US embassy cable - 05ROME1588

UNCLAS  ROME 001588 
 
SIPDIS 
 
 
SENSITIVE 
 
DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA 
PARIS ALSO FOR USOECD 
TREAS FOR HULL 
STATE PASS CEA 
FRANKFURT FOR WALLAR 
USDOC 4212/ITA/MAC/OEURA/CPD/DDEFALCO 
 
E.O. 12958:  N/A 
TAGS: ECON, EFIN, ELAB, PGOV, IT, EUN, KPRP, ITALIAN POLITICS 
SUBJECT: Italian Economic Policy and Challenges Under 
Berlusconi III 
 
Ref: A) ROME 1409; B) ROME 1150; C) ROME 1043; D) 04 Rome 
2630 
 
SUMMARY 
------- 
 
1. (SBU) By reluctantly agreeing to resign and form a new 
Government, PM Berlusconi bought himself and the governing 
coalition another year to convince Italian voters to re- 
elect them in 2006.  Growing evidence indicates that a weak 
economy is a leading contributor to public dissatisfaction 
with the Berlusconi Government.  However, budget woes will 
limit Berlusconi's ability to kick-start the economy through 
tax cuts or government spending.  New Deputy Prime Minister 
Tremonti, who was ousted as Finance Minister in mid-2004, is 
the economic policy wildcard; and it is unclear how much of 
a role he will play in setting Italy's economic policy.  The 
Government has sought to shift the blame for economic blues 
to procrustean eurozone monetary policy and cheap Chinese 
imports.  Berlusconi will face the ire of the European 
Commission and sovereign debt markets, if deficit spending 
balloons significantly above three percent of GDP; but 
without additional pre-election pork, and some credible 
actions to improve voters' perception of economic progress, 
Berlusconi faces long odds at the ballot box.  End Summary. 
 
TREMONTI - THE KEY "NEW" PLAYER 
------------------------------- 
 
2. (SBU) The new Berlusconi Cabinet, sworn in by President 
Ciampi April 23, was not that different from the one it 
replaced (Ref A).  The key change affecting economic policy 
may be the return of ousted Finance Minister Giulio Tremonti 
as Deputy Prime Minister.  In the first days of the newly 
formed Government, Tremonti made several economic proposals, 
including a ham-handed suggestion to raise revenue by 
leasing government-owned beachfront property in the 
underdeveloped south of Italy.  (Comment: Retaining 
political support in the south is essential for Berlusconi 
to win in the next national elections. End Comment.)  As 
Finance Minister, Tremonti relied heavily on one-off 
measures, such as tax amnesties, to shrink the budget 
deficit.  His successor, Domenico Siniscalco, indirectly 
disparaged Tremonti's policies by declaring an end to 
creative public finance, and proposed the most sweeping 
budget reform package of the last decade.  The dynamic 
between Tremonti, a political insider close to Berlusconi, 
and Siniscalco, a technocrat, but respected by the European 
Commission and the IMF (and, seemingly, the governing 
coalition, as well), will substantially affect Italy's 
economic policy over the next year. 
 
OTHER NEW FACES...AND OLD FACES IN NEW PLACES 
--------------------------------------------- 
 
3. (U) Berlusconi also replaced three new ministers with 
portfolios related to economic policy: Communications (Mario 
Landolfi), Productive Activities (Claudio Scajola), and 
Health (Francesco Storace).  Gianfranco Micciche' was named 
to the new Ministry (without portfolio) of Development and 
Territorial Unity.  Micciche' will focus on strategies to 
help the south.  See bios on these ministers in para. 17. 
 
CONFLICTING DOMESTIC/INTERNATIONAL DEMANDS 
------------------------------------------ 
 
4. (U) The Government faces conflicting demands 1) by voters 
(and some in the coalition), who want tax breaks, government 
jobs/pay raises, and relief from the impact of Chinese 
exports; and 2) by the European Commission and bond markets, 
which seek fiscal discipline, coherent and consistent 
economic reform, and a repudiation of emergency, one-off 
funding measures.  The Government will be hard pressed to 
please either grouping, let alone both at the same time. 
 
CHALLENGING ECONOMIC ENVIRONMENT; TEXTILES SLUMP 
--------------------------------------------- --- 
 
5. (U) GDP growth has been anemic over the last three years, 
averaging just 0.6 percent annually.  The Government has 
ratcheted down its 2005 growth forecast from 2.7 to a still- 
optimistic 1.2 percent.  The manufacturing sector has had 
negative growth in six of the last eight quarters.  Italian 
exports have become less competitive, in part because 
productivity increases have not kept up with wage growth. 
The textile industry, centered in the northern political 
base of Deputy PM Tremonti, has been hard hit.  Italy has 
nearly 50,000 small textile companies, averaging about a 
dozen employees each and exporting well over half their 
goods. 
 
JUGGLING BUDGET DEFICITS... 
--------------------------- 
 
6. (U) On April 29, the Government revised its 2005 budget 
deficit forecast from 2.9 to 3.5 percent of GDP, putting it 
in line with earlier estimates by the IMF and European 
Commission.  The Government also indicated that it would 
lower its stock of debt from 105.8 percent of GDP (end-2004) 
to 105.3 percent (end-2005).  Both figures are in excess of 
the EU's ceilings of three percent of GDP (deficit) and 60 
percent of GDP (debt).  The Government will seek to convince 
the EU that the weak economy justifies exceeding the deficit 
ceiling, while telling voters that the economy is on the 
mend. 
 
...AND DEBT 
----------- 
 
7. (U) Italy has been bringing down its stock of debt, 
thanks largely to low interest rates and privatizations. 
However, having already sold off its most attractive assets 
and with interest rates rising, the Government will strain 
to continue shrinking its debt.  Until 1999, Italian 
government debt was held mostly by Italians.  However, the 
trend has shifted since the introduction of the euro, and 
most Italian foreign debt is now held outside of Italy. 
Foreign bondholders will be watching closely for signs that 
the newly revamped EU Stability and Growth Pact will result 
in even greater divergence in fiscal policy among eurozone 
economies.  If so, Italy's outlier status would translate 
into a higher risk premium on its sovereign debt.  Standard 
and Poors has already downgraded Italian sovereign debt in 
July 2004. 
 
COMPETITIVENESS PACKAGE TOPS ECONOMIC AGENDA. 
--------------------------------------------- 
 
8. (U) The Senate passed the first part of the Government's 
competitiveness package May 4, and it now moves to the 
Chamber of Deputies for expected quick consideration.  The 
decree law includes provisions on corporate incentives, 
public works funding, bankruptcy reform, unemployment, and 
pension funds; and creates a new entity to promote foreign 
direct investment in Italy.  On the revenue side, the 
package also increases alcohol consumption taxes, fines for 
purchasing knockoff goods, and penalties for employers 
hiring off the books.  The second part of the 
competitiveness package is under consideration in the 
Chamber of Deputies as standard, not decree, legislation. 
Professional associations killed a provision that would have 
diminished their control over who can work in their 
occupation.  Lack of open access to enter many professions 
causes distortions in the Italian labor market.  In March, 
junior coalition partner the Northern League threatened to 
oppose the package if it did not address economic impact of 
Chinese textile exports.  At the EU-level, the Government 
has sought help combating counterfeit goods and remediation 
for alleged textile dumping from China (Ref B). 
 
"IRAP" BUMPS TAX CUTS OFF THE AGENDA. 
------------------------------------- 
 
9. (U) The European Court of Justice (ECJ) Advocate General 
issued an opinion March 17 that Italy's regional tax on 
productive activities (IRAP), a value-add tax on business, 
conflicts with EU legislation because the tax is too similar 
to the VAT.  The ECJ will soon issue its ruling.  If the ECJ 
rules that IRAP must be eliminated or changed, it would 
almost certainly include a phase-out period to keep from 
inducing a public sector funding crisis in Italy. 
Abolishing IRAP would slash 33 billion euro in GOI revenue. 
 
10. (U) Finance Minister Siniscalco declared, "The 
Government has always considered IRAP inefficient and poorly 
conceived...Now the Government must replace it as soon as 
possible...to make firms competitive and in line with the EU 
Stability and Growth Pact."  As the Government considers 
alternatives to replace IRAP revenue, it will have the 
opportunity to craft a tax alternative that will minimize 
market distortions on employers, investors, consumers, and 
property owners.  Confindustria, the Italian association of 
industrialists, has long called for abolishing IRAP and has 
recently pushed for elimination of any charge on 
labor/payroll in the taxes that replaces IRAP. 
 
11. (U) Despite Italy's fiscal woes, Berlusconi continued 
his mantra of income tax cuts right up to the Coalition's 
lopsided defeat in the early April regional elections.  Post- 
election analysis showed that tax cuts did not resonate with 
many voters, who were not convinced the cuts were 
sustainable into the future, and therefore, of little 
meaningful long-term value.  Voters also realized that tax 
cuts would be accompanied by offsetting fees and service 
charges, which on balance left little extra money in their 
pockets.  Finally, the tax cuts were not part of a systemic 
reform to make government spending more efficient and to 
reduce waste and redundancy in the bureaucracy -- changes 
that would have addressed key factors in Italy's economic 
stagnation and helped to stimulate the economy.  Since 
forming the new Government, Berlusconi has been silent on 
future income tax cuts. 
 
PROGRESS ON MARKET OVERSIGHT REFORM MAY SLOW. 
--------------------------------------------- 
 
12. (U) After the collapse of Parmalat in late 2003, then- 
Finance Minister Tremonti proposed sweeping market oversight 
reform legislation.  Subsequently, the reform was divided 
into separate bills, the first of which was passed April 13, 
2005, and implemented the EU Market Abuse Directive.  The 
second tranche of the reform has passed the Chamber of 
Deputies and is under Committee review in the Senate (Ref 
C).  However, since the Senate is likely to make changes to 
the bill, it would then need to return to the lower Chamber 
for reconsideration.  Competing legislative demands to 
prepare the 2006 budget and pass voter-popular measures, 
will likely delay progress on oversight reform.  If the 
Parliament does not pass the reform before dissolving for 
the 2006 elections, the reform package will be sent back to 
square one; and the next Government will need to submit a 
new bill for consideration. 
 
13. (SBU) The version passed by the Deputies would create 
tough oversight on conflict of interest between banks and 
companies and requires banks to provide potential retail 
investors with a prospectus for bonds that the banks sell. 
Consob, Italy's securities market regulator, would gain 
powers in the supervision of auditing firms, while the 
financial police (Guardia di Finanza) would work more 
closely with Consob.  The bill would make mega-fraud a new 
category of crime (fraud affecting more than 289,000 
investors or holdings greater than USD 7.5 billion).  The 
bill also puts limits on the credit that banks can extend to 
major shareholders (75 percent of the value of the shares 
the investor owns) and requires that company boards include 
an outside member who represents minority shareholders. 
 
THE SOUTH...AND OTHER MEASURES ON THE HORIZON 
--------------------------------------------- 
14. (SBU) The Government will be looking for low/no-cost 
actions attractive to disaffected voters, especially in the 
Mezzogiorno South.  One of the first of these, a proposal to 
raise revenue and increase tourism in the south by leasing 
Government beachfront property, was hurriedly conceived and 
poorly presented.  (Comment:  The presentation was 
reminiscent of the lack of consultation that contributed to 
Tremonti's resignation last year (Ref D).  End Comment.) 
Rather than garner support in the south, the proposal was 
viewed by many in the target region as a sign that the 
Government was out of touch with the south and unwilling to 
take on core issues, such as infrastructure development. 
 
15. (U) Separately, the public sector is pushing for a wage 
increase in 2005, which, if implemented, could increase the 
federal budget deficit by as much as 0.2 percent of GDP. 
Also, as a nod to the European Commission, the Government 
has discussed submitting to the Parliament earlier than 
usual the DPEF 2006-2009 (four-year budget plan) and 2006 
budget.  (Comment: DPEF is usually presented in July and the 
budget, at end-September.  End Comment.)  Early submission 
would give the Government an opportunity to demonstrate to 
the Commission that the excessive 2005 deficit was an 
anomaly. 
 
COMMENT 
------- 
 
16. (SBU) In 2001, Berlusconi swept into office as a reform- 
minded, practical businessman.  Over the intervening four 
years, however, he has accumulated a spotty record (at best) 
of implementing the systemic reform Italy's economy badly 
needs.  He will be even less likely to focus on reform over 
the next yeaQ especially the unpopular measures needed to 
rein in government spending and reduce bureaucracy.  Despite 
Finance Minister Siniscalco's abhorrence of one-off 
measures, we expect the Government to look for quick fixes 
to cut both the deficit and the debt.  Whichever side wins 
the next national elections will still be confronted with 
the tough challenge of getting Italy's economy back on 
track.  End Comment. 
 
17. (U) BIOGRAPHIES OF NEW KEY MINISTERS 
---------------------------------------- 
 
Giulio Tremonti, Forza Italia (FI), Deputy Prime Minister 
--------------------------------------------- ------------ 
 
Tremonti previously served as Finance Minister from June 11, 
2001-July 3, 2004, when he resigned as a result of intra- 
coalition infighting.  Tremonti is a tax law professor and a 
practicing attorney.  Tremonti has more than twenty years of 
service teaching and cooperating with Governments of both 
the left and the right.  In 1992, he was economic adviser to 
then-Italian Socialist Party (PSI) Prime Minister Giuliano 
Amato.  Tremonti stayed in that position through 1994 with 
Amato's successor and current Italian President Carlo 
Azeglio Ciampi.  During that time, Tremonti chaired the 
committee to streamline Italy's tax system. 
 
In 1994, Tremonti was elected to the Chamber of Deputies 
under the centrist ticket "Patto Segni."  He was appointed 
Finance Minister for the Government headed by Forza Italia's 
(FI) Silvio Berlusconi in 1994 and was not only a key 
economic adviser to the PM, but one of his closest political 
advisers, as well.  He is President of the Aspen Institute 
Italy and speaks English well. 
 
Claudio Scajola, Forza Italia (FI), Minister of Productive 
Activities 
--------------------------------------------- ---------- 
 
In 1982, Scajola was elected Mayor of Imperia (region of 
Liguria); but in 1983, he was forced to resign as a result 
of a local corruption scandal, for which he was arrested 
briefly but later fully acquitted.  Scajola was re-elected 
Mayor of Imperia in 1990.  He was elected to the Chamber of 
Deputies with FI in 1996, and was re-elected in 2001. 
Scajola is one of Berlusconi's closest advisers.  He was 
instrumental in deciding who to include in -- and who to 
exclude from -- FI's electoral ticket in the 2001 
parliamentary elections. 
 
In June 2001, Scajola was named Minister of Interior.  In 
this capacity, he intensified the fight against 
international and domestic terrorism and organized crime. 
In June 2002, Scajola resigned as Interior Minister, after 
he was accused of offending the memory of Marco Biagi, a 
Labor Ministry adviser killed by the New Red Brigades.  In 
November 2002, Berlusconi called on Scajola to coordinate 
the 2003 local elections, and on July 31, 2003, Berlusconi 
brought Scajola back into the government as Minister for 
Enforcement of Government Program.  Scajola speaks French, 
but does not speak English. 
 
Francesco Storace, National Alliance (AN) Health Minister 
--------------------------------------------- ------------ 
 
Storace was one of the promoters and founders of the 
National Alliance (AN) party, and formerly one of AN leader 
Gianfranco Fini's closest advisers.  Tension has emerged 
between the two leaders, however.  Storace was elected to 
Parliament in 1994, under Berlusconi's Freedom Pole (Polo 
della Liberta'), and re-elected in 1996.  He was elected 
Vice President of the Chamber of Deputies' Oversight 
Committee on Radio and Television, and was a member of the 
Joint Parliamentary Investigative Committee on the Mafia. 
As a journalist, Storace headed the AN press office. 
Storace was elected President of the central region of Lazio 
(Rome's region) in April 2000, but lost his 2005 re-election 
bid.  He speaks very little English. 
 
Mario Landolfi, National Alliance (AN), Communications 
Minister 
--------------------------------------------- -------- 
 
The former AN spokesman is a relative lightweight in the 
Cabinet.  As AN spokesperson, he has been a working level 
embassy contact. 
 
 
Gianfranco Micciche' Forza Italia (FI), Minister (without 
portfolio) of Development and Territorial Unity (new office) 
--------------------------------------------- ------------ 
 
Until his recent appointment, Micciche was Deputy Finance 
Minister, where his portfolio included Economic Development 
of Southern Italy.  Previously, he was Manager of the 
Regional Institute for Financing of the Industries of Sicily 
(IRFIS) for 11 years. He was the founder of Forza Italia in 
Sicily. Micciche' is a close advisor to PM Berlusconi, who 
appointed him National Vice Coordinator of Forza Italia in 
2004. 
Sembler 
 
 
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	2005ROME01588 - Classification: UNCLASSIFIED