RaboResearch - Economic Research

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Coronavirus will push the Italian economy into a recession

Economic Update

  • The outbreak of the coronavirus adds to the many headwinds the Italian economy was already facing
  • We expect the economy to enter a recession in the current quarter and the second quarter will be worse
  • We think recovery will come only late this year and will likely be limited
  • For 2020 as a whole we forecast the economy to contract with more than 0.5%
  • Public finances will worsen, with the public deficit expected to approach 3% of GDP this year
  • Brussels will allow Italy to deviate from its budget targets under the European budget rules
  • But at some point the Italian government will have to take measures to ensure future debt sustainability

With the rapid surge of confirmed COVID-19 cases on Italian soil since 21 February and the subsequent emergency measures taken by the government, downward risks to the Italian economy have significiantly increased (Economic outlook Italy: Coronavirus raises recession risk). We expect the coronavirus to push the Italian economy into a recession this year. We think that it will mainly suppress growth in the first half of the year and that there is room for a slight rebound late this and early next year. All in all, we think that the virus will shave off a bit less than 1 percentage point of GDP growth this year.

Manufacturing and tourism sector most exposed

In first instance, the corona outbreak in China mainly had an impact on the Italian economy via trade with China (figure 1 and 2). Mainly manufacturing industries that are substantially exposed via exports and/ or imports- such as the car sector - were expected to take a hit. With the outbreak in Northern Italy itself, albeit still relatively contained when compared to several Asian countries, the hospitality sector has now also fallen victim. Activity in the quarantined towns in Northern Italy has come to a halt and Italy’s economic capital Milan has essentially turned into a ghost town. Although the city has not been quarantined, its restaurants and bars are empty and schools and tourist attractions are closed. In fact, the decision on 4 March to close all schools around the country for two weeks will have an impact on the ability of employees with children to come to work all over the country.

Furthermore, while panic is said to be subsiding among Italians living outside of the corona hotspot near Milan, international airlines are canceling flights to Italy upon low demand and anecdotal evidence suggests tourist accommodations across the country are receiving cancellations. Travel warnings and bans from several national governments, travel bans to and within Italy by individual companies, and high uncertainty, all suggest weaker than normal tourism activitiy in the months ahead. Given that tourism makes up about 13 percent of GDP according to the World Travel and Tourism Council (WTTC) implies that a large shock to the tourism sector can have a substantial impact on economic growth.

Figure 1: About 3% of Italian goods exports goes directly to China
Figure 1: About 3% of Italian goods exports goes directly to ChinaSource: Macrobond, IMF, RaboResearch
Figure 2: In Italian industry, 8% of intermediate input imports comes from China
Figure 2: In Italian industry, 8% of intermediate input imports comes from ChinaSource: Macrobond, OECD, RaboResearch

Large uncertainties

Figure 3: Italian stock market takes a deep dive and drops almost 15%
Figure 3: Italian stock market takes a deep dive and drops almost 15%Source: Macrobond

It goes without saying that estimates are still surrounded by many uncertainties. In our basecase scenario, China’s economy will severely contract in the first quarter of the year and partially recover losses in the second half of the year. In Italy we expect that quarantine measures will not be extended to other Italian regions. The latter is why, for now, we do not expect large supply chain dispruptions caused by Italy’s manufacturing sector. While production in the broader Lombardy and Veneto region could be affected – which together create about one-third of total Italian value added -, the factories that are currently actually closed create less then 0.1% of Italy’s value added. Clearly, the longer China’s economy is effectively paralyzed and it will take to get the spread in Italy under control, the larger the negative economic impact. Furthermore, if current quarantine measures were to be extended to substantially more Italian regions, and containment measures last for months, this would stifle the domestic movement of products and disrupt national and international supply chains. That, in turn, would further slow the economy.

In any case, increased risks for the economic outlook have led to large losses for Italian stocks: between 19 February and 5 March, the MIB index dropped by more than 15% (figure 3).

Economy faces multiple headwinds

The outbreak of the coronavirus adds to the many headwinds the Italian economy was already facing. The Italian economy contracted substantially in the final quarter of last year (-0.3% q/q). While the nearly two-year decline in overall sentiment has been bottoming out recently (figure 4), most sentiment indicators still point to muted growth in the overall services sector and even to a contraction in the manufacturing sector in the current quarter: the respective PMIs stood at 52.1 and 48.7 in February (figure 5). A figure below 50 suggests activity is shrinking. With production in the manufacturing sector falling at a very fast rate and the workforce at an accelerating pace when compared to January. Moreover, all of these surveys were held prior to the rapid increase of cases in Italy and subsequent quarantine measures. Surveys held since then are very likely to paint a gloomier picture. We forecast growth to contract in the first half of this year and only foresee a slight rebound in the final quarter of this year.

Figure 4: Sentiment still points towards stagnation
Figure 4: Sentiment still points towards stagnationSource: Macrobond, RaboResearch
Figure 5: Manufacturing sector in decline for almost two years
Figure 5: Manufacturing sector in decline for almost two yearsSource: Macrobond, RaboResearch
Figure 6: Economy set to contract
Figure 6: Economy set to contractSource: Macrobond, NiGEM, RaboResearch

For the year as a whole, we expect the economy to contract by between 0.5% and 1%, after it grew with 0.2% in 2019 (figure 6). The weak forecast results partly from the coronavirus, but also from domestic policy uncertainty, lower disposable income growth and a weak global economic environment. Announced policy measures to mitigate the negative impact from the coronavirus – worth €7.5bn so far - are expected to prevent worse, but are unlikely to prevent a recession. Measures include outright support to severely hit regions, and tax credits and emergency loans to troubling firms for example.

Government finances are set to weaken

Figure 7: At some point the government will have to take measures to ensure public debt sustainability
Figure 7: At some point the government will have to take measures to ensure public debt sustainabilitySource: Macrobond, RaboResearch

Based on the budget 2020, the economic outlook and announced policy measures to mitigate the negative economic impact of the coronavirus, the public budget deficit will increase and could come in close to 3% of GDP this year. The debt-to-GDP ratio is also set to rise (134.8% of GDP in 2019, figure 7). The European Commission warned Italy in November last year that it risks significantly deviating from its obligations under the European budget rules. Since then, the outlook for the economy and public finances has worsened due to the coronavirus. Italy has already asked the European Commission for more flexibility regarding the budget rules. To the extent that corona can be blamed for deviations, the Commission will likely grant Italy this flexibility. Nevertheless, we think that Brussels will ask Italy to alter its fiscal policy at some point later this year. This could be in spring already, in line with the cycle of the European Semester, provided that the corona outbreak will have run its course by then. Otherwise it is more likely to pop up in negotiations over the 2021 budget. If the current government is still in place by then, as we expect, and governing parties are still substantially lagging in the polls, the coalition is likely to broker a deal with Brussels to prevent a clash as seen end 2018. In the unlikely event Lega is heading a government at that time, more fireworks should be expected.

In the meantime, the ECB’s expansionary monetary policy is keeping a lid on bond yields even as investors are flocking to safer assets amidst the virus scare. Yet with a rapidly ageing population and a potential growth rate close to zero, it is difficult to see how Italy’s public finances can remain affordable and sustainable in the long term, without a change in fiscal policy and reforms to enhance productivity.


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