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It’s Time to Shun Berlusconi
Italy’s High Level of Government debt makes it Vulnerable to a Worsening Sovereign debt crisis. Can Italian PM Silvio Berlusconi, who is Currently Facing Sex & Power abuse Charges, save Italy from a free fall?
Issue Date - 09/06/2011
While the Italian Prime Minister Silvio Berlusconi has been extremely successful in organising his famous “Bunga Bunga” parties (which he denies of and is currently facing sex & power abuse charges), the 74-year-old TV magnate-turned-conservative politician has totally failed when it comes to handle the Italian economy which has been struggling to gain momentum following the 2009 recession that forced the value of its economic output to shrink by 6.7% (Q1 2009).

A closer look at the numbers and one can easily sense the real trouble. First, at 130%, the debt-to-GDP ratio of Italy is surpassed by no other eurozone nation (except Greece and Ireland, which have already opted for EU-IMF bailout package). Second, its anemic nominal GDP growth rate of 1.23% per annum over the past decade makes it the second slowest growing economy in the euro area after Portugal (Portugal’s growth rate has averaged only 1% during the past ten years). If this isn’t enough, Italy’s recovery has already started losing momentum as GDP growth slows to 0.1% (q-o-q) in Q1 2011 from 0.3% in Q3 2010, the weakest performance over the last one year.

In fact, several economists expect the Italian GDP growth to slow to 0.6% in 2011 from 1% in 2010 as major fiscal consolidation at the domestic level, as well as in most of its European trading partners, weighs on demand. While fiscal tightening across Europe is set to dampen demand for key Italian exports as four of its five biggest trading partners (Germany, France, Spain and UK) are in Europe, private consumption (which comprises over 50% of Italy’s GDP) too is expected to remain under pressure considering high unemployment, subdued wage growth, and tight credit situation in the country. Softer domestic and export sales could even prompt some companies to stop hiring and slim workforces. This, combined with public sector job cuts, is set to put upward pressure on the unemployment rate, which is already hovering at 8.7% at present.

Further, the economy lacks one of the most important components of all if growth is expected to be sustainable – the gross fixed investment, which has once again started falling after growing at a healthy rate of 4.6% during first quarter of 2010. In fact, the rate of gross fixed investment is expected to deteriorate further as the weak economy erodes profit margins and puts downward pressure on capacity utilisation. What’s more? Moody’s Analytics anticipate the growth in gross fixed investment to come down to literally zero by Q3 2011.

Italy’s high level of government debt too makes it vulnerable to a worsening sovereign debt crisis. According to Eurostat data, Italy’s government debt reached 119% of GDP in 2010, the highest in the euro zone (considering that Ireland and Greece have already opted for a bailout package). In fact, a bailout of Italy (to fund its bond redemptions and finance modest budget deficits over the next few years) would require more than $1.4 trillion, way above the $390 billion bailout packages of Greece, Ireland and Portugal put together, and more than double the amount required by Spain ($600 billion), if it fails. This probably is beyond the ability of the European Union (EU) and the International Monetary Fund (IMF) to deliver as the combined rescue fund of both the organisations stands at just $1 trillion.

Although there is a small possibility that Italy will need a bailout (as Italy’s budget shortfall, at 4.6% of GDP in 2010, compares favourably with Ireland’s at 32.4%, Greece’s at 10.5%, Spain’s at 9.2% and Portugal’s at 9.1%, which implies that Italy’s financing requirement is relatively small compared with those of some of its counterparts), one cannot deny of a mishap considering that the slow economic growth in the rest of the euro area and real exchange rate appreciation in Italy probably will constrain Italian export growth for the foreseeable future. In fact, considering the economy’s poor growth prospects, international ratings agency Standard & Poor’s (S&P), on 20 May 2011, downgraded the outlook for the Italian economy to negative from stable. This makes the situation all the more difficult for the Italian policymakers who are struggling to find investors for Italian bonds (yields on 10-year government bond are already hovering at around 4.8%, and are expected to only move north).

While Banca d’Italia didn’t respond to the queries sent by B&E (till the time this magazine went to print), Jay H. Bryson, the New York based Global Economist at Wells Fargo Securities agrees to the fact as he tells B&E, “Growth in Italian domestic demand has been sluggish, even in the years preceding the downturn, and significant acceleration in consumer and business fixed investment spending does not seem likely anytime soon. Therefore, signs of weaker-than-expected Italian economic growth could raise concerns about debt sustainability in Italy.”

In fact, if critics are to be believed, Italy, which has more than $800 billion worth of government bonds maturing by the end of 2012, could be forced to restructure its debt profile if investors desist from rolling Italian government debt. Interestingly, Italian households too have grown more pessimistic about their economic and personal financial situations. In fact, recently released data from National Statistics Office, shows that the consumer confidence has fallen to 105.3 in March from 106.3 in the previous month, the lowest since August 2010.

Well, to fix the problem, all Italy needs is a structural reform that not only boosts competitiveness and productivity, but also reduces risk premium in interest rates thereby supporting sustainable growth over the long term. While all of this is doable, it won’t be easy. Reason: The trial is likely to take Berlusconi’s focus off reforming Italy’s economy over the coming months, leaving it with a relatively inflexible labour market, low productivity growth, and high unit labour costs. So, what’s the way out for this beleaguered euro nation? Shun Berlusconi, we would say!

Manish K. Pandey           

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