Hearing of the PBO as part of the consideration of the 2018 Economic and Financial Document

The Chairman of the Parliamentary Budget Office (PBO), Giuseppe Pisauro, testified today at a joint session of the Budget Committees of the Senate and Chamber of Deputies as part of the preliminary consideration of the 2018 Economic and Financial Document (EFD) published on 26 April by the Government.


Pisauro emphasised that, in light of the content of the EFD, the endorsement process for the forecasts focused solely on the trend macroeconomic scenario on a current legislation basis, which also includes the increase in indirect taxes resulting from the activation of the VAT clause for 2019 and 2020. Based on the information available at the time of endorsement, which took place on 5 April this year, the macroeconomic scenario – of which an initial version was transmitted on 5 March, a second version on 21 March following a number of comments by PBO and a final update on 4 April after the revision of the national accounts announced by Istat – was endorsed, as it fell within an acceptable range despite small divergences from the upper bound of the PBO panel forecasts for 2019 and 2020.


In the light of more recent information, continued Pisauro, the PBO has updated its forecast, which – together with those of the other forecasters on the panel (CER, Prometeia and REF Ricerche) – served as the basis of the endorsement exercise. Given that the short-term PBO models forecast GDP growth of 0.26 per cent in the second quarter of 2018 and 0.6 per cent in the first half compared with the previous six months, the PBO scenario now envisages slightly slower growth than that forecast in March. A potentially even stronger factor than the slowdown in economic activity observed in the early months of the year is another risk factor that is weighing on the medium-term macroeconomic outlook, namely the geopolitical, trade and financial strains present at the global level: if they were to escalate, they could trigger a deterioration in the climate of confidence among economic agents and an intensification of market instability, with adverse consequences for the continuation of the global expansion, which would inevitably affect the Italian recovery. The depressive effects would be expressed not only in the intensity of real growth, but also in the GDP deflator and, therefore, to a greater extent in nominal GDP.


Pisauro noted that in public finance scenario for the 2018-2021 period, the trend deficit should gradually decrease both in absolute value and as a percentage of GDP, achieving substantial break-even in 2020 and turning into a surplus (+0.2 per cent of GDP) in the final year of the forecasting period. The improvement would essentially be a consequence of the rise in the primary surplus, which should gradually increase to 3.7 per cent of GDP in 2021. Interest expenditure is expected to fall from 3.8 per cent of GDP in 2017 to 3.5 per cent in 2018 and then stabilise. The improvement in the primary surplus is mainly due to a reduction as a percentage of GDP in primary expenditure, especially current spending, partly in reflection of the current-legislation nature of the forecast. From 2019, revenue will be boosted by the activation of the safeguard clauses for indirect taxes.


The PBO Chairman also noted that the EFD updates the trend forecasts for the structural balance (i.e. general government net borrowing adjusted for cyclical conditions and excluding one-off revenue and expenditure measures), the aggregate relevant for the assessment of compliance with the fiscal rules. The structural balance is expected to improve progressively from an estimated -1.1 per cent in 2017 to a small surplus in 2020 (+0.1), which will be maintained in 2021 as well. Comparing these developments with the European Commission’s projections for 2017-2019, we find that the Commission estimates that the structural balance will be worse than that indicated in the EFD by -0.6 points of GDP in 2017, -0.7 points in 2018 and -1.6 points in 2019. In all three years, the disparity reflects differences in the assessment of the cyclical component of the balance, which according to the Commission is 0.6 points smaller each year compared with the figure estimated in the EFD. The divergence largely stems from the different methods adopted by the Government and the Commission to estimate the output gap. In addition, the Commission’s forecast for the overall budget balance for 2018 is marginally more pessimistic (the Commission puts it at -1.7 points of GDP, while the Government projects -1.6 points), which is also reflected in its structural component. The forecast for 2019 is also affected by the different assumptions about the safeguard clauses (which improve the balance indicated in the EFD by 0.7 points of GDP), which in the Commission scenario are deactivated without offsetting measures, and a more cautious approach by the Commission for other components, which means that net borrowing is generally about 1 point of GDP higher than in the EFD forecasts.


The PBO Chairman remarked that the trend scenario for the public finances must be assessed in the light of the European and national fiscal rules.


According to the EFD, in 2017 the change in the structural balance was a negative 0.2 percentage points, representing a divergence from the path towards the medium-term objective (MTO) compared with the adjustment of about 0.2 points of GDP required under the rules. For 2017, this would give an annual deviation of around -0.4 points of GDP, which is therefore not significant. For the 2016-2017 biannual period, the deviation is estimated at about -0.3 points of GDP, and therefore close to significant. According to the European Commission’s 2018 spring forecast, the change in the balance would be -0.3, the estimated cyclical conditions more favourable and therefore the required adjustment slightly larger, so the deviation would be even more pronounced, being close to significant in one-year terms and significant in two-year terms. In light of the functioning of the corrective mechanism, according to the EFD the significant deviation for 2016-2017 does not appear to have altered the path of adjustment towards the MTO compared with the 2018 DBP. Therefore, since the significant deviation that occurred in 2017 does not seem to jeopardize the path of adjustment towards the MTO in the following years, at least on a current-legislation basis, there is no reason to activate the corrective mechanism envisaged in Article 8 of Law 243/2012.


The trend scenario in the 2018 EFD essentially confirms the developments in the public finances, with achievement of the MTO in 2020 despite a significant deviation from the structural balance rule in 2016-2017, as already indicated in the 2018 DBP. For 2018, the European Commission decided to apply its “degree of discretion” for Italy, which halved the required adjustment under the matrix from 0.6 to 0.3 percentage points. However, given the required adjustment, the forecasts in the 2018 EFD show an improvement of only 0.1 points of GDP in the structural balance, threatening a deviation of -0.2 points of GDP, which should require additional adjustment measures amounting to 0.2 points of GDP for 2018. Moreover, the most recent estimates of the European Commission show no structural adjustment in 2018, thus pointing to the risk of a deviation of -0.3 percentage points, greater than previously forecast. Using the estimates reported in the EFD, the expenditure rule would show more favourable results in 2017 than those for the structural balance rule, but a deviation from the targets would remain for 2018. In 2019, the planned adjustment in the structural balance is 0.6 points of GDP, equal to the required adjustment and therefore fully compliant with the fiscal rules. Finally, in 2020-2021, the MTO would be achieved or exceeded, in compliance with the fiscal rules.


Considering the ex-post data for 2017, compliance with the numerical rule for debt reduction as a percentage of GDP does not appear to have been achieved under any of the criteria established under EU rules (backward-looking, forward-looking or cyclically adjusted). On this basis, the European Commission, as required, should prepare a report on the debt setting out the relevant factors that may have contributed to non-compliance with the debt rule in 2017 for the purpose of deciding whether to open an excessive deficit procedure connected with the debt criterion. The scenario for the debt/GDP ratio presented in the 2018 EFD does not appear to be consistent with compliance with the numerical rule for the entire 2018-2021 period under the backward-looking criterion, and therefore is not compliant under the forward-looking criterion until at least 2019. In 2021 , the difference between the actual debt stock and the benchmark level would be 0.8 points of GDP.