As Italian economic signals improve, gov't turns sights to sparking growth

With positive economic signs trickling in and hopes on the rise that the worst may be over for Italy's beleaguered economy, analysts say the Italian government appears to be gradually shifting focus from debt reduction to ways to spark growth.

Ever since then-Prime Minister Silvio Berlusconi stepped down in November 2011 amid fears that Italy could fall victim to the European debt crisis, the Italian government's stated its top goal was to reduce debt.

Former European Commissioner Mario Monti took over for Berlusconi, leading a technocrat government, with a policy of raising taxes and slashing spending. Those policies assuaged investor fears of default but hurt Monti's approval levels, and his coalition finished a distant fourth in February's national elections.

After a two-month standoff, Enrico Letta was named prime minister, and his government generally continued the austerity policies.

From one perspective, the difficult cutbacks and tax increases worked: investor fears shrank, with a positive impact on the Italian Stock Exchange in Milan and on bond markets, where yields fell, taking Italy's borrowing costs down in step. And some positive news has been seen: improving consumer sentiment and industrial production, and hopes of positive growth as soon as the end of this year.

But while the deficit is no doubt smaller than it would be with no action, it is still growing: according to the Italian National Statistics Institute (ISTAT), Italy's total public debt was 1.989 trillion euros (2.665 trillion U.S. dollars) in real terms at the end of last year (preliminary estimates are that it passed the 2-trillion-euro threshold in March).

That's higher than 1.907 trillion at the end of 2011, and 1.843 trillion at the end of 2010. Combined with mostly negative economic growth, debt as a percentage of GDP has surged: from 117.2 percent in 2010, to 120.7 percent in 2011, and 127.0 percent at the end of last year (preliminary estimates are that it reached 127.7 percent in July).

But despite the limited impact on the country's massive debt levels (only Greece has a higher debt level as a percentage of GDP, though Portugal and Ireland are close), there is evidence that the government is starting to direct more of its efforts toward creating economic growth.

"For every government, there's a balancing act between keeping spending under control and increasing revenue on one side and creating the conditions for growth, which may mean spending money on stimulus or lowering taxes, on the other," said Hildebrandt and Ferrar economist Javier Noriega. "But perhaps the balance is shifting more toward the growth side in recent weeks."

On Monday, Minister of Industry Flavio Zanonato said the government would soon unveil a plan to lower Italian energy costs, among the highest in the European Union and rising fast.

The government still appears likely to scrap the controversial IMU property tax, which generates 4 billion euros a year in revenue, despite a report from the Italian Treasury on how the levy could be reformed rather than suspended and calls from multi-lateral groups to leave the tax in place.

The government has also delayed a long-planned 1-point increase in the country's value-added tax to 23-percent, delaying the increase several times and looking for ways to cancel the increase all together by offsetting the lost revenue with spending cuts.

There is likely a pragmatic side to the apparent shift in priorities: economic growth is likely to help the Letta government's approval levels far more than any realistic amount of debt reduction. And higher approval levels increase the government's chances of staying in power long enough to have an impact on the country.

That's a point Letta himself made over the weekend, telling a group on Sunday that the country will emerge from its crisis much faster if his government stays in power.

"No one should block the hopeful path we have begun to travel," Letta said, adding, in a slightly veiled warning to political forces who could bring the government down, "Italians will punish anyone who puts his personal interests ahead of the common good represented by emerging from this crisis."