Don't trust Italian growth forecasts, experience suggests

October 13, 2016 6:27 AM EDT

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By Gavin Jones and Giuseppe Fonte

ROME (Reuters) - Italy has a chronic problem with official economic forecasts, and its habit of making overambitious growth assumptions suggests that either its forecasting models are hopelessly outdated or it does not want to face up to the need for radical reform.

This pattern of building optimistic projections into each year's budget, only to cut them later as reality dawns, is nothing new - and neither is this exclusive to Italy, although it is by far the worst offender among major European economies.

But a consequence of the missed growth targets is that successive governments in Rome have failed to cure a much more profound problem, Italy's vast public debt as a proportion of its economy. Now this issue will take center stage as Prime Minister Matteo Renzi goes into tough negotiations with the European Commission over his 2017 budget plans.

The omens are not good. In an unprecedented step, Italy's independent public finance watchdog refused last week to sign off on the government's latest economic planning document, describing the growth forecasts as too optimistic.

Politics may be at work. Renzi is anxious to avoid belt-tightening before a referendum on constitutional reform in December that could decide his future. Like last year, he has appealed to Brussels for "flexibility" under EU budget rules.

By forecasting higher growth, projections of tax income can also be raised, allowing a more generous budget.

"If you want to spend more, then you raise the economic forecast to justify it," Luca Ricolfi, professor of data analysis at Turin University, told Reuters. "The forecasts are totally political and they are also opaque because the government doesn't make its economic models public."

Renzi is standing by the forecasts but experience suggests the Parliamentary Budget Office (UPB) may well be right.

Between 2011 and 2015 every edition of the Economic and Financial Document (DEF), Rome's annual multi-year forecasting plan, which is published in April, has overestimated the following year's growth by wide margins.

Italy has achieved its year-ahead growth forecast in only two of the last 10 years. For instance, in 2012 it predicted the economy would expand 0.5 percent the following year; in the event, gross domestic product (GDP) shrank 1.7 percent. The previous year the forecasting error was even bigger.

The extent of the shortfalls suggests Italy's official forecasting models are out of date and "useless," said economist Lorenzo Bini Smaghi, who formerly served at the Italian Treasury and on the board of the European Central Bank.

To be fair, forecasters at the International Monetary Fund and European Commission have also overestimated Italian growth, though normally by smaller margins.

Bini Smaghi told Reuters they were all struggling to account for Italy's long-term economic and demographic problems.

"The models being used do not seem to capture the erosion of Italy's growth potential as its population has aged, its productivity has languished and it has lost competitiveness as a result of globalization," he said, adding that overestimating growth prospects was a way of turning a blind eye to the urgency of deep reforms.

GRAPHIC - Italy's lagging economy: http://tmsnrt.rs/2dWGLDz

GRAPHIC - Its forecasting problem: http://tmsnrt.rs/2e0O3Xc

PALING BY COMPARISON

Other countries' governments also tend to overestimate their growth outlook, but by far smaller amounts than Italy.

In the five DEFs published from 2011 to 2015 the sum of the annual growth rates forecast for 2012 to 2016 was 5.8 percentage points. Instead there has been a contraction of 2.9 points, including the government's latest projection for this year, giving a massive difference of 8.7 percentage points.

In the same period German growth has been 2.7 points below official forecasts and French growth 4.3 points lower. In Spain, which like Italy was sucked into the euro zone debt crisis in 2011-12, growth has been 4.8 points lower than projected, but it has beaten the official forecast in two of the last three years.

A Treasury spokesman said Italy often revises down its year-ahead projections in the autumn and these figures prove more accurate. The current forecast of 1 percent growth in 2017 is only 0.2 points above the average estimate of private sector economists, he added.

However, using the autumn forecasts Italy's growth was still 6.5 points below target in 2012-2016, a bigger shortfall than for Germany, France and Spain even using their April forecasts.

Stefania Tomasini at the Prometeia think-tank said forecasting models for Italy probably underestimate the structural damage inflicted by two steep recessions since 2008.

"The models are based on past experience and they probably exaggerate our ability to bounce back," she said. "We keep forecasting Italy can grow at close to the rate of the rest of the euro zone, but it never manages to."

Economists have failed to grasp the effect of years of under-investment in technology that is partly due to an industrial fabric made up mainly of small companies, she added.

Italy has few major corporations able to invest heavily in raising their productivity. According to OECD data, almost 60 percent of Italian companies have fewer than 20 employees, compared with just 30 percent in Germany.

The problems have deep roots. Overall, the economy has barely grown since the euro was introduced in 17 years ago. Since the global crisis year of 2008, industrial output and investment have dived, while GDP has shrunk around 9 percent.

Italy invests less in education than any other European Union country as a proportion of GDP.

HEAVY BURDEN

The missed targets hurt public finances, not only because less growth means less tax revenue, but also because the budget deficit and public debt are expressed as a proportion of GDP. So as growth has undershot in each of the last five years, the deficit-to-GDP ratio has overshot.

Debt, proportionately the highest in the euro zone after Greece's, has risen to an all-time record. The government says it will amount to 132.8 percent of GDP this year, up from 132.2 percent last year.

Only by curbing the deficit can that figure fall but Renzi has said that with extra spending due to the migrant crisis and reconstruction after an earthquake disaster in August, the 2017 shortfall could hit 2.4 percent, the same as in 2016.

European Commissioner for Economic and Financial Affairs Pierre Moscovici has made clear there are limits to how flexibly EU budget rules can be applied. "We believe that raising public debt above the current level is not reasonable, because the burden is already very heavy," he told Reuters.

REFORM IMPACT?

Successive governments have introduced reform measures and the DEFs have repeatedly estimated they will have a major impact on future growth. This never seems to materialize, although growth may have been even more dismal without them.

For example, the planning document in 2013 estimated labor and product market reforms passed the previous year would have raised GDP by 1.6 percentage points by 2015.

GDP actually fell in 2013 and rose just 0.1 percent in 2014 and 0.7 percent in 2015. The Bank of Italy says it would have declined last year too but for the ECB measures to stimulate the wider euro zone economy.

The latest update to this year's DEF, presented by Renzi last week, says his reforms and fiscal stimulus will almost double growth next year to 1.0 percent from a government estimate of 0.6 percent under a scenario of unchanged policy.

This projection "appears to be marked by an excess of optimism", UPB chief Giuseppe Pisauro told parliament, adding that it was "significantly out of line" compared with the estimates of a panel of independent Italian think-tanks.

(additional reporting by Michael Nienaber in Berlin, Leigh Thomas in Paris and Sarah White in Madrid; editing by David Stamp)



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