Economic Fact Book: Italy‏

The general elections in Italy have left the political outlook highly volatile. The election result caused negative market sentiment but no panic. The interest rate on 10-year government bonds quickly rose by about 0.5pp. The current situation might not differ that much from the political history of Italy. Since 1945, Italy has had 63 governments, so a government that may remain in office for only six months does not necessarily result in a loss of investor confidence.

Prior to the general elections, Mario Monti led a unity government with the purpose of implementing reforms and austerity measures. This came after Italy had been through a chaotic year both economically and politically. In 2011, the European debt crisis spread to Italy, which caused the interest rate on 10-year government bonds to rise to a record high around 7%. Former Prime Minister Silvio Berlusconi was forced to resign after losing his majority in Parliament. Prior to this, Berlusconi had a standoff with the ECB over reforms and bond purchases. Angela Merkel and Nicholas Sarkozy gave Berlusconi a non-verbal no-confidence vote.

Italy has a long history of government budget deficits and high government debt. Austerity measures were implemented under Mario Monti, and the Italian government improved public finances substantially. The European Commission estimates that Italy ran a primary budget surplus of 2.6% of GDP in 2012, up from 1% of GDP in 2011, and that it will increase further to 3.2% in 2013. The Commission expects general government debt to peak at 128.1% of GDP in 2013. The yields on Italy’s government bonds have fallen markedly since July, when the ECB’s Mario Draghi signalled the introduction of the OMT programme. Three days before the Italian elections, the ECB announced that it had bought EUR99bn of Italian government bonds under the Securities Market Programme, in what could be seen as a reminder to the Italian people that they need friends with big pockets.

After a decade of almost no growth, Italy is currently trapped in a severe recession, with negative growth since Q3 11. We now expect the recession to continue throughout 2013. The unemployment rate has increased to 11.2% in December 2012.

Italy has made several labour market reforms but is still struggling with very low productivity growth. The business climate is hampered by significant bureaucracy. The World Bank’s Doing Business report ranks Italy as number 73, just after Romania. Corruption is deep rooted, which distorts incentives and hampers productivity growth. On Transparency International’s Corruption Perception Index Italy figures as number 72 (Romania is 66). Italy has partly specialised in labour-intensive production of luxury goods, which also limits the scope for productivity gains.

Mario Monti pushed through a substantial number of reforms in his first 13 months in office - it is our assessment that it will not be a disaster if Italy ends up with a government that does not undertake reforms for a while. What is important is that a new government does not start to roll back reforms and that it behaves in such a way that investors can remain confident that the ECB OMT programme remains available to Italy.

To Read the Entire Report Please Click on the pdf File Below.