Will Italy’s ambitious Structural Budget Plan solve its debt problem?

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Italy this week unveiled an ambitious Structural Budget Plan – “Piano Strutturale di Bilancio (PSB)”, aimed at tackling its long-standing debt challenge while stabilising public finances. 

Although the plan aims to steer Italy out of the European Union’s Excessive Deficit Procedure (EDP) by 2026, some economists are warning that the aggressive fiscal consolidation it proposes could harm growth, potentially pushing the country into recession.

Presenting the plan, Economy Minister Giancarlo Giorgetti laid out ambitious targets to reduce the deficit, sustain public investment, and lower Italy’s towering debt levels. However, striking a balance between fiscal discipline and economic reform will be crucial for its success.

Italy’s PSB: Key economic targets unveiled

The Structural Budget Plan establishes several key targets aimed at stabilising Italy’s fiscal outlook:

• Real GDP growth: Projected at 1.0% for 2024.

• Deficit-to-GDP ratio: Reduced to 3.8% in 2024, with a goal of falling below 3% by 2026.

• Debt-to-GDP ratio: Estimated at 134.8% in 2023, expected to rise to 137.5% by 2027 before stabilising at 134.9% by 2029.

• Primary surplus: Achieving a small surplus of 0.1% in 2024. According to the government this is seen as a “moral target”, as it marks a turnaround from years of primary deficits.

• Structural primary balance: Forecasted to average 1.1% of the gross domestic product from 2025 to 2029.

  Italy’s public debt, one of the highest in the eurozone, remains a significant obstacle to fiscal sustainability. Interest payments alone are forecast to reach 3.9% of gross domestic product in 2024, consuming a large portion of public resources and limiting room for growth-oriented investments.

 Minister Giorgetti acknowledged the heavy burden of debt and the pressing need for structural reforms.

“Our fiscal path is realistic, credible, and prudent,” Giorgetti wrote in the PSB presentation, adding that it is “designed to gradually reduce the interest rate on new debt and control the spread on government bonds”. 

Public investment and the PNRR

While fiscal tightening is a central focus, the new fiscal plan also stresses the importance of public investment, particularly through the reliance on Italy’s National Recovery and Resilience Plan (PNRR). The government expects PNRR-backed investments to boost GDP by 1.1% by 2031.

In the short term, Italy will focus on fully implementing the PNRR through 2026, targeting key sectors such as:

• Judicial reform
• Public administration efficiency
• Digitalisation
• Improved competition
• Business environment enhancement

However, as public investment alone will not be sufficient to meet Italy’s long-term needs, particularly in areas such as green energy and infrastructure, the PSB emphasises the need to attract private capital. 

Structural reforms aimed at removing barriers to private investment will be crucial in ensuring the volume of funding necessary to support the energy, environmental, and technological transitions.

Could an excessive fiscal consolidation lead to economic recession?

While the government is optimistic about the benefits of its fiscal strategy, economists, including Filippo Taddei from Goldman Sachs, have expressed concerns about the potential impact of such aggressive fiscal tightening on Italy’s economic growth.

Taddei praised the government’s commitment to fiscal consolidation but cautioned that the faster pace of fiscal tightening may lead to unintended consequences, especially if growth momentum continues to weaken. 

According to Taddei, the plan’s reliance on nominal growth driven by inflation to reduce debt could backfire if the European Central Bank (ECB) succeeds in bringing inflation back to its 2% target sooner than expected.

Taddei also pointed out two specific challenges Italy will face in the medium term:

1.    Rising borrowing costs: Starting in 2025, Italy’s real borrowing rates are expected to turn positive for the first time since 2020, making it more expensive for the government to finance its debt.

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2.    Construction tax credits: The cost of tax credits issued between 2021-2023 will continue to weigh on public finances, adding more than 2% of GDP to yearly debt issuance until 2027, further complicating efforts to reduce the deficit.

He further warned that Italy’s economy could slip into a recession by 2030 as the fiscal tightening reduces growth prospects.

“The fiscal consolidation proposed by the Italian government will likely weigh on future growth, possibly pushing, as in the government projections, the Italian economy into recession,” Taddei said. 

The tightrope walk to fiscal stability

Italy’s Structural Budget Plan sets out a bold course for fiscal consolidation, aiming to reduce the country’s towering debt levels and stabilise public finances. While the plan’s fiscal targets are clear, its success will depend on how well Italy navigates the complex economic landscape in the coming years. 

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The government’s ability to maintain fiscal discipline while supporting growth will be key. 

However, if the tightening measures prove too aggressive, they could stifle economic activity and potentially push the country into a recession.

The road ahead for Italy is fraught with challenges, but the PSB offers a path toward long-term stability – if executed carefully.