 and how that
package might depress the already slow-growing economy in

2005. (This would be the toughest deficit reduction package
since 1993.) However, in a more collaborative way than the
controversial Tremonti would have used, Siniscalco has
reached out to Coalition parties, local government
officials, unions, and the employers' association to discuss
the size and the shape of the huge euro 24 billion (roughly
USD 31 billion) deficit reduction package for 2005.


2. The good news is that the 2005-2008 DPEF is based on
conservative assumptions and addresses the need for
structural reform. (Seventy percent of the deficit
reduction package results from structural changes, while
only a modest thirty percent will continue Tremonti's
tradition of one-time measures.) The DPEF also includes a
sound GOI plan to privatize (sell off) key State-owned
business to bring down the current 106.2 percent debt-to-GDP
ratio to 100 percent by end-2007.


3. The bad news is that the GOI frankly admits in the DPEF
that Italy cannot balance its budget before 2008, since GDP
growth rates may range only from 1.9 to 2.1 percent in the
four-year period.


4. Parliament "reviewed" the DPEF August 3, but does not
need to approve it. The next step in the budget process
will be Siniscalco's release of the draft 2005 budget in
September. End summary.

The Basic Facts: DPEF 2005-2008
--------------



5. On July 29, the Cabinet approved the 2005-2008 DPEF
(Documento di Programmazione Economica e Finanziaria) a four-
year economic plan outlining economic/budgetary goals for
each year through 2008. While not binding, the DPEF
previews the 2005 budget to be presented to Parliament late-
September. Finance Minister Siniscalco briefed the Cabinet
on the DPEF. On the budget deficit, he admitted that
because the 2005 deficit would be 4.4 percent of GDP (above
the three percent European Monetary Union (EMU) ceiling),
Italy would need a euro 24 billion deficit reduction package
to reduce the 2005 deficit/GDP ratio to 2.7 percent. He
described the euro 24 billion package as including euro
seventeen billion in spending cuts and euro seven billion in
one-time revenue measures. Should a tax reduction package
go forward, he said, those tax cuts would produce another
euro twelve billion budget shortfall.


6. On tax cuts, it appears Siniscalco has been able to win
political support for his idea not to institute them in

2005. The plan to lower tax rates, reduce the number of tax
brackets from six to three, and reduce the IRAP (the
regional tax on value-added business income) is mentioned in
the DPEF, but these changes are planned for 2006.


7. The key goals of the DPEF are:

-- structural change of public accounts;

-- policies to support growth;

-- sustainable public debt reduction to increase the


credibility of GOI financial policy;

-- macroeconomic/financial policies in line with European
Stability and Growth Pact commitments;

-- real GDP growth of 1.9 percent in 2005, increasing
gradually to 2.1 percent in 2007-8;

-- steady reduction of Italy's high debt from 106.2 percent
of GDP in 2004 to 98.8 percent in 2008 through
privatization/sale of euro 100 billion of State-owned assets
over the next four years;

-- a 2005 euro 24 billion deficit reduction package, of
which euro 17.0 billion represents spending cuts and euro
7.0 billion are one-time measures. (Note: there are large,
but less draconian, budget reductions in subsequent years:
euro 13.7 billion in 2006; euro 7.3 billion euro in 2007;
and euro 6.0 billion in 2008. These annual packages total
euro 51 billion, of which euro 44 billion are spending cuts.
This plan is consistent with the GOI agreement with the EU
Commission and ECOFIN to limit one-time measures to no more
than one-third of the overall budget reduction package. End
note.)

-- Predictions of inflation to decrease from 2.4 percent in
2004 to 2.1 percent in 2008;

-- Increased GOI investment (euro 20 billion over the four-
year period) to encourage productivity and competitiveness
in Italy' key sectors;

-- Lowering of tax rates, reducing the number of tax
brackets from six to three in 2006, and reducing IRAP (the
regional value-added business income tax).

Most Assumptions and Numbers Are Realistic.
--------------


8. This is the first DPEF that does not bet on economic
recovery, and the assumptions seem realistic. Siniscalco's
2005 GDP growth target of 1.9 percent is in line with the
latest consensus forecast that assumes a 1.8 percent growth
next year. In addition, the GDP growth predictions for the
next three years (ranging from 2.0 percent to 2.1 percent)
also seem realistic. As Siniscalco explained to the unions,
"our numbers are conservative."

But One Heavily-Politicized Figure Is in Dispute.
-------------- --------------


9. The one figure in dispute is "target" inflation, which
the GOI set at 1.6 percent in 2005 - some fifty basis points
below the latest consensus estimates (2.1 percent and 2.0
percent, respectively). The GOI "target" inflation rate is
extremely important, because it provides the reference
inflation rate for labor contract renewals. According to
the Finance Ministry, the target inflation rate must be
lower than the real projected inflation rate to avoid the
inflationary effect of any subsequent wage increases. The
unions are pressing for a target inflation rate as close as
possible to the projected real inflation rate in 2005: 2.2
percent. If that 1.6 percent figure does not change, they
have announced protests and demonstrations this fall.

Prospects for Further Privatization
--------------


10. The DPEF does not specify which spending cuts and
revenue-raising measures the Government will propose in the
2005 budget, but does provide detail on a Government plan to
raise euro 100 billion over the next four years by selling
off state-owned firms to help reduce the debt/GDP ratio from
the current 106.1 to somewhere below 98.8 percent in 2008.


11. Comment: As market conditions improve, we expect the GOI
to begin again to sell off assets. So far, the GOI has been


reluctant to sell shares in firms in sectors considered
critical to national security, such as aerospace and
defense. Thus, the GOI will likely retain its 32.3 percent
stake in Finmeccanica (the large aerospace and defense
holding company) and the 30 percent stake in ENI (Italy's
largest hydrocarbon company).


12. The first privatization will be the sale of 10-20
percent of Enel, Italy's main electrical producer, in
October. The sale is expected to produce revenue ranging
from euro 4 to 8 billion and to reduce the GOI's current 67
percent stake in Enel. In addition to the Enel sale, the
State might also consider reducing its current 100 percent-
ownership in both Ferrovie dello Stato (railway services)
and Poste Italiane (postal services). End Comment.

Siniscalco Silences Some Critical Voices, but Not All.
-------------- --------------


13. Last year's DPEF release led to a months-long squabble
between Finance Minister Tremonti and Central Bank Governor
Fazio. However, there has been no public comment (or
criticism) of the 2004 DPEF by the Central Bank, one reason
for which might be Siniscalco's more collaborative approach
and his insistence on dialogue among those groups most
affected by budget decisions to seek to gain their
confidence.


14. Siniscalco has extended this collaborative approach to
both the unions and the employers' association
(Confindustria),and - in a novel approach -- has asked both
to e-mail him their comments and suggestions at a specially-
established email address DPEF@tesoro.it.


15. Nonetheless, the unions have reacted coolly to the
plan, despite the GOI offer to discuss the labor issues
contained in the DPEF. Guglielmo Epifani, the Secretary
General of the powerful left-wing union federation CGIL,
expects the four-year plan to "affect workers, pensioners
and firms," all of whom he says have already paid the
consequences of the economic crisis. He also notes union
dissatisfaction with the Government's decision on a target
inflation rate. On tax cut proposals, the unions suggested
- but have not yet received - confirmation that cuts would
be weighted toward lower-income workers, and would be
accompanied by a plan to attack the endemic problem of tax
evasion.


16. Confindustria (employers' association) President Luca
Cordero di Montezemolo lent his support for budget
discipline because without it, "Italy risks loss of
confidence in the financial markets," further expenses in
servicing public debt, and then another drag on economic
growth. However, he called for more investment both in the
south and in R&D. On the tax cut issue, he pressed for
reduction of IRAP, the regional value-added business income
tax, since it is "the heaviest tax (drag) on growth of the
national product."

What About the 2005 Budget?
--------------


17. Siniscalco is now preparing the 2005 euro 24 billion
deficit reduction package, but there is no word yet on what
one-time revenue measures or budget cuts might make up that
package. However, his public statements suggest he does not
believe that the tax cut proposals which Prime Minister
Berlusconi advocates are enough to spur economic
development, and that the deficit reduction package and the
budget must also create conditions for economic development
- confidence in the economy and investment. On tax cuts,
Siniscalco has hinted that if there were a "political"
decision to go forward on the cuts, they might be
implemented not before 2006 and perhaps over two years (with
the subsequent need for even further deficit reduction). We
also know he has committed to the unions not to cut health,
education, social services, and homeland security. It will


be interesting to see if these ideas take shape in the 2005
budget announced in September and if they survive the long
parliamentary debate until the budget in finally passed in
December.

Final Comment
--------------


18. Although just a planning document, the DPEF nonetheless
indicates how the GOI might reconcile the somewhat
contradictory goals of 1) achieving budget discipline to
meet EMU requirements on budget deficits; and 2) stimulating
growth. Italy's growth, though, is dependent not only upon
budget discipline, but also on market liberalization. Thus,
to raise itself from the unenviable position of having the
lowest growth rate in the EMU area, Italy must also take the
painful steps to privatize State firms and to liberalize its
heavily-protected services sector and increase competition
there, especially in the banking industry.


19. With the Government's formal presentation of the 2005
budget to the Parliament end-September, attention will shift
again to Finance Minister Siniscalco. He will once again
need to call upon his collaborative ways to open dialogue
and convince both the major political parties and the social
partners to bridge their differences and take the necessary
steps to grow.


20. Finally, on privatization, the sale of Italy's State
assets may also open opportunities for U.S. investment
banks, especially those now operating in Italy (Goldman
Sachs, Merrill Lynch, JP Morgan, Morgan Stanley, Citigroup,
and Lehman Brothers). End comment.

SKODON


NNNN
2004ROME03232 - Classification: UNCLASSIFIED