US embassy cable - 03ROME3697

C O N F I D E N T I A L  ROME 003697 
 
SIPDIS 
 
 
PARIS FOR USOECD, FRANKFURT FOR WALLAR 
 
E.O. 12958: DECL: 08/14/2008 
TAGS: ECON, EFIN, PGOV, IT 
SUBJECT: ITALY'S BUDGET BATTLE BEGINS (CORRECTED VERSION - 
PARAGRAPH NUMBERING) 
 
REF: ROME 2853 
 
Classified By: Economic Counselor Karen Milliken for reasons 1.5 (b, d) 
 
1. (SBU) Summary. The release of the government's four-year 
economic blueprint (DPEF) has started off Italy,s annual 
budget process with a bang.  The DPEF, which sets budgetary 
guidelines for the upcoming year and makes projections about 
economic performance, was a carefully crafted compromise 
among feuding coalition partners.  The result, nonetheless, 
triggered controversy and finger pointing.  Italy,s Central 
Bank Governor and leading industrialists harshly criticized 
the Berlusconi government for the DPEF,s failure to address 
the need for structural reforms and for making what they say 
are unfounded claims about a positive economic performance. 
 
2. (SBU) While not binding, the DPEF is normally a preview of 
the final budget package. Players in the political process 
are scrutinizing the DPEF for insight into the government,s 
economic priorities. With its publication, they have begun 
their posturing to ensure that, at the end of the day, the 
budget preserves their special interests. The DPEF also was 
caught up in political tensions within the ruling coalition. 
There's a heated dispute among coalition partners on 
spending, reforms and the direction economic policy should 
take. 
 
3. (U) Even the Italian government admits in the DPEF that 
Italy is unlikely to balance its budget before 2007, while 
GDP growth rates are expected to hover between two percent 
and 2.6 percent in the four-year period. Noticeably absent 
from the DPEF are any government plans to privatize key 
state-owned business, or for tax and pension reform.  End 
Summary. 
 
The Basic Facts: DPEF 2004-1007 
------------------------------- 
 
4. (U) On July 17, the Berlusconi Government presented to 
Parliament its financial plan ) Documento di programmazione 
economica e finanziaria (DPEF) - for 2004-2007, which was 
reviewed by Parliament before it adjourned for the August 
summer recess.  The plan outlines the parameters for the 
annual budget for 2004, which will be presented to Parliament 
in late September. 
 
5. (U) The key targets of the DPEF are: 
 
-- Real GDP growth of 0.8 percent in 2003 and two percent in 
2004, increasing gradually to 2.6 percent in 2005-2007. 
 
-- Steady reduction of Italy's high debt from 105.6 percent 
of GDP in 2003 to 104.2 percent in 2004 and to 97.1 percent 
in 2007.  (Note: Last year,s DPEF predicted a drop in 
Italy's debt to 95 percent of GDP in 2007. End Note). 
 
-- Stable inflation under 2 percent per year.  Inflation is 
expected to decline from 2.5 percent in 2003 to 1.7 percent 
in 2004, to 1.5 percent in 2005 and 1.4 percent in 2006 and 
2007. 
 
-- Lower unemployment, expected from an economic recovery 
combined with measures designed to increase labor market 
flexibility, from 8.8 percent in 2003 to 8.2 percent in 2004 
and 7.5 percent in 2007.  The GOI also plans to increase the 
labor participation rate to close to 60 percent in 2007. 
(Note: The target has been postponed by one year.  Last 
year,s DPEF predicted that the 60 percent target for the 
labor participation rate would be achieved in 2006.  End 
note). 
 
-- Investment in physical capital, human capital and 
technology, aimed at raising productivity and competitiveness. 
 
-- Implementation of macroeconomic and financial policies 
that are in line with the European Stability and Growth Pact 
commitments. 
 
-- Increased investment in infrastructure, both through the 
Tremonti-proposed Euro-wide project and through domestic 
initiatives. The GOI has allotted 32 billion Euro for 
infrastructure projects in the period 2003-2006. 
 
The problem with the numbers 
---------------------------- 
 
6. (SBU) The government,s GDP growth target for 2003 of 0.8 
percent is, according to some analysts, still too optimistic. 
 
 
The latest consensus forecast assumes 0.6 percent growth this 
year and 1.6 percent growth in 2004.  Comment: The 
government's projected growth rate would be possible only if 
there were a global economic recovery in the second half of 
the year, which at this moment seems unlikely. End Comment. 
In the period 2004-2007, the GOI predicts a GDP growth rate 
ranging from two percent to 2.6 percent. 
 
7. (SBU) The GOI expects 2.4 percent inflation for 2003, 
which many analysts also believe is unrealistic.  This 
prediction is 20 basis points below the latest data available 
(2.6 percent in June), 30 basis points below the average of 
the first half of the year (2.7 percent) and 10 basis points 
below the latest consensus estimates (2.5 percent). 
 
8. (SBU) The DPEF does not specify what spending cuts and 
revenue raising measures will be proposed in the 2004 budget. 
 The DPEF also does not identify any government plans to sell 
off state-owned companies in the short term. In the last ten 
years, the GOI raised USD135 billion through privatizations, 
which helped reduce the debt/GDP ratio from 125 percent to 
106 percent of GDP. End note. As it has argued previously, 
the GOI contends in the DPEF that it is delaying selling off 
companies because of uncertain market conditions. 
 
9. (SBU) Comment: Even when market conditions improve, we do 
not expect the government to sell off its most valuable 
assets.  Reluctant to sell shares of firms in sectors 
considered to be critical to national security, such as 
aerospace and defense, the GOI is likely to hold on to its 
32.3 percent stake in Finmeccanica (the large aerospace and 
defense holding company), 67 percent stake in Enel (Italy,s 
main electrical producer) and 30 percent stake in ENI 
(Italy,s largest hydrocarbon company).  The GOI also is not 
considering sale of RAI (radio and TV broadcasting) or 
Alitalia (national airlines.)  Both entities are 
over-staffed, money losers.  End Comment. 
 
Controversy Erupts 
------------------ 
 
10. (SBU) With the DPEF,s release, a long-brewing squabble 
between Finance Minister Tremonti and Central Bank Governor 
Fazio bubbled over.  The DPEF was the ostensible reason for 
the spat, with Fazio harshly and publicly criticizing the 
DPEF for ignoring the need for major structural reforms. 
However, the dispute,s roots went much deeper. 
 
11. (SBU) Although initially enthusiastic about the 
Berlusconi government's economic program, Fazio has become 
increasingly disenchanted with the government writ large, 
but, most pointedly, with Tremonti. Fazio has criticized the 
government for not tackling more seriously the need for 
structural reforms, including pension and tax reforms, and 
for consistently projecting a positive economic performance, 
which he argues, is unfounded.  Fazio,s criticism is shared 
by many, including Antonio D,Amato, president of Italy,s 
largest business confederation, who argued that the Italian 
government has not done enough to improve Italy,s 
competitiveness and to address major structural problems. 
 
12. (C) Comment: The position of the Central Bank Governor is 
traditionally a "neutral8 voice in economic policy making. 
Fazio, many believe, has personal political aspirations to 
become Finance Minister and so is distancing himself from the 
Government's policies.  Tremonti has argued that Fazio's 
inaction to protect Italian investors and consumers requires 
systemic change to take away some of the Central Bank's 
banking supervisory authority, a challenge to one of the few 
independent functions still exercised by the Bank of Italy. 
 
13. (C) Comment continued: There has been a lot of jockeying 
in the ruling coalition over who has the upper hand in 
economic policy making. Tremonti, a technocrat firmly linked 
to coalition partner Northern League, still has the lead, but 
National Alliance (AN) and the Union of Christian Democrats 
of the Center (UDC) recently pushed hard for a greater role 
in economic policy making, complaining of being presented 
with faits accomplis in meetings of the Council of Ministers. 
 Some ministers also are complaining that they have no extra 
funds for "politically necessary" expenditures. A proposal by 
Berlusconi to create a mini-cabinet under the direction of 
Deputy Prime Minister Fini to coordinate economic policy 
making was overturned. But AN and UDC laid down markers that 
they expect to be given decision-making power in the run-up 
to the final budget package. The DPEF was a compromise 
document carefully crafted to keep the coalition in line in 
the face of these tensions. 
 
 
Other voices of criticism 
------------------------- 
 
14. (SBU) Labor unions reacted coolly to the plan, despite 
the GOI offer to discuss the labor issues contained in the 
DPEF.  The opposition, as expected, criticized it. Banking 
lobbies, forced the GOI to delete provisions regarding home 
mortgages. 
 
The last time? 
-------------- 
 
15. (U) Given this year,s controversy over the DPEF and the 
questionable utility of this annual exercise, Finance 
Ministry Tremonti has called for a much different DPEF next 
year. Pointing out that only Italy goes through this annual 
exercise, Tremonti has said the 2004 DPEF will be reduced to 
just one page.  Budget details will only be revealed in the 
presentation of the budget each September before Parliament. 
 
Final Comment 
------------- 
 
16. (SBU) The DPEF, while just a planning document, 
demonstrates how difficult it will be to enact major 
structural changes.  Even mention of the need for such 
reforms was struck out at the last minute based on some 
coalition partners' objections.  Already various political 
parties, industrial associations and labor unions have put 
the government on notice that they expect more from the final 
budget package in terms of growth initiatives. Recent 
indications that Italy is now officially in recession for the 
first time since 1992 (the economy has shrunk over two 
quarters) will fuel this clamor.  Yet many of these groups 
have fought hard against needed tax, labor and pension 
reforms. 
 
17. (C) The August vacation season has stilled the 
controversy over the DPEF. The battle will begin again with 
the September presentation of the budget to Parliament, with 
attention focusing on Finance Minister Tremonti.  Embattled 
for several months, Tremonti seems to have held his ground, 
although resentment of what is perceived as his high-handed 
style lingers, as do real differences among coalition 
partners toward the way ahead for Italy's economy.  The 
question remains whether the intra-coalition struggle will 
challenge Tremonti's staying power and his pro-reform 
policies.  His coalition opponents see the clocking ticking 
toward spring elections, are hungry for more budgetary 
flexibility to permit "political expenditures."  Once again, 
in Italy, it is politics as usual.  End Comment. 
Skodon 
 
 
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	2003ROME03697 - Classification: CONFIDENTIAL