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Italy: Arrivederci recessione?!

Economic Update

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GDP growth stagnated in 13Q3. One cannot talk of a start of economic recovery yet, though. The contribution of domestic demand was negative and there are still significant headwinds. On a positive note, policy uncertainty might fall going forward.

Stagnation, but without substantial recovery

GDP growth stagnated in 13Q3 (0.0% q-o-q). As such, Italy’s longest recession in history officially came to an end. Note, though, that a minor downward revision would push the economy right back into the negative territory. Private consumption, fixed investment, and net trade contributed negatively. Only the volatile inventory formation component of GDP managed to pull the economy out of recession. In other words, one cannot talk of a start of economic recovery. Sentiment indicators have provided mixed signals, but on the whole the outlook for 13Q4 seems to have slightly improved compared to 13Q3 amid the improving external environment. Against this backdrop, quarterly growth is expected to broadly stagnate in 2014 and only slightly pick up at the end of the year. GDP growth for the year as a whole is likely to remain close to 0%, also owing to the negative carry over effect from 2013.

Figure 1: Growth stagnated in 13Q3
Figure 1: Growth stagnated in 13Q3Source: Reuters EcoWin
Table 1: Forecast table
Table 1: Forecast tableSource: Reuters EcoWin

One’s patience is being put to the test

In the coming quarters, private consumption growth is likely to remain subdued. One reason is the record-high unemployment rate (12.5% in October, figure 2) and the weak labour market outlook. Employment is expected to decrease further according to employers (European Commission survey), despite the stabilisation in October on a monthly basis. In addition, the all-time low hourly wage growth and the postponed VAT hike (from 21% to 22%) that came into effect in October will act as a drag on consumption growth. Some relief might come from the fall in inflation (0.6% in November) on account of negative contributions from food and energy components. That said, consumers’ expectations about purchases of big-ticket items in the coming year are very discouraging. The figure reached an historic-low in recent months and is miles away from its long-term average. Given that private consumption accounts for roughly 60% of Italian GDP, weak consumer spending is going to remain a significant headwind.

As a result of this weak economic outlook, investment needs are low. At the same time, obtaining funding is difficult as credit standards (figure 3) are tight. According to the recent bank lending survey, banks foresee a slight increase in credit demand and loosening of credit standards in the next three months (figure 3). Going forward, we do not expect the latter to improve substantially given that banks need to repair their balance sheets and boost capital buffers in order to pass ECB’s upcoming stress tests and asset quality review (AQR). Small and medium sized enterprises (SMEs) also believe bank loan availability will again decline in the coming six months (Survey on the Access to Finance). Against this backdrop, investment demand is expected to continue to act as a drag on growth.

Figure 2: Record-high unemployment not fall rapidly
Figure 2: Record-high unemployment not fall rapidlySource: Reuters EcoWin
Figure 3: Credit demand remains weak and standards tight
Figure 3: Credit demand remains weak and standards tightSource: Banca d’Italia

Budget 2014: fiscally neutral, for now

The recently presented Budget draft for 2014 is almost fiscally neutral (i.e. has no significant impact on the real economy). If it is implemented without any significant changes, fiscal policy should not weigh on activity like in recent years (figure 4). That said, the European Commission has warned Italy that the Budget draft is at risk of ‘non-compliance’ with the debt reduction rules under the Stability and Growth Pact. On top of that, we deem it likely that both the 2013 and 2014 budget deficit turns out to be larger than the 3%-GDP, amongst other things due to lower growth than currently expected by the Commission. Another round of fiscal consolidation measures might thus be necessary, which would further hurt economic activity.

The drag called uncertainty

Since the start of the crisis, political instability has also raised policy uncertainty to above its pre-crisis average (figure 5), which has weakened domestic demand. In that sense, we take comfort from the fact some recent developments might, for the time being, lead to a less turbulent political landscape going forward. Among these are the expulsion of Berlusconi out of the Italian Senate and the break-up of Berlusconi’s party Popolo della Libertà into Forza Italia and Nuovo Centrodestra (NCD). While Forza Italia has moved into the opposition, the more moderate NCD has lent its support to the ruling coalition, which enjoys a slim but more coherent majority as a result. Having said that, downsize risks to this relative stability stem from the probable radicalisation of Forza Italia; the aspiration of the new PD party secretary to become the next Prime Minister; and the possible inability of the current coalition to make effective progress on the reform front, which would increase opposition from within the coalition and the broader public. Note, though, that the risk of either party pulling the plug would diminish in case the electoral system becomes purely proportional, in line with the recent preliminary Constitutional Court ruling. This implies that it would become far more difficult for a single party to obtain a workable majority in elections.

Figure 4: Fiscal drag will decrease
Figure 4: Fiscal drag will decreaseSource: European Commission
Figure 5: High policy uncertainty might be slightly reduced
Figure 5: High policy uncertainty might be slightly reducedSource: policyuncertainty.org
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