18 February 2012

Ignazio Visco: The sovereign debt crisis and the outlook for Italy

Mr Visco, Governor of the Bank of Italy, said that in recent months Italy's economic policy has taken steps towards financial sustainability which were once deemed inconceivable, for example regarding the pension system.

Equally bold steps are expected on other, decisive fronts, to which the Government is already committed: the efficiency of the taxation system and the fight against tax evasion; the public sector spending review, which will analyse every item to identify possible redundancies and savings; and the simplification of laws, institutions and practices that are blocking the country’s energies, reducing firms’ competitiveness and frustrating the expectations of the younger generations.

The sovereign debt crisis and the outlook for Italy

The limits of euro area governance have become apparent. Multilateral monitoring of national economies failed to ensure sufficiently prudent budgetary policies in good times, and underestimated the macro-economic imbalances of several countries. The initial lack of satisfactory instruments for managing and resolving sovereign debt crises has been compounded by the faltering and scarcely effective progress of the Greek aid programme and the drawn-out negotiations for governance reform.

The measures adopted by Italy during the summer to bring budget balance forward to 2013 and the acceleration of the EU governance reform process with the definition of the “Six-Pack” in the autumn, did not succeed in alleviating the tensions in the financial market. Instead, the concerns over the adequacy of the European financial support mechanisms and the fears over the weakening of the international economy prevailed.

In Italy, the three budget correction packages passed between July and December 2011 should lead to a primary surplus on the order of 5 per cent of GDP in 2013 and a reduction in the debt ratio. The adjustment will come mainly from an increase in revenue but expenditure savings will increase over the three years 2012–14. The pension reform will immediately reinforce the financial sustainability of the pension system by setting stricter requirements. In the medium term, the Italian economy’s capacity for strong and stable growth must be restored, by making firms more competitive. GDP is still 5 points below the level reached in 2007, before the crisis; households’ real disposable per capita income is down by 7 points, and industrial output by a fifth. The deficit on the current account of the balance of payments remains large.

The reforms decided must be rapidly completed and put into effect, in particular those to make the regulatory and administrative structure favourable rather than unfriendly to economic growth: the liberalisation of important service sectors, the effective simplification of administrative acts, the better functioning of the labour market, special attention to human capital and innovation, and faster responses by the judicial system. Even if the effects of individual interventions arrive gradually, a comprehensive and wide-ranging plan can have a positive influence on expectations in the short term, and so stimulate aggregate demand and a recovery in investment. The point is to create favourable conditions for those who invest and create jobs in Italy, not with subsidies but by furnishing suitable intangible infrastructure; not through the shadow economy but by cracking down on tax evasion. Society pays a high price for corruption and crime in general in the form of deteriorating civic life and lost economic development.

Combating them, and especially their financial implications, will remove one of the brakes on growth. Economic growth favours the consolidation of the public finances, which in any case are already on a sustainable path, even under unfavourable assumptions concerning growth and interest rates. With modest real growth of around 1 per cent and a spread on 10-year government bond yields stable, if high, at 300 basis points, primary surpluses of 5 per cent of GDP, as forecast for 2013, will reduce the debt ratio by more than is required by the new European budget rules.

This year will be a year of recession. As we indicated in the forecasting scenarios set out in our Economic Bulletin in January, we expect a year-on-year decline in GDP of about 1.5 per cent. But it is important to look ahead, to act in such a way that as conditions in the financial and credit markets return to normal it will be possible to stabilise economic activity in Italy already by the second half of 2012 and return to growth next year.

Bank liquidity, the extraordinary measures of the Eurosystem and credit to the economy

Italian banks are sound, but they have been especially hard hit by the sovereign debt strains. To reconcile the objective of increasing banks’ access to refinancing with the need to preserve the solidity of the central bank’s balance sheet, the new eligible collateral will be selected rigorously. In particular, it will include bank loans with a very low probability of default, not exceeding 1 per cent. As a result of the above changes, once haircuts have been applied, Italian banks’ total eligible assets will increase by another €70–90 billion to a little under €450 billion. This may permit a progressive reduction in the importance of government-guaranteed bank bonds, the volume of which is about €60 billion after the application of haircuts.

Banks’ profitability and capital strengthening

In 2009, the financial crisis and the recession caused a sharp fall in Italian banks’ profits. In contrast with what happened in the other main European countries, the recovery in 2010 and 2011 was modest and the outlook for this year is not good. We have asked Italy’s leading banks to strengthen their capital considerably in recent years. They have complied, even in difficult times, mainly by raising funds, to a value of almost €20 billion, on private capital markets.

Much ground has been covered in just a few years. The core tier 1 ratio of the five largest banking groups has reached an average of 9.5 per cent of risk-weighted assets, compared with 5.7 per cent at the end of 2007, on the eve of the crisis. The gap, now narrower, that remains between the capitalisation of our leading banks and the average capitalisation of their main foreign competitors partly reflects differences in the way risk-weighted assets are calculated in the various systems.

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