The Chairman of the Parliamentary Budget Office (PBO), Giuseppe Pisauro, testified today at a hearing (in Italian) before the Budget Committees of the Chamber of Deputies and the Senate, meeting in joint session, as part of the preliminary examination of the Update to the 2018 Economic and Financial Document (the Update) published on 4 October by the Ministry of Economy and Finance (MEF). The following outlines the salient issues addressed at the hearing.
The macroeconomic scenario of the Update – The PBO assessed the macroeconomic policy scenario, which incorporates the effects of the upcoming budget package, employing, as is its practice, the analysis of the panel of forecasters (in addition to the PBO, the panel includes CER, Prometeia and Ref-Ricerche). The PBO feels that it cannot endorse the macroeconomic forecasts for 2019 contained in the 2018 Update’s policy scenario, judging that the significant and multiple divergences between the main variables in the policy scenario and the projections formulated by the panel make the forecasts for growth overly optimistic, both for real GDP (1.5 per cent) and nominal GDP (3.1 per cent in 2019), with the latter variable playing a crucial role in determining developments in the public finance aggregates. The divergences prompting the negative assessment ultimately regard the scale ‑ but not the sign ‑ of the impact of the budget measures on the macroeconomic scenario. In addition, the significant downside risks to which the forecasts for 2019 are exposed must be considered in the light of a number of factors: a) weak short-term economic conditions, which make the sharp increases from the trend scenario for next year unrealistic; b) the possibility that investors may expect the demand stimulus generated by the expansion of borrowing to be curtailed by a simultaneous increase in financial turbulence. Divergences between the PBO panel forecasts and downside risks about real growth also affect 2020-2021, a period that lies outside the horizon considered in the endorsement exercise.
Developments in public finances – For 2019, the Update forecasts a structural deficit of 1.7 per cent of GDP, which is expected to be maintained for the entire 2019-2021 planning period. In this scenario, the nominal deficit, estimated at 1.8 per cent of GDP in 2018, is expected to rise to 2.4 per cent in 2019 following the enactment of the Budget Act, before declining to 2.1 per cent in 2020 and 1.8 per cent in 2021. Although a comprehensive analysis of public finances will only be possible when all the details of the measures contained in the budget bill become available, the content of the Update already allows a number of initial comments: 1) the new policy deficit in the 2018 Update incorporates higher interest expenditure compared with the trend forecast due to the increase in the spread with respect to the other EU countries registered in recent months. Between 2018 and 2021, this increase will total at least €17 billion (0.9 percentage points of GDP); 2) the nominal and the structural budget balances are affected by the complete deactivation of the safeguard clause raising VAT rates and excise duties in 2019 and their partial deactivation in the following two years. Unlike previous policy documents, retaining the VAT increases in 2020 and 2021 is not intended to achieve the objective of a balanced structural budget over the planning period, but rather to stabilise the structural deficit at its 2019 level, financing permanent expenditure increases and revenue reductions. If the safeguard clauses were fully deactivated, the nominal deficit would rise to 2.8 per cent of GDP in 2020 before easing to 2.6 per cent in 2021 (the structural policy deficit would rise from 1.7 per cent in 2019 to 2.4 per cent in 2020 and 2.5 per cent in 2021); 3) investment as a proportion of GDP should increase from 1.9 per cent in 2018 to 2.3 per cent in 2021, an objective which is certainly desirable but one that seems especially ambitious compared with recent trends (investment contracted between 2010 and 2017 and in 2018 it is expected to decline by 2.2 per cent, compared to the projection of an increase of 2.5 per cent in the EFD), as plans call for an increase in investment of 16 per cent in 2019, 10.7 per cent in 2020 and 7.1 per cent in 2021.
Sensitivity of debt – To verify the sensitivity of the debt/GDP ratio in the short-to-medium term, the policy scenario in the 2018 Update was compared to alternative scenarios. A first scenario assesses the impact of the elimination of the partially retained VAT increases in 2020-2021: the debt/GDP ratio would continue to decline in 2020-2021 but to a lesser extent than envisaged in the Update’s policy scenario, reaching 128.4 per cent at the end of the planning period rather than 126.7. A second scenario simulates the real GDP growth needed to stabilize the debt/GDP ratio at its 2018 level (130.9 per cent), positioning it at 1 per cent in 2019, 0.7 per cent in 2020 and 1.1 per cent in 2021. In a third exercise, various scenarios concerning the difference between nominal GDP growth and the implicit cost of debt are considered. Developments in the Update’s debt/GDP ratio would be consistent with especially favourable values for this difference, values that have been seen in only the best five of the last eighteen years.
Compliance with fiscal rules – The 2018 Update’s policy scenario differs from that in the 2018 EFD published in April in the adjustment path towards the medium-term objective (MTO), with the path diverging away from the MTO in 2019 and no adjustment seen in 2020-2021. The projected changes impact compliance with fiscal rules. In particular, in 2019 the deterioration of 0.8 percentage points of GDP of the structural balance, compared with a required adjustment of 0.6 percentage points results in a significant deviation from the structural budget rule in both annual and two-year average terms. Similarly, the forecasts imply a significant deviation for the spending rule as well. At the EU level, if the fiscal effort indicated for 2019 in the Update were retained in the Draft Budgetary Plan (DBP) and if this effort was judged by the European Commission to be “clearly” lower than the Council’s recommendation last July (a structural adjustment of 0.6 percentage points), the non-compliance with the Pact’s rules could be regarded as “particularly serious”.
The Report to Parliament – An analysis of the Report to Parliament highlights a number of problems. In particular, it appears to lack a comprehensive analysis of the cyclical conditions that prompted the Government’s proposal to deviate from the adjustment path towards the MTO, as well as the pace of the return to that path. An examination of the dialogue with the European Commission reveals the concern of supranational institutions about the policy scenario proposed in the Update. The lack of a framework for agreeing to additional flexibility would seem to be the greatest difference compared to the Reports to Parliament submitted in previous years.