15 November 2015

Financial Times: Italy’s economic recovery is not what it seems

[...]Friday’s preliminary figures for eurozone gross domestic product show that the slowdown has started. Italy’s quarter-on-quarter growth rates have been falling: from 0.4 per cent in the first quarter to 0.3 per cent in the second to 0.2 per cent in the third.

Italy’s ability to sustain a healthy rate of growth is critical — for the country’s political stability, for its young people with no hope of finding work, for debt sustainability and in particular for its future in the eurozone. The euro has brought Italy nothing but stagnation. Real GDP is now at the same level as at the start of 2000, a year after the euro was launched. GDP today is 9 per cent below the pre-crisis level in early 2008.

If Italy fails to bounce back strongly from this recession, it is hard to see how it can stay in the eurozone. At some point it might well be in the country’s undisputed economic self-interest to leave and devalue. So when we ask whether the economic recovery is sustainable, we are not having a technical dialogue about economics. We are talking about Italy’s future in Europe.

There are three reasons why I am sceptical. The first is evident in last Friday’s GDP data. Italy is not exceptional.

The second reason is the lack of restructuring of Italian banks. The stock of non-performing loans as a percentage of all loans is about 10 per cent, which is close to the peak level in the current cycle. Many of the small and medium-sized banks are in effect insolvent. The clean-up of the banking system — following the 2008 crisis and the two subsequent recessions — has yet to happen. If it does, it will take place in a much tougher regulatory environment. From next year EU “bail-in” rules take effect. Then the Italian government will no longer simply be able to bail out banks but will have to make bondholders and depositors pay up first. Can we be sure the rotten banks will continue to sustain the recovery in this environment?

My third concern is Mr Renzi’s fiscal policy choices. His priority has been to ensure that these create more winners than losers. This is exactly what Silvio Berlusconi did when prime minister. And it should come as no surprise that Mr Renzi ends up with similar policies. Instead of reforming the public administration or the judiciary, he has opted for a cut in the housing tax. This will win votes but will not deliver the change to the economy. We have been here before.

The danger of this strategy is that it could go horribly wrong if the economic shock is big enough and the banking sector weak enough. On current projections, Italy’s 2016 budget deficit will be 2.2-2.4 per cent, depending on how you account for the cost of addressing the refugee crisis. This includes flexibility clauses that Rome has negotiated with the European Commission to take account of that cost. The original deficit goal would have been 1.4 per cent for 2016, but the EU has allowed more leeway because of economic reforms. [...]

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