At the end of last year the one-and-a-half year slide in the Italian economy intensified. On the previous quarter economic output fell by a seasonally adjusted 0.9%, resulting in a 2.2% decline in real gross domestic product (GDP) over the year as a whole. Rising unemployment (which reached a record high of 11.2% in December, with 36.6% of young Italians without a job), tight lending conditions, government austerity measures in view of the debt mountain totaling 127.3% of GDP, and uncertainty about the development of the European debt crisis have clobbered domestic demand, which is likely to have tumbled by around 5% last year according to estimates by the national statistical office Istat.
But there is also positive news: the trade balance was in the black for the first time since 2004. In the first three quarters of last year net exports (goods and services) rose steadily and in the months July to September amounted to a seasonally adjusted 1.3% of GDP (EUR 5.3bn). Thanks to this improvement the Italian current account deficit, impaired by interest payments, narrowed by more than two percentage points of GDP (estimate for full-year 2012: -0.8%, 2011: -3.3% of GDP). TARGET2 liabilities of the Banca d’Italia within the Eurosystem have fallen of late by almost EUR 29bn to EUR 222.6bn.
Moreover, despite the recession, the government inRomemanaged to push the Italian budget deficit below the 3% mark last year (2011: -3.9% of GDP). The public-sector deficit is determined to a large extent by interest payments on government debt (set to amount to 5½% of GDP in 2012), whereas the primary balance rose further (2012e: 2.6% of GDP).
Further rays of hope have emerged of late: Industrial production edged up 0.4% month-on-month in December, having fallen for six months in a row. The manufacturing purchasing managers’ index is creeping up towards the 50-point expansion threshold, climbing 1.1 points in January to 47.8 (highest since March 2012). Business sentiment has improved, consumer confidence rose in February.
Public sector budget consolidation is likely to continue to exert a drag on the domestic economy, but the impact this year is likely to be lower than in 2012. In the course of the year the economy is likely to stabilize – we are penciling in average quarterly sequential rates close to zero – but, given the statistical underhang, this results in a decline in GDP in the region of 0.8% in 2013 as a whole. Growth is not likely to return to positive territory until next year (2014f: +1.0%).
In this context, the uncertain political outlook is doubtless a threat to the fragile Italian economy, possibly feeding through into rising risk premia on Italian government bonds and falling business confidence.
Whether the election on Sunday and Monday will produce a clear result is open. The latest polls suggest that the lead of the center-left alliance led by the social democratic leading candidate Pier Luigi Bersani over the center-right parties supporting Silvio Berlusconi in the Chamber of Deputies has been shrinking. In the event of an election victory Bersani is likely to continue Mario Monti’s reforma agenda with more of an eye on the welfare state.
The share of votes gained by the centrist alliance of the departing PM could be decisive for the formation of a stable government in both chambers of parliament, the nationally elected Chamber of Deputies and the regionally elected Senate. For a majority in the Senate, in which the election victor does not get a “majority bonus” in the form of extra seats, Bersani’s center-left alliance is likely to be reliant on cooperation with Monti’s centrist coalition. Monti’s continued involvement in the government would probably bolster market confidence inItaly’s reform zeal.
Sticking to the reform course is essential in order to improve the growth potential of the Italian economy, which suffers from structural weaknesses in three areas in particular: labor market rigidities, lack of competition on product markets – above all in the service sector – and a bloated public administration. Under the technocratic government and the pressure from the marketsItalyhad shown a swift pace of reform, also in politically sensitive areas such as labor law and welfare system.
Last year spreads over the German benchmark had narrowed markedly as a result of Monti’s reform policy in combination with the ECB’s announcement of Outright Monetary Transactions (OMT). The spread most recently stood at 290 basis points. Italy is a beneficiary of European crisis management. Almost half of the government bonds purchased in the framework of the Securities Markets Programme were from Italy (book value: EUR 99bn), as the ECB announced yesterday. Italy should not squander this regained confidence by tinkering with strong anti-European political forces and abandoning the path of reform undertaken.