US embassy cable - 04ROME3232

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