The IMF warned on Tuesday that Italy’s economy remained “vulnerable” to the euro debt crisis and could have a knock-on effect globally despite “strong efforts” being made by Italian Prime Minister Mario Monti.
The IMF said it expected a recovery to “take hold” only at the start of next year with a rise in exports, but said growth rates would continue to lag behind the rest of the eurozone without major reforms.
It also said that Italian banks were broadly stable, but still heavily reliant on liquidity from the European Central Bank and that lenders were becoming too exposed to sovereign risk and rising loan rates.
While the IMF kept its economic growth forecasts at minus-1.9 percent for this year and minus-0.3 percent next year, it said Italy’s debt would rise to 125.8 percent of GDP this year and that the deficit would decline only to 2.6 percent.
However, the Fund also said that Italy’s primary surplus would rise to more than 4 percent of GDP by 2014 — the highest level in the eurozone.
“The authorities have embarked on an ambitious agenda to secure sustainability and promote growth,” the IMF said in an annual report.
“Despite these strong efforts, Italy remains vulnerable to contagion from the euro area crisis, with spillover consequences for the region and globally,” the report added.
The report stressed the importance of keeping up the reform momentum with continued public support for Monti, whose popularity ratings have dipped, but remain relatively high as budget cuts have taken hold.
“The key will be forceful and expeditious implementation of these reforms. To the extent that public support weakens, then this will become more challenging,” said Kenneth Kang, head of the IMF’s mission to Italy.
“Public support is still there and it is important that it remains there,” he added.
The IMF also urged Italy to cut spending and lower taxes in the medium-term and to implement structural reforms like overhauling the labor market, introducing laws that made it easier to do business and boost competition in the service sector.
The fund hailed a new constitutional, balanced budget law as “an important tool for strengthening fiscal discipline and policymaking” and praised former European commissioner Monti’s efforts to curb public finances in the short term.
The report said banks had strengthened their capital positions, but cautioned that they were at risk from the recession and financial market pressures.
Impaired loans in Italy have risen to 11 percent of the total last year, from less than 6 percent before the crisis.
Banks’ holdings of government bonds have also grown to seven percent of assets, compared with a four percent eurozone average.
Foreign holdings of Italian bonds have decreased from about 51 percent last year to an estimated 37 percent now, the report said.
The IMF forecast that Italy’s debt-to-GDP ratio would peak at about 126.4 percent next year before declining to 119 percent in 2017, but warned that a slow recovery, high interest rates or policy slippage could push debt even higher.