Italy’s economic resilience amid fiscal challenges ahead

‘Duchess Chameleon’ Prime Minister Meloni adapts

As Italy approaches two years under Prime Minister Giorgia Meloni’s government, and with European elections looming, concerns persist over the rise of a right-wing government in the third-largest country in the European Union.

During electoral campaigns, anti-European and anti-Atlantic rhetoric from two major coalition parties fuelled uncertainties about Meloni’s government stance. However, recent developments indicate Italy’s clear positioning within the Atlantic and European spheres, despite lingering populist shadows.

Amid a downturn in many of the euro area’s industrial sectors, Italy’s economy shows surprising signs of vitality. Germany – hardest hit by reduced purchases from China and disruptions in energy-intensive sectors and global manufacturing supply chains – experiences a sharp decline in industrial production. In contrast, Italy demonstrates relative resilience.

In 2023, Italy’s gross domestic product grew by 0.7%, with similar projections for the current year. Inflation – recorded at 1.3% in March – is anticipated to remain below 2% in 2024. Now, Italy’s GDP is 3.6 percentage points higher than it was at the end of 2019, compared with increases of 1.8 percentage points in France and 0.1 percentage points in Germany. In 2023, employment increased by 1.9%, reaching its highest point in many years.

However, Italy’s industrial production faces challenges due to stagnation in Germany and reduced demand from key export markets. While growth in value-added services remains modest, the construction sector benefits from ongoing incentives.

Italy’s GDP performance heavily relies on extraordinary post-pandemic support measures enacted by successive governments between 2021 and 2023, totalling €296bn – equivalent to about 15% of GDP. These measures included €173bn for the housing bonus, €88bn for addressing energy costs and €35bn for tax reductions. In 2023, the deficit-to-GDP ratio reached 7.2%, down from 8.6% in 2022, significantly exceeding the ministry of finance’s official estimate by the end of last year of around 5.3%.

Many production sectors in Italy’s economy demonstrate dynamism. The country has achieved significant trade surpluses in recent years and has bolstered its net international creditor position, underscoring the competitiveness of Italian firms globally.

Italian banks are currently well-capitalised, contributing to their stability and resilience. Last year, the government attempted to impose a tax on bank windfall profits. The measure – poorly designed and not previously agreed upon – immediately caused a sharp drop in bank stock prices and drew criticism from national and international press outlets, the European Central Bank and some members of the government.

The government decided to backtrack. Banks were allowed to opt out of paying the tax provided they allocated a portion of their profits to strengthen their capital reserves. Most large banks agreed, thus bolstering their capitalisation. Moreover, the surge in production following the pandemic has played a role in improving credit quality. Firms have built up substantial liquidity buffers over the years, partly due to their access to state-guaranteed loans.

With the advent of the new stability and growth pact, Italy is compelled to progressively reduce its deficit-to-GDP ratio by 0.5% annually over the next two years to meet the targeted 1.5%. This necessitates a rigorous fiscal tightening, poised to exert significant political pressure on the government, but also on Europe’s perception within the electorate, already inclined towards Euroscepticism. Fortunately, Italy can draw reassurance from the forthcoming disbursements under the National Recovery and Resilience Plan.

With the largest share of Next Generation EU funds – accounting for approximately 30% of the total – Italy is poised to receive a substantial stimulus for its economy. However, the challenge lies in effectively using these funds and adhering to the strict deadlines set by the European Commission. Despite initial hurdles, Italy seems to be gaining momentum. Nevertheless, concerns persist regarding the efficient and swift allocation of these resources.

The spread between Italian and German government bonds reached its lowest level since November 2021 in mid-March, standing at 1.22%. This marks a decrease of 2 percentage points, reflecting growing market confidence in Italy’s robust economic recovery and steady political landscape. The Bund-BTP spread has since risen again to close to 1.40 – although still around 60 basis points below the peak in October 2023. Despite forthcoming European elections posing internal challenges within coalition parties, they are unlikely to threaten the government’s continuity.

Among the unfolding European Parliament elections, Meloni has earned the epithet of the ‘Duchess Chameleon’ due to her deft navigation of the political landscape. Romano Prodi, former president of the European Commission and former Italian prime minister, remarked on the intricate position of the Meloni government in Europe, describing it as ‘marvellously ambiguous.’ Prodi also noted Meloni’s adeptness, stating, ‘If needed, she’ll support [Ursula] von der Leyen and make her pay, but at the same time, she’s with [Viktor] Orbán.’

Edoardo Reviglio is Visiting Senior Research Scholar at Yale Law School and a member of the OMFIF Advisory Council.

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