New government finds hole in the accounts

* It is almost a tradition for new elected governments within the Eurozone to find black holes in the public accounts when taking office – Italy is no exception. After examining the books, which reveal that the deficit could hit 4.8% of GDP this year, the new economy minister says extra cuts are now inevitable. The government claims it is still committed to reducing the deficit below 3% of GDP in 2007 and will discuss how it intends to achieve this with EU finance ministers later this month. All of this only illustrates Italy’s formidable problems; the 2% of GDP tightening in fiscal policy required to meet this target looks illadvised given the fragile state of the economy. However, the fiscal mess, which has led Fitch – a ratings agency – to assign a 75% probability of a downgrade in the status of Italian government debt in the next 3-5 months, needs addressing.

* The uncertainty around our central growth forecast of just 1¼% both this year and next has increased. Any major fiscal restraint would completely undermine this projection. In our view, the government would be better served in the short run by taking the OECD’s recent advice and liberalising its service sectors to help improve a dismal productivity record, rather than immediately slashing spending or raising taxes. The latter policy would undermine the upside risks to our forecast that are emerging: both consumer and business confidence have improved significantly since the election, while activity in the service sector increased at its fastest rate for six years in May.

Copyright Oxford Economic Forecasting Jun 2006

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