Domestic demand props up growth
In 2023, real GDP grew by 0.9%, driven by a vigorous expansion in capital spending. This took the form of sizeable tax credits for the energy-efficient renovation of residential buildings, which continued to display their effects until the end of the year. Consumption expenditure by both households and the government rose by 1.2%. Net exports provided a positive contribution to growth, as exports of goods fell slightly less than imports, while trade in services kept increasing at a healthy pace.
In 2024, economic activity is set to expand at the same rate as in the previous year (0.9%). Government incentives to housing investment are projected to unwind, while investment in infrastructure and equipment picks up gradually. Despite the recovery in real disposable incomes, households are set to increase savings, taking advantage of higher interest rates. Annual household consumption is thus expected to remain subdued, also given the drag from the final quarter of 2023. Net exports are projected to provide a positive contribution to GDP growth.
In 2025, private consumption is set to keep benefiting from positive real wage dynamics. Faster implementation of RRF-backed projects is expected to offset the housing investment shortfall. This is set to boost import demand and result in a small negative net export contribution. Overall, GDP growth is forecast to accelerate slightly to 1.1%.
Labour demand cools as real wages increase
Total employment rose in 2023 by 1.8%, at the same brisk pace as in the previous year, also because self-employment increased again, helped by a more favourable tax regime. This is expected to have a temporary effect, resulting in a decrease in the number of self-employed people as from this year. In spite of an increase in participation, the unemployment rate fell in 2023 and is expected to continue declining over the forecast horizon to 7.3% in 2025. At the same time, nominal wage growth is set to exceed inflation, as contracts in private services and public administration are eventually renewed, incorporating part of the past price increases.
Energy price fall leads to rapid disinflation
The sharp decrease in energy prices throughout 2023 and early 2024 is expected to abate in the second quarter. A reduction in producer prices has eased pressure across most components of inflation, proving more persistent in labour-intensive services. Thanks to base effects, annual inflation bottomed out below 1% at the beginning of this year and is projected to pick up moderately going forward, reaching a 1.6% annual rate in 2024 and 1.9% in 2025.
High borrowing requirements weigh on public debt
In 2023, the general government deficit fell to 7.4% of GDP, from 8.6% in 2022. This was underpinned by a decrease in both the primary deficit – also thanks to the reduced budgetary cost of measures mitigating the impact of high energy prices (-1.4 pps. of GDP to 1.0% of GDP) – and interest expenditure, owing to the lower impact of inflation-linked securities. Current taxes rose more than nominal GDP, mainly driven by income taxes and by the return to ordinary levels of taxation on fuels and electricity. Primary expenditure growth was boosted by the partial indexation of social benefits to 2022 inflation, a sharp increase in public investment – financed by EU and national funds – and surging investment grants, as the housing tax credits were recorded in this expenditure item.
The deficit is forecast to drop to 4.4% of GDP in 2024, benefiting from the complete phase-out of energy-related measures and from legislative changes to housing tax credits leading to a smaller impact on the deficit. Current revenue is expected to rise along nominal GDP growth, as further cuts to the labour tax wedge are balanced by stronger wage dynamics. Primary current expenditure growth is driven by the indexation of pensions to the still high 2023 inflation and the public wages’ 2022-2024 renewal, partly compensated by some savings from the spending review (0.1% of GDP). Higher interest rates on new bond issuances are projected to push interest payments to 4.0% of GDP.
The deficit is expected to increase marginally to 4.7% of GDP in 2025, based on unchanged policies, on the back of a slowdown of current revenue and a further increase in interest expenditure. The continuous mobilisation of RRF funds is set to sustain public investment.
The debt-to-GDP ratio fell by 3.2 pps. to 137.3% in 2023, as the high primary deficit was offset by both a favourable interest-growth differential and a debt-decreasing stock-flow adjustment. Going forward, the stock-flow adjustment is expected to play a major role in debt developments, as tax credits for housing renovation, which had already been recorded on an accrual basis in the deficit, start being fully reflected in the cash flow. Together with a less favourable interest-growth-rate differential, it is set to lead to an increase in the debt ratio to 141.7% of GDP by 2025. A primary deficit, though smaller, is set to continue to weigh on debt developments over the forecast horizon.
