Italian economy perseveres, despite political turmoil
With its long history of political chaos, the recent split within the ruling party of Italy’s prime minister Silvio Berlusconi is unlikely to derail the nation’s attempts to reduce its budget deficit, while the economy seeks to climb out of the recession.
Gianfranco Fini, the speaker of the Parliament and former long-time ally of Berlusconi, recently broke off from his ex-mentor’s People of Freedom Party (PDL), and formed a new party called Future and Freedom for Italy (FLI), apparently due to Fini’s disenchantment with corruption scandals engulfing several high officials close to the Prime Minister.
As such, it seems unlikely that Berlusconi will be able to finish his term which is scheduled to end in 2013. (He was elected to a third term as prime minister in 2008).
Many Italian observers believe a new election will be held — perhaps as early as next spring, raising the probability that Berlusconi is finished.
Moreover, Fini — who has gradually moved away from his neo-Fascist roots to adopt a more mainstream center-right philosophy — does not appear to have much support nationally, nor even in the lower house of parliament.
In addition, the Italian left-wing, which is celebrating Berlusconi’s weakened power base, remains fragmented as ever, adding to the overall confusion and uncertainty.
Meanwhile, the Italian economy continues to chug along.
Indeed, last Friday, Italy’s national statistical bureau, ISTAT, reported that the country’s economy grew for the second consecutive quarter, in spite of the Euro Zone’s debt crisis.
Italian GDP edged up 0,4 percent sequentially in the second quarter, matching the first-quarter expansion — attributed primarily to strengthening export demand (the economy shrank 5,1% in 2009).
For many Euro Zone members, rising exports (in league with a weak Euro) has served as the principal economic growth driver as the continent seeks to crawl away from the devastating recession.
On a year-on-year basis, the Italian economy climbed 1,1 percent in the second quarter, up from a 0,5 percent figure in the first quarter (which represented the first quarter of positive GDP growth since early 2008).
Moreover, industrial production rose in June for the fifth straight month and the Italian jobless rate unexpectedly dropped, after remaining flat for the prior two months.
However, despite a pretty strong second quarter, risks to the economy abound.
For one thing, the Italian Parliament just passed a highly controversial and unpopular 25-billion euro austerity package that is designed to cut the budget deficit to below 3% of GDP by 2012 from 5,3% in 2009; and to engineer a decline in public debt which now totals a whopping 120% of GDP.
Crafted by Economic Minister Giulio Tremonti, the austerity program has already been severely criticized by unions and left-wing politicians. The package calls for, among other measures, big reduction in transfers to regional governments from Rome; a three-year wage freeze for most public employees; a reduction in the hiring of new civil servants; pay cuts for high-earning public sector employees; significant spending reductions across all government ministries; and an increase in the retirement age.
Interestingly, the austerity scheme doesn’t include any tax hikes, although it spells out a plan to reduce tax evasion.
«This should be the forerunner of a prolonged period of better fiscal management,» said Raj Badiani, senior economist at his Global Insight in London.
«Italy needs to break its protracted cycle of modest growth and high debt, otherwise it will remain vulnerable to future external shocks.»
Badiani cautions, however, that Italian GDP growth will probably slow down in the third quarter.
«The overall pace of recovery is expected to be gradual in 2010 and 2011, with Italy still facing strong headwinds,» he said.
«Fiscal policy will be increasingly restrictive. Indeed, the Greek debt crisis and contagion effects are increasing pressure for fiscal policy to be tightened earlier and faster. Consequently, we project Italian GDP growth at 1,0% in 2010 and 0,9% in 2011.»
Badiani adds that the investment climate in Italy still remains uncertain, with firms still enduring substantial spare capacity and tighter profit margins.
«In addition, many companies’ uncertainties over the longer-term strength of the upturn mean that business investment and employment intentions will be gradual and vulnerable to relapses,» he noted.
«Doubts [also] remain about the sustainability of the export recovery with still-muted spending across the Eurozone, particularly as spending in Italy’s key export markets — the consumer markets in Germany, France, and Spain — is expected to endure another difficult year. Businesses will be worried about the strength of the recovery across the Eurozone with many member countries accelerating their fiscal-consolidation plans while still struggling with fragile economies.»
Brian May, European economist at Capital Economics in London, does not expect the current political turmoil to pose a major risk to Italy’s progress in cleaning up its public finances, since the country has already put in place the aforementioned austerity measures.
However, the sheer size of the nation’s public debt — plus the specter of a potentially drawn-out election — could raise some alarms longer-term.
On the bright side, Italy has relatively low household and business debt; and the majority of government debt is held by local Italians, reducing the negative impact of a potential sell-off by foreign holders.
«For now at least, the markets appear to be unconcerned by these recent developments,» May said.
«Ten-year government bond yields have fallen by more than 50 basis points since early June and are currently at their lowest level since February 2006.»
May also indicated that Italy’s budget problems pale in comparison to the painful fiscal consolidation set to be endured by the other ‘peripheral’ nations of the EuroZone (Greece, Spain, Ireland and Portugal).
«What’s more, there appears little need for the [Italian] government to implement further austerity measures to ensure that it meets its near-term deficit reduction targets,» he added.
However, May warns that there is still a real risk that government debt could reach uncomfortably high levels over the coming years even if government interest rates remain low.
«Our major concern has always been that that weak growth in the medium term will make it very difficult for the Government to
gradually bring public debt down to a more sustainable level,» he explained.
«If, as we expect, growth starts to disappoint and the economy stagnates next year, the markets could begin to get twitchy.»
The International Monetary Fund also recently stated that the high level of public debt in Italy could make the nation susceptible to reversals in market sentiment.
Thus, Italian stock and debt markets have much more to worry about than the fate of Berlusconi and his cronies.
