Perhaps It’s Time to Start Worrying About Italy Again


The causes for concern surrounding Italy are growing, even as the ECB keeps a tight lid on its bond yields, pushing its debt servicing costs lower as its debt explodes higher.

The Euro Area’s weakest link, Italy, is once again in the familiar grip of a political crisis. The trigger this time was a decision by former Prime Minister Matteo Renzi to orchestrate the resignations of two ministers from his fledgling IItalia Viva party. Renzi accuses the current premier Giuseppe Conte of amassing too much power during the coronavirus crisis. He also challenges Conte’s reluctance to draw upon European Recovery and Resilience funds and the European Supervisory Mechanism, which Conte fears could come with all sorts of nasty strings attached.

What happens next will depend on whether Conte can shore up support in parliament among independent lawmakers. He still has the backing of the Democratic Party and the 5-Star Movement, which have criticised Renzi’s move as irresponsible. On Monday, Conte made his case in the lower house and will have to do the same in the Senate on Tuesday. Each appearance must be followed by a voice vote, which is tantamount to a vote of confidence. On Monday, Conte won the vote after Italia Viva’s members chose to abstain but he’s likely to face a stiffer challenge in the Senate.

In the best case scenario, this crisis — like so many political crises in Italy — will fizzle out. Conte may well survive to lead what would be his third government by amassing enough support in both houses. But his already flimsy government will be further weakened. If he fails to form a new government, he will probably submit his resignation to Italian President Sergio Mattarella, who could call for the formation of a technical government.

An early election is the least likely outcome, given the logistic nightmare of holding a political campaign and election during the pandemic. The coalition partners are also fearful that a resurgent right could end up winning. 

Much Ado About Nothing? Not Quite

For the moment the financial markets are pretty sanguine about this latest episode of Italian high drama. The yields on Italian bonds are still close to an all-time low, at 0.63%. The main reason for this is that the ECB is buying even more Italian bonds than ever before. Through its public sector purchase program (PSPP) and pandemic emergency purchase program (PEPP) it purchased €165 billion of Italian bonds in the first eleven months of 2020, bringing its total holdings to €529 billion. 

Italian banks have also expanded their holdings of Italian sovereign debt, which now account for 11% of their total assets, a new record. This has stoked fears that the dreaded “doom loop” — the dangerous relationship of mutual independence between Euro Area sovereigns and their banks — is stronger than ever.

But even as the ECB and Italian lenders keep a tight lid on Italy’s bond yields, pushing the country’s debt servicing costs lower while its debt explodes higher, there are still major causes for concern. 

The pandemic has disproportionately affected Southern eurozone countries that were already weighed down with huge debt loads. Italy has the third highest incidence of coronavirus (COVID-19) deaths in the European Economic Area, after Belgium and Slovenia. The pandemic has also laid waste to its economy. The ECB forecasts that Italy’s GDP will have declined by 9.0% in 2020. Plunging output and soaring spending are expected to push its debt as a percentage of GDP up to 158%, from 135% in 2019.

“Credit risks are highest in Italy, Cyprus, Spain and Portugal given their high economic exposure to the crisis, together with their more limited fiscal space,” Moody’s warns in its 2021 outlook for the region. “High debt levels, together with stop-start growth, intensify the risk and potential impact of another shock, particularly if investor confidence in sovereigns that need to refinance very large amounts of debt weakens.”

Loss of Tourism

The virus crisis has devastated Europe’s tourism industry, a vital source of income for southern eurozone economies. In Italy it accounted for 13% of GDP and was one of the few areas of the economy that had been growing in recent years.  In 2019, for instance, it grew by 2.8% while Italy’s industrial output shrank by 2.4%. But in 2020 it collapsed. In October, for instance, foreign visitors spent just €1.193 billion in the country, down 70.4% with respect to the same month in 2019, according to a new report by the Bank of Italy. 

“The sudden, drastic contraction in tourism flows in Italy will have a significant impact on national GDP and serious consequences for businesses in the sector and their suppliers,” the report said

Last Thursday, the Bank of Italy said that the COVID-19 pandemic had led to “the biggest contraction in non-financial private incomes in 20 years in the first half of 2020.” Per-capita primary incomes dropped by 8.8% in the first half of 2020 with respect to the same period in 2019. That dwarfs the income drops registered during the credit crunch (-5.2%) and the sovereign debt crisis (-3.4%).

Back in July, the central bank published the findings of a survey of Italian households on the impact of the lockdown. Given the timing of the survey, shortly after a three-month nationwide lockdown, most of the findings were pretty bleak:

  • More than half of the respondents said they had suffered a contraction of household income following the measures adopted to contain the epidemic.
  • Fifteen percent of households had lost more than half their income.
  • Some 40% of families were struggling to keep up with their mortgage payments.
  • More than half of the survey’s respondents said that even when the epidemic is over, they expect to spend less on travel, holidays, restaurants, cinema and theaters than they did before the crisis.

The Euro Zone’s Ultimate Loser

This is all happening in a country whose economy has not grown since it adopted the euro at the turn of this century. In that time its debt-to-GDP ratio has exploded from just over 100% to almost 160%. A study published in early 2019 by the Centre for European Policy think tank, titled 20 Years of the Euro: Winners and Losers: An Empirical Study, found that out of eight Euro Area economies examined (Germany, France, Italy, Spain, the Netherlands, Belgium, Portugal and Greece) only two — Germany and the Netherlands — actually benefited from the introduction of the euro. Italy lost out most:

Without the euro, Italian GDP would have been higher by €530 billion, which corresponds to € 8,756 per capita. In France, too, the euro has led to significant losses of prosperity of € 374 billion overall, which corresponds to € 5,570 per capita.

As Bill Mitchell points out in a recent blog post, the situation will have almost certainly worsened over the three years after the cut-off point of the dataset used (2017). 

One of the main reasons Italy’s economy is in such dire straits is its strict adherence to the EMU’s macroeconomic rule book — in particular the rules on fiscal austerity and structural reforms — as Dutch economist Servaas Storm painstakingly details in his article “Italy: How to Ruin a Country in Three Decades”, which was featured on Naked Capitalism in April 2019:

Italy kept closer to the rules than France and Germany and paid heavily for this: The permanent fiscal consolidation, the persistent wage restraint and the overvalued exchange rate killed Italian aggregate demand—and the demand shortage asphyxiated the growth of output, productivity, jobs and incomes. Italy’s stasis is an object lesson for all Eurozone economies, but—paraphrasing G.B. Shaw—as a warning, not as an example.

There are, of course, many other homegrown reasons for the country’s economic stagnation. Corruption is rife, as is organized crime. Together with establishment inertia, a widespread predilection among the country’s business financial elite for property speculation and good old-fashioned nepotism, they ensure that much of the money that comes into the country is badly invested.

The Banks are Still a Problem

Then, of course, there are the banks. Monte dei Paschi di Siena (MPS), Italy’s fourth largest lender and the world’s oldest, was bailed out in 2017. Now, the government is hastily looking for a buyer so that MPS can be reprivatised before a European Commission deadline expires. The problem is that the bank is still chockablock full of non-performing loans (NPL). Its NPL ratio is currently around 12%. It also has a €2.5 billion capital shortfall. Craziest of all, according to MPS’ own strategic plan it is still “evaluating” the impact of the single most important new piece of banking regulation out there, the calendar provisioning rules.

This new legislation, together with new rules on default, forces banks to class a borrower as in default after an even partial payment delay of more than 90 days. Banks must also write down impaired loans in full over a set number of years. Such rules are already in place for lenders that use an advanced internal model to assess client risks. Banks using standard models had to begin complying from 2021. 

The idea behind the legislation is to force banks to begin moving impaired loans off their balance sheets before they become a major problem. But the timing of the legislation could not have been worse, coming in the midst of the deepest economic crisis in decades. Millions of businesses have had to take on huge amounts of new debt just to stay alive. As lockdowns continue to paralyse entire sectors of the economy, many will struggle to pay it back.

Most European countries have put debt moratoriums in place but once they end there is likely to be a sharp spike in defaults. The impact is likely to be particularly bad in countries such as Italy where debt recovery is notoriously slow and NPLs have been allowed to fester on banks’ balance sheets. Italian business lobbies have warned the EU that the new legislation could trigger a “huge surge” in borrowers being classified as in default. The fact that MPS is still evaluating the impact of the legislation two weeks after its implementation would certainly suggest that it is not remotely ready for it.  

The only Italian lender that is big enough to absorb MPS and apparently crazy enough to actually want to is Unicredit. But in return it will try to extract as high a price as possible, including — according to Reuters — getting the government to take on €14 billion of its own impaired loans as well as some of MPS’ high-risk loans. To make the deal even more palatable, the government is considering shielding any future owner of MPS from around €10 billion in legal claims.

Time is of the utmost essence: after warning its capital reserves would breach minimum thresholds in the first quarter, MPS must tell the ECB by the end of January how it plans to address the shortfall. MPS’ apparent delayed reaction to the EU’s most important new banking regulation does not exactly inspire confidence that its decades of mismanagement are behind it. Perhaps it’s no surprise that some very important Unicredit shareholders are mobilising forces to try to block the deal.

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  1. vlade

    Agree Italy’s a problem, especially it’s banks. Italy banks are, to put it simply a mess. Italy has the fourth highest number of banks in the EU (past Germany, Austria and of all countries, Poland), and it has a lots of small banks. Historically, the banks used to be quite involved on the local scene, for good and bad, but recently it’s mostly bad IMO (and translates into bad debts). It’s a mess that will end up badly.

    That said, I have a problem with the methodology in the quoted EUR vs non EUR study (and I say that as someone who believes EUR is really really bad). I can get the proxy methodology, but I’d expect that the proxies would be chosen differently.

    Blindly proxying France with 50% of Australia is just dumb, because their economies, especially since EUR introduction, are fundamentally different. Oz’s growth in that period was entirely riding on commodity boom, which had trivial impact on French economy. Even w/o commodity stuff, Oz’s economy is driven by entirely differnet markets than French one, so the fact that they might have performed similarly in the period before EUR is most likely a coincidence rather than an expectation setting rule. Similar, Italy is proxied by Oz (31%) and the UK (63%). I could actually get the UK proxy (in fact, I’d argue that the UK + CE would be the best proxies, as fundamentally their economies have similar drivers and experienced similar external conditions), but again, no way Oz growth trajectory in that period could serve as a substantial proxy of anything in the Europe.

    Seems to me it was “let’s do a regression and use the best fit” w/o any sensibility checking.

    1. Anonymous 2

      I agree with your reservations about the choice of countries made to perform the calculations.

      One point which I wish people would notice a bit more is how calculations and comparisons are made. As an example, look at the relative performances of the UK and Italy.

      The following does not take account of developments in 2020 where I have serious doubts about the reliability of anyone’s data for that year at present.

      The common perception of these two countries is that the UK has done better than Italy since the start of the century. Italy is generally calculated to have recorded no significant growth in twenty years, whereas the UK had grown by roughly 40% (I have rounded the figures and am working from memory).

      The one gremlin here, however, is that these calculations are made in the currency of the country concerned – euro for Italy and sterling for the UK. The pound has fallen by 30% against the euro since 2000 so if one converts the figures into the same currency ( I opt for the euro but the essential point would be the same in sterling), the results look very different. Indeed the UK performance looks very comparable to that of Italy. To do the sums, a 40% increase in a currency which falls by 30% is equivalent to no real growth at all – 140 X 0.7 = 98.

      So has the UK outperformed Italy or not?

      Something discussion of the euro should take more into account is that the creation of the single currency has effectively moved all eurozone members on to a Germanic model of monetary policy where what appears to be a slow rate of growth measured in the home currency is accompanied by an appreciation in value over time in the foreign exchange markets, increasing the relative purchasing power of inhabitants of that currency area. Now of course there are many critics of the traditional German approach in these matters but if one compares it with the British approach (which if one looks back to 1945 is clearly one of currency devaluation whenever pressure comes on), I think you would find few Germans who consider the British approach superior. After all, Germany has clearly outperformed the UK economically over that period.

      I understand why economists criticise EZ arrangements, but having travelled widely in Europe in recent years before March 2020 I have found no significant support for any country to leave the euro. Ultimately the decision is a political rather than an economic one.

  2. SOMK

    That report by the Centre for European Policy is extraordinary, if you ad up the column in Table 2 ‘Cumulative effect of euro-introduction on prosperity 1999 – 2017’ you get -€6.392 Trillion!

    Surely that can’t be the case? Even for the biggest Euro pessimists out there that that seems an unbelievably large figure (and going by what Mitchel said it’s gotten worse since).

    1. PlutoniumKun

      The CEP is an openly pro-austerity ordoliberal think tank. Its a very odd choice for a source to be quoted approvingly by Bill Mitchell. As Vlade above points out, the baseline choices for the study are, to put it mildly, somewhat dubious.

      If you compare euro countries to those European countries that stayed out, such as Denmark, Sweden and the UK, there is no strong evidence that most Euro countries have done worse, and most have relatively speaking prospered in that period. Certainly, most Spanish and Portuguese I know consider their countries to have done very well from the Euro (Ignacio could maybe comment more on this). I note that it also left out Ireland, maybe the Euro’s star performer, even allowing for the Celtic Tiger crash in the middle of it (a crash likely exacerbated by euro membership).

  3. vlade

    Ha, the wiki page even mentions this study under “Controversy” heading. Apparently, CEP said “but it [methodology] worked elsewhere!” to the critique. Duh.

  4. Kurt Sperry

    I spend (or spent, now) a lot of time in Italy and I’ve seen no political will to leave the EZ on the ground there. Even M5S, who were definite EZ skeptics, pretty quickly changed their tune when they joined a ruling coalition. Italians who follow the news all know how shaky MPS and other large banks are, I’m surprised they still have so many depositors. I use a small, cooperatively-owned local bank who seem to be well-run. And there’s something to be said for banking at a bank where you, even as a small account, are on a first name basis with the bank president. People who derive income from tourism are suffering, I certainly hope vaccination will allow things to open up this year before too much irreparable economic damage is done.

    1. vlade

      A friend used to have a house in Italy (an old farm he lovingly rebuilt, and then earthquake damaged it, with the house becoming dangerous to live in, and he couldn’t afford to rebuild as the insurance paid all of 200 EUR IIRC). He said that the banking experience in Italy was very interesting, with literally each larger town having its own bank, where the management was very much chums and part of the local elites (legal _and_ illegal). Then depending on how the local town was run, the bank was run.

      If I remember correctly (I might not, at the time I was drinking some local spirit his neighbor farmer was distilling), he was saying that the ones with more established illegal elites were better run, more for a long term, than the noveau riches. Which in those towns meant anyone who moved in after the unification of Italy. But take that as a rumour, not a fact.

  5. Kurt Sperry

    Local cooperative banks in Italy (good cocktail napkin length English description here) are worth looking at, they are roughly analogous to US local credit unions and are both mutual and non-profit and they also have savings banks, casse di rispamio that are non-profit and local, plus there is decent postal banking as well. There are viable alternatives to the big bel casini like MPS.

  6. Chris Herbert

    I cannot figure out why the euro still exists. Not having your own currency cripples your ability to help manage your economy. You lose your sovereignty. Your independence. Can’t they have keep their trade agreements and open borders without everyone using what is operationally a foreign currency that used to be called the Deutschemark? This borders on the masochistic.

    1. Louis Fyne

      There are big operational hurdles for a country to leave the Eurozone—even if Italy were to issue a “New Lira” at parity with the Euro, it would take years to plan, on par with the multi-year phase-in of the Euro.

      Even then, using the Euro creates winners-losers. The winners generally are the ones with bigger voices in the media and the bigger voices in the ruling class.

      And even if all these hurdles were magically solved….I’m an Italian small business with debt in Euro. If/When Italy moves to the “new Lira,” I still got all this Euro-denominated debt. And depending on the industry, I have to buy US dollar or Euro-priced fuel, spare parts, medicine, widgets with my (presumably weaker) Lira.

  7. Franco

    I lived in Italy for a few years. I also have a lot of admiration for the Italian entrepreneur and ingenuity.
    But Italy is doomed and will never recover. Why?
    Demographically it is contracting. “Traditional Italians” are making up less and less of the population.
    But more importantly the whole legal system is inneficient and constructed to serve the political elite.
    There is no desire to change it. An italian owed money cannot enforce debt payment. A person renting a property need never pay rent and it is almost impossible for a landlord to kick them out. They claim disability or get pregnat or move a kid in and that is it.
    Italians have no faith in their legal system, It is impossible for forirgn companies to enforce contracts and recover money owed.
    A strong efficient reliable legal system allows entrepeneurs to florish. Italy has probaly the most inefficient and unfair legal system in the world. Certian interest groups will never allow this to change.

    1. Kurt Sperry

      That’s pretty much the boilerplate take of the Lega (née Lega Nord) and the Italian far right. I would differ.

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