Italy needs miracle, not just Monti
By James Saft
(Reuters) – Italy is going to need considerably more – in luck, growth and cohesion – than is likely to be delivered by premier Mario Monti’s technocratic charms.
Monti, unelected and a former European Commissioner, is so much more reliable and authoritative than the opera buffa figure of Silvio Berlusconi that it is tempting to think that Italy, now enjoying the qualified backing of the ECB and financial markets, is past the worst. And in truth, progress in a few short months has been impressive; Monti makes the right noises on structural reforms and has been rewarded by a sharp fall in Italian interest rates.
And yet the country still faces enormous risks and uncertainties with multiple paths for the uncertainties to magnify the risks. Italy is only in the very early stages of a recession that could last for years, it is hostage to outside shocks from other weak euro zone members and there is no guarantee that the political consensus for reform will survive the effects of the resulting austerity.
And be in no doubt, Italy is in a fairly deep hole. Its borrowing is 120 percent of GDP, well above the 90 percent level that seems to represent a tipping point historically. Monti managed to ram home 20 billion euros in spending cuts and tax increases in December, something that very likely heavily influenced the ECB’s support in the form of supplying ample money to banks with which to buy government debt. These cuts, though, are being made to an economy that the IMF thinks will shrink by 2.2 percent this year.
Richard Batty, global investment strategist at Standard Life in Edinburgh, thinks Italy is going to need nominal growth of 5 percent between now and the end of 2015 and a 10-year yield of 3.6 percent to stabilize its debt. Italy is now paying 5.6 percent, and Batty estimates its growth will average just 2.5 percent, far short of what is required.
“Italy, given the current debt metrics and policy inflexibility, will struggle to avoid a liquidity and debt trap,” Batty wrote in a note to investors.
Italian industry is not competitive, is hamstrung by the strength of the euro and while Monti has pledged labor market reforms, that will be a long process and one which requires political cohesion which is not only uncharacteristic of Italy but uncharacteristic of any country suffering as Italy surely will.
Italy will surely feel a fiscal shock if it manages to effect the kinds of policies needed, not just to stabilize its debts but to keep Germany and the ECB on its side. These are enormous cuts, something on the order of 4 percent of GDP or more in this year and next. Vladimir Pillonca, senior European economist at Societe Generale, argues that that, in combination with an uncertainty shock and a credit shock, will magnify the impact on growth.
“The simultaneity and strength of these shocks will result in a deep and prolonged recession for Italy lasting the best part of two years,” Pillonca told clients in a video.
The credit shock – less money available for Italian companies and households to borrow and at higher rates – is probably inevitable, despite the best efforts of the ECB to ease the funding strains of Italian banks. Lenders in Italy are already sharply tightening their standards both to corporations and house buyers, according to data from the Banca d’Italia and ECB. Little wonder – a two-year recession and the inevitable squeeze on wages required to make Italian exports viable will have to translate into loan losses, which will in turn squeeze banks’ capital and make them more likely to carefully husband their thinning resources.
Pillonca argues, convincingly, that the huge amount of uncertainty in the outlook for Italy is only compounding the potential damage. Faced with an almost absurd range of potential outcomes, Italian households and businesses will pull in their horns and delay investment and consumption where possible. This is sensible individually but disastrous collectively. It is also almost exactly what we saw in the U.S. in the dark days of 2008. If anything Italy’s position is more uncertain than that of the U.S. in 2008. The U.S., at the very least, knew with utter certainty that it would still be using the dollar in 10 years’ time and with the same complement of states in the union.
The best hope for Italy is a policy of support and qualified tolerance from Frankfurt and Berlin, as it slowly becomes more competitive. It will be, however, all too easy for something to go wrong, at home or abroad.
Italy has had a good couple of months, but it needs a good few years. (Editing by James Dalgleish) (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com and find more columns here)