Will Italy squander its €200bn opportunity?

Tommaso Gambino has been selling traditional Sicilian snacks at Mondello beach, on the outskirts of Palermo, since the 1960s. For nearly as long, the 67-year-old owner of the popular kiosk has been hearing of plans for an imminent tramline to bring visitors from the city centre to the beach. “Mondello is a small place and we can’t handle the pressure of all the cars,” he says. 

Gambino hoped the long-touted Palermo-Mondello tramline might finally be realised through Italy’s €191.5bn, EU-funded post-pandemic economic recovery plan, the country’s biggest aid programme since its second world war reconstruction. Among the plan’s many bold targets: construction of at least 206km of new green public transport infrastructure in 16 cities, Palermo included. 

Rome initially planned to give Palermo EU recovery funds to finance the Mondello tramline project. But mayor Roberto Lagalla recently told Rome that the works — yet to begin — could not be completed by the EU’s strict mid-2026 deadline and should be stricken from the scheme.

“This is a big job — it’s impossible to finish it respecting the schedule,” Lagalla tells the Financial Times at Palermo’s city hall. “We responsibly said that such a large project can’t be done by 2026 — there is practically no time.”

For people living and working around Mondello, it was a bitter disappointment. “They have meetings, they promise, and they promise, but we get zero,” Gambino says. “Our stomachs are full of words.”

The fate of the Mondello tramway highlights the challenges confronting prime minister Giorgia Meloni’s government, as it tries to execute a far-reaching, EU-funded reform and investment programme designed to reboot Italy’s chronically underperforming economy. 

Unveiled with great fanfare two years ago, the plan aims to strengthen Italy’s fragile physical and social infrastructure, while incentivising Rome to undertake difficult economic and administrative reforms to raise its long-term economic growth trajectory. Success is critical for putting Italy’s heavy debt burden — around 144.4 per cent of GDP — on a more sustainable footing. 

The effort is being financed by Brussels’ €800bn Next GenerationEU programme, which was established in the wake of the Covid-19 pandemic and aims to modernise Europe’s economy with debt jointly guaranteed by EU member states. It is the bloc’s boldest joint economic initiative since the creation of the common currency.

But Italy, which is slated to be the largest single recipient of the funds, has struggled to keep pace with the demanding reform and investment timetable agreed with Brussels in 2021, particularly since Meloni’s rightwing coalition took power last year. That has revived longstanding concerns over whether Rome can carry out promised reforms and effectively utilise the cash windfall.

“It is a once-in-a-generation opportunity,” said Sarah Carlson, senior vice-president at Moody’s, the rating agency. “The question we’ve always had is, will Italy make the most of that opportunity?”

The answer to that question will reverberate far beyond Italy’s borders and throughout the EU, as new doubts about the long-term sustainability of Italy’s heavy debt could reawaken fears over the financial stability of the entire eurozone.

“The central credit issue is Italy’s growth potential,” Carlson adds. “Without structurally stronger economic growth, it is very difficult for a country to erode the debt burden the size of Italy’s.”

As of the end of February Italy had spent just €25.7bn of the €66.9bn NextGenEU funds received so far. Brussels’ payouts to Rome have stalled with its third €19bn tranche of funds delayed for months by bickering over whether Italy had fulfilled one of its obligations, the creation of new accommodation for 7,500 university students. 

Though a €18.5bn payment is expected in early autumn — with €500mn deducted for the unmet targets — Italian opposition leaders warn that Rome could forfeit some of its outstanding balance of €124.6bn in grants and concessional loans unless the programme gets back on track.

“Italy risks losing the resources that it has worked hard to obtain from the EU,” Elly Schlein, the leader of the opposition Democratic party, said last month. Former prime minister Giuseppe Conte, leader of the populist Five Star Movement, complained to his supporters that Meloni’s government “does not have the ability to spend this money”. 

The IMF recently urged Rome to step up the pace, too, warning of slower-than-expected growth unless funds are utilised more rapidly — a growing concern after Italy’s GDP unexpectedly contracted 0.3 per cent in the second quarter.

Even Italian president Sergio Mattarella — whose largely ceremonial role mostly keeps him out of day-to-day politics — has fretted that Italy’s potential inability to fully invest the funds would be a huge setback.

“Any failure — or any partial result — would not be a defeat just for a government but for Italy,” Mattarella said last month. “That is how it would be seen and interpreted outside our borders — and that is what it would be in reality.”  

Revising the plan

For her part, Meloni insists her coalition is committed to fully utilising the EU cash windfall. She denies responsibility for recent difficulties. Instead, she and her allies say the plan they inherited from former prime minister Mario Draghi was deeply flawed, even before the high inflation and supply chain constraints unleashed by Russia’s invasion of Ukraine. 

Meloni has also criticised EU economy chief, Paolo Gentiloni, saying he should have exercised “more vigilance” before approving the Italian programme. 

Now, Rome is asking Brussels to approve a major overhaul, with changes to 144 of the 63 reforms and 235 investments it had originally promised. It argues the changes — which Meloni calls “corrections” — are required to make the plan more feasible given the current economic headwinds, and to ensure Italy can hit the targets to unlock its remaining funds. 

In its revamp — sent to Brussels earlier this month — Meloni’s coalition has proposed scrapping €16bn in public investments it deems either impossible to complete on time, or not strategically relevant. That includes €5.8bn to renew derelict urban neighbourhoods and dilapidated public infrastructure; €1.8bn to reduce landslide and flood risks; and €725mn to strengthen social services in Italy’s most neglected areas.

Instead, Rome intends to redirect these funds to strengthen gas and electricity infrastructure and offer tax credits to businesses and households that invest in renewable energy generation and improving energy efficiency — a thrust backed by the powerful business lobby, Confindustria.

“We promised that Italy would not lose a euro of these resources, that it would spend them well and things are going exactly this way,” Meloni said in a recent social media video, explaining that such investments would “create the conditions to ensure economic growth in the future”.

While a drastic reduction in funds for city-level projects has triggered domestic political outcry, analysts say Brussels is likely to accept most of the changes. The NextGenEU programme allows for a midcourse revision of investment plans if warranted by “an objective change of circumstances”, and other countries are also making changes, though none so sweeping as Italy.  

“Given all that has happened in terms of the energy crisis since the invasion, it is fair and square that a recipient country says, we want to revise the plan,” says Filippo Taddei, senior European economist at Goldman Sachs. 

Allocating more money to tax credits could help Italy speed up use of the funds, as private entities tend to be more nimble than public agencies bogged down in cumbersome bureaucracy. 

“The original plan had a lot of emphasis on public investment but there are a lot of ways to finance investment,” Taddei says. “Incentivising private investment in areas identified as strategic is a low-hanging fruit . . . It’s about getting the balance right.”

Yet Rome’s proposed tweaks are not limited to spending. Meloni’s government also wants Brussels to change demanding structural reform goals aimed at strengthening Italy’s public finances, improving administrative efficiency, boosting competition and making it easier to invest and do business. 

In particular, Meloni’s coalition wants to lower targets for reducing Italy’s huge court case backlog, and for curbing “the propensity” for tax evasion, a notorious problem that Rome warns could worsen next year due to the gloomy global outlook and a private sector liquidity crisis.

“Taxpayers’ behaviour is also influenced by exogenous factors — particularly macroeconomic conditions — beyond the control of authorities responsible for efficient management of the tax system,” the government wrote in its pitch to amend the plan.

But many economists believe Brussels will balk at any dilution of reforms aimed at problems long identified as a big drag on growth. “Reforms are the central part of the plan,” says Francesco Giavazzi, a Bocconi University economics professor who, as Draghi’s economic adviser, helped draft the programme. “The whole plan was designed to give you some chocolate, but you do reform. That was the political strategy. They will not accept any cancellation of reforms.”

Stakes are high. Meloni wants to project herself as a prudent economic manager capable of handling Italy’s challenges, especially after her government recently roiled markets with the shock announcement of a windfall tax on banks. Successful execution of the EU programme is key, given that investors are counting on Rome’s receipt of €35bn in EU funds this year, and €26bn next year, in their calculations for Italy’s growth and public finances. 

Any hint of jeopardy could unsettle markets, which Taddei says have so far had a “benign attitude” towards Italy’s “slower than expected” progress this year, but will not be so forgiving next year.

“In 2024, it will be very important how well, and how much you use, that opportunity,” he says. “Everyone will be looking at ‘are they fostering capital expenditure?’ and ‘are they raising potential growth?’”

A ‘dead loss for local communities’

Rome’s performance also has implications for Brussels’ hopes of deepening EU financial integration and the possibility of similar joint financing schemes to meet future challenges. Such considerations will weigh as commission officials assess Italy’s revamp pitch. 

“The risk that it doesn’t go through at all is pretty slim,” says Lorenzo Codogno, a former senior Italian Treasury department official. “There is an alignment of interests . . . to make it work.” 

Still, Rome and Brussels now face the prospect of painful negotiations to hammer out a deal that will be approved by other EU members, especially conservative northern European capitals suspicious of joint borrowing and Italy’s willingness to reform. 

“It will be a difficult decision at the EU level — the incentives go in two different directions,” says Carlson of Moody’s. “It’s difficult to imagine that the EU institutions are keen to create a precedent where if there is a change of government, countries do a complete rewrite of their programmes. But they also have a lot riding on Italy’s programme going well.”

No one ever thought it would be easy for Italy to execute the bold plan, given its past poor record in using EU funds. Draghi, a former European Central Bank president, established a special finance ministry unit to monitor progress and give technical advice to local governments.

But the unexpected collapse of Draghi’s national unity government last summer — and early elections — prompted Moody’s to lower Italy’s credit ratings outlook to negative, citing new political risks to execution of the programme.

Before taking office in October, Meloni, leader of the rightwing Brothers of Italy, had called for revisions in light of the invasion of Ukraine. In power, she disbanded the finance ministry unit overseeing the plan, and gave the job to ally Raffaele Fitto, minister for European affairs, who complained the massive public investments were never realistic, given Italy’s labour constraints, red tape and weak administrative capacity.

Still, cities that had expected funds are now up in arms. Of the €16bn in investments Rome wants to scrap, €13bn were for local governments, and mayors complain projects already under way will be left in limbo or that city finances will be under severe strain due to commitments made.

“You must explain to us what you have against municipalities,” Schlein, the opposition leader, said in a heated parliamentary debate this month. It is, she said, “a dead loss for local communities . . . You are stealing our future in a very real way.”

Fitto has called the cuts necessary to ensure Italy can meet tight deadlines, though he has promised that Rome will find other money to finance works stricken from the recovery plan. 

“We don’t accept the irresponsible narrative of a government busy defunding useful projects,” he told parliament, adding that the government is “thinking and finding solutions with a sense of responsibility”.

But in Palermo, which expected to receive nearly €200mn in urban regeneration funds, critics argue the Meloni government’s frequent talk of overhauling the plan itself led to a slowdown on the ground.

“There has been a climate of uncertainty,” says Leoluca Orlando, the city’s former mayor, who drafted the original urban regeneration plan. “This lack of clarity produces a lack of enthusiasm, which risks becoming lost time and jeopardising the work.”

Others see political ideology at play in the decisions of a coalition whose principal figures were historically hostile to the EU. “I think the Meloni government will try to spend less [of the Covid recovery] money than they could,” says Marco Picone, a University of Palermo architecture professor, who has written extensively on the city’s development. “They want to be able to say they are not ‘EU slaves’.” 

Antonella Di Bartolo is the headteacher of a school in a gritty crime-ridden neighbourhood of Sperone around Palermo’s southern coast, a wide sandy beach used for decades as a dumping ground for construction rubble and now as empty as Mondello is packed. 

Palermo officials were planning to use €47mn of NextGenEU funds to reclaim the beach and create recreational infrastructure, giving new opportunities to a downtrodden community. That vision now looks set to be a casualty of Rome’s move to scrap all urban renewal schemes. 

Di Bartolo sees it as just the latest in a long series of promises made — and later broken — to improve conditions in Italy’s poorest, most neglected regions, ostensibly one of the plan’s key goals.

“When there was a chance of these recovery funds, people started talking about these magic projects as if it were a promised land,” she says. “I have listened to these fables for 10 years. I believe in fairy tales. But I’d like the final kiss.”

Additional reporting by Giuliana Ricozzi