Debt-heavy Rome reins in spendthrift regions

By Guy Dinmore in Rome

Published: May 23 2010

Calabria – rugged, Mafia-ridden and backward – has always seemed a world apart from Italy’s prosperous north. And just as Brussels labours to impose fiscal discipline on distant Athens, so Italy’s central government is struggling to control the debt-laden finances of its own wayward regions.

“Italy is like a microcosm of Europe,” says Stefano Manzocchi, international economics professor at Rome’s Luiss university, noting disparities in wealth and income between north and south and the problems facing a weak central government in managing a quasi-federal system while national debts rocket.

Giulio Tremonti, Italy’s finance minister, is expected to reveal this week how he will plug a deeper-than-expected hole of some €25bn ($31bn, £22bn) in his 2011-12 budgets. Fearing contagion from the sovereign debt crisis that began in Greece, the word “sacrifice” has been thrust into Italy’s political vocabulary.

Ministers and parliamentarians face cuts to their generous salaries, all civil servants might face a freeze and some regional administrations will be forced to raise local taxes on personal income and business to plug their deficits.

For Silvio Berlusconi, the centre-right prime minister whose 2008 election campaign promised tax cuts not increases, this is a particularly sensitive issue. Three regions with big deficits – Lazio, Calabria and Campania, with a combined population of 13.4m people – are governed by his own party, which ousted centre-left administrations in March elections.

Bank of Italy figures show that local government borrowing requirements rose €7.1bn in 2009, with total debt accounting for 7.3 per cent of gross domestic product, equal to more than €100bn. The bulk is owed to the central government, according to economists, although some municipalities and regions have issued their own debt.

CMA, a London-based credit information specialist, ranks the world’s 10 most volatile sovereign debt issuers in terms of highest default probability, based on credit default swap levels. To the surprise of Italians the semi-autonomous island of Sicily was this month ranked ninth, a notch below Portugal.

“Greece means that Italy has to get on top of this,” says Mr Manzocchi, pointing out that the 20 regions account for 80 per cent of total state spending for consumption purposes. Healthcare, managed by the regions, accounts for some 64 per cent of their budgets and is rising fast, totalling some €133bn. The IMF estimates this will double in real terms by 2050.

Mr Manzocchi says some regions are doing well, others are not: in the south, “what economists call the bordello of Europe”, money seems to be spent mainly on either fulfilling election promises or on corruption, with health sector contracts a large contributor to the Mafia’s income.

Lazio, the region around Rome, ran up a health deficit of €420m last year, while Campania reached €500m. Calabria, in the toe of Italy, where per capita GDP is 40 per cent lower than the north, has not provided figures. Rome has frozen funds earmarked for development until Calabria’s budgets are in order, causing uproar as politicians ask how the north, one of the richest parts of Europe, is still receiving EU development funding, while poorer areas are blacklisted.

“The good old days for the regions of soft budget constraints seem finally over,” says Fabio Pammolli, head of the Cerm economic research institute. “The only possibility they have is to increase taxation.”

In the long run, legislation on fiscal federalism, currently before parliament, is intended to put the regions in financial order.

Regions will assume more powers over spending but will be bound by a system setting standard costs or benchmarks for services, based on the performance of the more efficient. A five-year adjustment period will see Rome continuing to bail out the weakest.

As Italy moves to a fully federal system, the government is also classifying the nation’s assets – such as official buildings and natural resources – between the state, regions and provinces. Determining who owns what will lead to the sale of such jewels as lighthouses and military barracks to reduce debt.

Massimiliano Marcellino of the European University Institute says fiscal federalism is good in principle but it must be accompanied by consistent policies to boost growth in the south.

“This did not happen over the past 150 years and it is not clear to me why and how it should happen in the next 20 years,” he adds.