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Italy’s budget deficit contracted last year and further improvement is expected to occur with the implementation of the 2007 budget. This is a welcome development that results from both unexpected revenue buoyancy and a greater degree of spending control. Nonetheless, the state of public finances remains difficult. The public debt ratio is the second highest in the OECD, with no sign of significant decline, making the budget vulnerable to sudden increases in interest rates and changes in market sentiment. Alleviating somewhat the risk to fiscal sustainability is the moderate cost pressure from population ageing, but this still requires the full implementation of measures to adjust pension benefits, which have been approved but not yet fully put into place. Tax rates are high compared to other countries, so that consolidation must come not from new tax increases but from better spending control. Hence, there is no other choice than decisive budgetary consolidation: the authorities’ goal of bringing back the primary surplus to the level prevailing at the time of entry into EMU, namely 5% of GDP, is welcome; while it is planned to reach this target by 2011, this should be possible ahead of time considering recent strong fiscal outcomes. The first signs of improvement recorded last year and expected this year are encouraging. But the way ahead remains challenging.