Call For Better Public Finance Management


The Italian government is currently doing some adjustments in its fiscal policy composition. The country faces dilemma in light of not being able to keep its government budget deficit below 3.0% of GDP for 2013 without enforcing a few fiscal policy adjustments amounting between EUR 2.5B and EUR3.0B. Italy may not be considered as one of the best foreign exchange rates contributor but it already incurred reputational costs and thus could impact the debt servicing costs of the nation.

Budget Policy

Italy is considered as the only European nation that emerged from the Excessive Budget Procedure last July. Barclays therefore believes that the government will present a full set of policy measures to maintain the public finances at par with the European Commission’s specifications and thus prevent a reopening of said operations. The government will publish the Stability Law and the details should be available some time around October of this year. Forex strategists believe that risks related to implementation should not be underestimated despite the small size of adjustment needed.

Political instability remains under control and approved arrears liquidation is completed in full as long as total revenues continue to hold at current levels in July which is up 1.9% Y/Y. Barclays expects additional tightening required to hold the budget deficit below 3.0% of GDP to be insignificant between EUR2.5B and EUR3.0B.

Fiscal Risks

Italy remains committed to achieving a general government budget deficit of 3.0% of GDP this year. According to the DEF, the government will implement a growth-neutral fiscal adjustment. The Italian government presented an update to the Economic and Financial Document (DEF) released in April. The government expects GDP to decline by 1.7% this year and to grow by 1.0% next year. Economists are less upbeat than the government about the economic outlook next year. Barclays forecast GDP to climb by 0.8% in 2014 while they also anticipate a drop of 1.7% this year.

Fiscal Drag

Economists note that suspending the VAT rate hike this coming October would incur them EUR1.0B while not be able to collect the second tranche of the IMU property tax would cost about EUR2.4B. Non-deferrable expenditures will comprise peacekeeping missions plus unemployment benefit (CIG, Cassa Integrazione in Deroga) which is suspended and reaching about EUR0.8B. VAT. Revenues from the VAT generated through liquidation of state arrears should produce an estimated EUR1.5B this year. It was assumed about EUR20B to be liquidated this year but the Italian government decided the intention is to deliver EUR27B. It would only partially offset the lack in revenues due to the fiscal easing released last fourth quarter for a total of EUR4.2B.

Government Commitment

According to Prime Minister Enrico Letta, the hidden cost of political instability could be of EUR1.5bn. Under this scenario, not only would the fiscal adjustment necessary to meet this year’s target increase, but the likelihood of a smooth agreement between parties would decline substantially. That said, should political instability increase, debt-servicing cost would rise, along with the risk of further rating downgrades.

Five Years – A Long Time

Meanwhile, it makes no sense at all to ambition for the best foreign exchange rates by extrapolating the weakness of the US economy that underpinned Fed’s decision not to proceed with tapering going into 2018 to 2023. Analysts would instantly revert to forecasting the best foreign exchange rates, though what is needed is extrapolation of data. To cite an example, the 5y5y forward period could end up being another bout of economic weakness. A more plausible base case is that the economy continues to heal and at some point between now and then returns to a more normal state that calls for more complete normalization of monetary policy. Much healing can take place during five years. If, for example, the unemployment rate were to continue to drift down at the rate that it has done during the past four years of disappointing but reasonably steady recovery, it would reach 4.5% in five years, close to the level it reached during the 2005-07 economic and financial boom. This is an extrapolation, not a forecast, but it offers a reminder how dramatically the cyclical context can change in five years.

One explanation of the ‘excess sensitivity conundrum’ may be that the Fed’s direct intervention in the US forex market is so powerful that it overwhelms fundamental drivers of what could have been the best foreign exchange rates . This may well be an important part of the explanation. To the extent that it is, market participants will have are responsible in reminding investors that what Quantitative Easing gives, it will eventually take away.


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