RaboResearch - Economic Research

Italy: goodbye recession, hello stagnation

Economic Update

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In 13Q4, Italy’s recession officially came to an end. Looking forward, the economic outlook has improved somewhat, but GDP growth will greatly depend on exports. Meanwhile, in Rome the game of musical chairs was won by the centre-left democrat Renzi.

GDP growth of 0.1% q-o-q

In 13Q4, Italy finally left the longest post-war recession behind, though it was a close call. GDP volume rose with less than 0.1% q-o-q after having shrunk with 0.1% q-o-q in 13Q3 (figure 1). The latter figure was revised down from 0% q-o-q. Stagnation is a better word for the current development than recovery.  For 2013 as a whole, GDP volume fell with 1.8% y-o-y after having contracted with 2.4% in 2012. As a result, end 2013, GDP in volume terms was almost 9% lower than in 08Q1, making the Italian economy the worst performer of the eurozone after Greece. Looking forward, overall sentiment indicators show Italy’s outlook is gradually improving. For example, the Economic Sentiment Indicator (ESI) of the European Commission is heading towards its long-term average (100, figure 2). That said, we do not expect output to recover fundamentally over the coming quarters as domestic demand continues to face strong headwinds. This is confirmed by the fact that consumers indicate to be very much unwilling to spend money on big-ticket items and the still very negative producer sentiment in the construction and services sector. We do believe, however, that an increasing export volume on the back of a bettering economy in eurozone member states will prevent Italy from another year of contraction in GDP volume. 

Figure 1: GDP volume 9% below pre-crisis peak
Figure 1: GDP volume 9% below pre-crisis peakSource: Reuters EcoWin, Rabobank
Figure 2: ESI indicates outlook is improving
Figure 2: ESI indicates outlook is improvingSource: Reuters EcoWin 

Net trade takes the lead

If we look at the expenditure breakdown, we see that in 13Q4 net international trade was the largest driver of the quarterly GDP volume growth with a contribution of 0.3%-points on the back of faster rising exports than imports (figure 3). Fixed investment came surprisingly second (0.15%-points) on the back of an unprecedented high quarterly growth in spending on transport equipment of 14.4%, while investment in construction, and machinery and equipment, declined further compared to 13Q3. Though quarterly investment growth was relatively high (0.9% q-o-q), we stress that underlying data is still weak. At the same time, private consumption continued its sequence and fell for the 12th quarter in a row on account of rising unemployment and decreasing real household disposable income (figure 4). But the largest drag on growth was inventory formation (contribution of -0.4%-points) after being the only positive contributor in the previous quarter. 

Figure 3: Inventory formation spoils the ‘party’
Figure 3: Inventory formation spoils the ‘party’Source: Reuters EcoWin
Figure 4: Real household disposable income keeps falling
Figure 4: Real household disposable income keeps fallingSource: Federal Reserve Bank of Dallas 

Domestic demand lengthens path of recovery

Going forward, domestic demand continues to act as a drag on growth. Fixed investment will likely lose some steam compared to the final quarter of 2013 as fundamentals are still poor. Both investment needs and possibilities are restricted. Low needs result from, among other things, the weak outlook of both private and public consumption and the fact that the capacity utilisation rate is still below its long-term average (72.5% compared to about 75%) despite recent increases (since 13Q2). Meanwhile, it is difficult for businesses to obtain (banking) funding for investments, while nine quarters of recession have hollowed own financial resources. Credit standards and conditions as applied to banking loans remain tight (bank lending survey) and credit availability low (ECB) on account of ongoing balance sheet repair by banks and high credit risk of non-financial corporations due to the weak economic environment and still decreasing firms’ solvability. In addition, activity in the construction sector continues to be hampered by less public spending on infrastructure, due to fiscal austerity, and weak housing demand, owing to still worsening labour market conditions and declining household income. The latter also restrains private consumption. From figure 5 we see that employment has kept on shrinking in recent months, which in combination with a stagnating labour force has led unemployment to reach the record-high rate of 12.9% in January of this year. Given that producers’ employment expectations in all sectors are below their long-term average, with the construction sector being the weakest link by far, and the usual time-lag between economic and labour market recovery, we do not expect employment growth to pick up soon. As a result of the weak labour market conditions, real household disposable income is unlikely to substantially increase in the coming quarters. 

Figure 5: Unemployment is still rising
Figure 5: Unemployment is still risingSource: Reuters EcoWin
Table 1: Forecast table Italy
Table 1: Forecast table ItalySource: Reuters EcoWin, Rabobank 

Just another day in Rome

One of risks mentioned in our previous economic update materialised in February. Matteo Renzi, the party leader of the Partito Democratico (PD) took over the role of PM Enrico Letta, after the latter was asked to resign by its own party, the PD. Although we take no comfort from the fact that Letta was brought down by his own party, political stability seems to have improved somewhat Uncertainty surrounding whether Renzi would backstab Letta and the related consequences are no longer clouding the sky. In fact, as a reaction to Renzi taking over, 10-year government bond yields did not rise and fell instead. This results from the fact that Renzi is widely hailed for being very reform minded, energetic and young. The public hopes are that he is the one to turn things around. However, we stress that reform progress is very likely to be slowed by a fragmented coalition. That said, we agree the upward potential has increased, also as it seems Renzi will enjoy more support from Berlusconi’s opposition party. As far as economic policy is concerned, Renzi recently announced to cut the income tax for low-income workers and the regional business tax (IRAP) in May, and also to repay around €68bn (4.3%-GDP) of debt arrears to private sector corporations. This has not much to do with pushing through deep and difficult reforms, but it could provide a tailwind for private consumption and business investment in the coming quarters. That said, the European Commission (EC) has warned Italy to respect the European budget rules. In November of last year the EC already notified Italy that its budget draft 2014 was at risk of non-compliance with the deficit and debt rules under the Stability and Growth Pact, and that more austerity measures might be necessary this and/ or next year. Part of the abovementioned announced measures likely needs to be financed through additional borrowing, further endangering non-compliance and risking necessary additional fiscal austerity which might nullify the positive effects of the loosening measures. 

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