Italy coughs, looks frail and doesn’t take its medicine. No wonder some see this country as the new sick man of Europe. The fundamental situation of Italy does not seem to bode well for the country and the new government plans do not make it any better. A growing fiscal debt is completely fine for a country, as long as it’s economy grows even faster, which would actually make the debt-to-GDP ratio decrease. The new Italian coalition argue these fiscal stimuli will help Italy to grow out of its debt. However, the assumption that Italy will reach a growth of over 2.5% over the coming years appears hopelessly as wishful thinking. Some of the main reasons for this are:
After Germany, Italy has the oldest population of Europe. This is a bad omen for the long term growth potential of a country, as young people are more likely to work longer hours and purchase stuff like houses, education for their children etc. Additionally, of all OECD countries Italy has the highest proportion of young workers (aged 16-24) who have low literacy and numerical skills, while only Spain has more old (55-65) low skilled workers. This is an indication that Italy may not be optimally prepared for a changing economy. Finally, add to this the brain drain that has taken place of young people over the last decade of non-existent growth in Italy, and demographic factors paint a bleak picture for Italy’s long term growth prospects.
Italy scores the worst of all European Union countries on the Corruption Perceptions Index by Transparency International. This obviously doesn’t add to a healthy business climate for the country either.
Even if the plans of the new Italian government are solid (which one can doubt), one can cynically observe that the perception of markets is more important than their eventual efficacy. As markets start to worry about the fiscal position of Italy, risk premiums – and thus lending costs – for the country go up. This would already rise the Italian deficit even without the extra planned expenditures of the new government. Add to this that the European Central Bank is on its way to exit its Asset Purchasing Program and will start unwinding its balance sheet at some point in the not too far future, and the most important “buyer of last resort” for Italian debt instruments is disappearing from markets. This will have markets repricing the risk on Italian debt and can easily send It 10 year yields back to the 5% level it resided around before the ECB started its APP.
The surplus on the Current Account of almost 3% compared to the size of the GDP is one of the few silver linings for the Italian economy, as more money flows into the country than out. This money however mostly goes to the pockets of business and do not flow to the treasury directly. In order to obtain a larger part of this pie the new government could rise taxes, but this would then likely slow down the Italian economy as well.
All in all long term risks to Italian growth and the fiscal position of the country appear to the downside, especially when the current government plans are followed through upon. On the short run Purchasing Manager Indices already start to lag behind the rest of Europe, with for example the September Manufacturing PMI pointing to zero or low growth in Q3. This can likely become a theme for euro weakness in 2019. Can someone please call a doctor?
