Italy’s massive budget deficit and debt, together with delays in spending post-pandemic European Union funds could impact investor confidence, according to the International Monetary Fund on Monday.

In its annual Article IV report on Italy’s economy, the IMF urged the government to achieve a primary surplus - excluding debt servicing costs - of approximately 3% of output to ensure a gradual fall in the debt-to-GDP ratio.

Italy aims to reduce the deficit to below the European Union's 3% threshold by 2026, while its debt, which is the second highest in the eurozone relative to output, is expected to trend upwards towards 140% of GDP by 2026.

For 2024, the government predicts a primary deficit of 0.4% of GDP, falling from a primary deficit of 3.4% in 2023, Reuters news agency reports.

“Domestic factors could weaken growth, including an inability to complete the post-pandemic spending and effectively implement reforms, while still large fiscal deficits could erode investor confidence, further weakening public finances,” the IMF stated.

Rome should also increase the effective retirement age to help reduce its costly pension expenses.

The IMF projects Italian GDP to grow by 0.7% in 2024 and 2025, as the expansionary impact of EU funds is expected to largely counterbalance the gradual elimination of the costly home renovation incentives known as the Superbonus.

That said, a “faster than planned fiscal adjustment is warranted to lower the debt ratio with high confidence and reduce financing risks.”

According to the IMF, the Italian banking system remains stable. However, there is a possibility of stability risks increasing as monetary policy becomes less restrictive and the effects of exceptional support measures diminish.

“The current increase in bank profits should be used to reinforce resilience to potential future shocks while funding should be adequately diversified,” the report states, going on to add that any scheme that enables borrowers to repurchase previously sold non-performing loans (NPLs) could potentially weaken the secondary market for bad loans.

An increasing number of lawmakers from both ruling and opposition parties supported proposals last year to revise bad-loan regulations to aid borrowers, including individuals and small- and medium-sized businesses. 

This has raised uncertainty in the sector that acquires bad loans, which is already experiencing a lack of activity.