VZCZCXRO8250
PP RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHRO #2279/01 2231525
ZNR UUUUU ZZH
P 111525Z AUG 06
FM AMEMBASSY ROME
TO RUEHC/SECSTATE WASHDC PRIORITY 5611
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUEHMIL/AMCONSUL MILAN 7507
RUEHFL/AMCONSUL FLORENCE 1635
RUEHNP/AMCONSUL NAPLES 1740

UNCLAS SECTION 01 OF 02 ROME 002279 
 
SIPDIS 
 
SIPDIS 
 
DEPT FOR EUR/WE, EUR/ERA, EB/IFB/OMA 
DEPT PASS TO CEA 
PARIS ALSO FOR USOECD 
TREAS FOR OASIA HULL 
USDOC 4212/ITA/MAC/OEURA/CPD/DDEFALCO 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ELAB PGOV IT
SUBJECT:  BUDGET 2007 ITALY: TIGHTWIRE ACT BEGINS WITH RELEASE OF 
DPEF PREVIEW 
 
REF:  ROME 00028 
 
ROME 00002279  001.2 OF 002 
 
 
¶1.  Summary:  The public release of Italy's four-year financial 
plan, the DPEF, officially opens Italy's 2007 budget process.  Prime 
Minister Prodi's coalition will formally present its draft 2007 
budget by end-September.  Parliament must approve the final budget 
by the end of December.  To avoid creating tension within the 
governing coalition, the DPEF only makes vague references to budget 
cuts and tax increases.  Jockeying among ruling coalition and 
opposition politicians over the budget has already begun in the 
media.  The 2007 budget could serve as one important issue on 
whether Prodi's fragile coalition will last into next year.  End 
summary. 
 
--------------- 
DPEF Background 
--------------- 
 
¶2.  Italy's four-year budget "preview," the "Documento di 
Programmazione Economica e Finanziaria" (DPEF), covers the period 
2007-2011.  (Note:  Italy's fiscal year is the same as its calendar 
year.  End note.)  This year's DPEF was presented July 7, along with 
a supplemental deficit reduction package to close the 2006 budget 
gap and a competition/liberalization package affecting, inter alia, 
insurance policies, taxi licenses, and retail operations.  The DPEF 
was reviewed by Parliament without a final vote.  This year's DPEF 
sets budgetary guidelines through 2011, projecting economic 
performance and identifying budgetary goals.  While not binding, the 
DPEF serves as a preview of the 2007 budget that Prodi's coalition 
will present to Parliament in late September.  Leading coalition and 
opposition politicians have already begun to argue publicly in the 
press about what needs to be done with the budget to improve Italy's 
financial situation and prospects for economic growth. 
 
------------------- 
DPEF Budget Targets 
------------------- 
 
¶3.  The stated goals of this year's DPEF are to: a) reduce the 
Italian public debt/GDP ratio (currently at 108 percent) to 99.7 
percent by 2011; b) return the budget deficit/GDP ratio to below the 
EU-mandated three percent ceiling by 2007 and to 0.1 percent of GDP 
by 2011; and c) increase the primary surplus (budget deficit less 
interest payments as a percentage of GDP) by 2011.  (Note:  A 
condition of Italy's entry into the European Monetary Union was a 
primary surplus of five percent.  End note.)  Implicit in the DPEF 
is that Prodi's ruling coalition lasts until 2011. 
 
¶4.  The DPEF states that Italian public accounts are "potentially 
unsustainable," due to the large budget deficit, a primary surplus 
hovering near zero, and rising public debt.  The DPEF recognizes 
that Italy has not met its Eurozone commitments on public debt and 
budget deficit levels. (Note:  The European Commission has warned 
Italy that it must reduce its current 4.1 percent budget deficit/GDP 
measure to 3.0 percent in 2007.  End note.) 
 
-------------------------------------- 
Suggested Budget Measures; Projections 
-------------------------------------- 
 
¶5.  The DPEF projects a budget deficit of 4.0 percent this year -- 
slightly above the 3.8 percent target of the 2006 budget (reftel) -- 
and a budget deficit of 2.8 percent of GDP in 2007. While its aims 
are ambitious, the DPEF's contents are vague.  The DPEF anticipates 
unspecified budget cuts and tax increases by 35 billion euro in 2007 
(equal to 2.3 percent of GDP) to meet EU budget compliance 
commitments, an economic stimulus package, and social programs.  The 
DPEF does not offer concrete suggestions for lowering public debt 
and decreasing the budget deficit to improve public finances -- 
probably to avoid creating too much tension within the governing 
coalition.  The DPEF also does not include concrete proposals to 
stimulate GDP growth and improve Italy's competition in 
international markets.  The document mentions unspecified plans to 
implement structural measures equal to half a percentage point of 
GDP each year in 2008-2010 through unspecified further tax increases 
and spending cuts.  The DPEF also includes a macroeconomic 
assumption/target of 1.5 percent GDP growth in 2006, followed by 1.2 
percent growth in 2007. 
 
--------------------------------------------- --- 
 
ROME 00002279  002.2 OF 002 
 
 
Central Bank Supports Calls for Tougher Spending Cuts. 
--------------------------------------------- --- 
 
¶6.  In July 17 testimony before the Senate and Chamber Budget 
Committees, Central Bank Governor Draghi offered his support to this 
year's DPEF.  However, Draghi suggested the government should be 
more aggressive in cutting pension and local government expenditures 
and increase the retirement age to make Italy's pension system 
sustainable.  Draghi noted that both measures would help ensure that 
Italy remains competitive internationally. 
 
------- 
COMMENT 
------- 
 
¶7.  Prodi and Finance Minister Padoa-Schioppa will have a difficult 
task convincing their coalition partners, constituents, and the 
opposition to take the steps necessary to return Italy to financial 
stability and economic growth.  Since a significant increase in 
economic growth is not forecast in the DPEF, tax increases and/or 
spending cuts are necessary to meet the DPEF's goals.  However, 
Prodi and Padoa-Schioppa will find it tough to sell increased taxes 
or spending cuts to skeptical coalition allies.  The opposition will 
also be extremely difficult to engage, and has already declared it 
will oppose any deficit reduction measures that "penalize" their 
constituencies.  The opposition would like nothing more than to see 
the collapse of Prodi's coalition, and will likely try to use the 
2007 budget to bring about this collapse. 
 
¶8.  Another last-minute, surprise challenge to Prodi's DPEF is a 
12.3 percent (20 billion euro) windfall in tax revenue in the first 
half of 2006.  This gain is largely due to increased Value Added 
Tax, personal and corporate income tax revenues.  This bonus, 
however, has already fueled speculation and political demands that 
2007 budget cuts are not necessary.  Both Prodi and Padoa-Schioppa 
have had to make it clear this revenue increase was already assumed 
in the DPEF and that it will not impact the 2007 deficit reduction 
package (which, of course, includes budget cuts).  Nonetheless, 
coalition or opposition politicians will still try to use this 
windfall to force Prodi into watering down proposed spending cuts 
and/or tax increases.  End comment. 
 
SPOGLI