Economic situation of Italy during financial crisis and outlook for the next years

Abstract

This work takes into investigation the situation of Italy during the initial phase of the financial crisis that begun in 2008 and next we have gone through the short-term recovery in 2010 till the return of the bad results in 2012 and negative predictions for the future. We have analyzed the background of Italy economy, the main economic measures and the actions taken by the Italian government to recover the financial situation of the country.

In the following chapters we have reviewed the most important financial ratios as gross domestic product, public debt, budget deficit, inflation and others. We have analyzed the historical data, trends of the ratios and tried to predict the future situation taking into consideration the economic factors as well as the political circumstances coming from the last elections in Italy in February 2013.

Finally we have concluded the highest risk of Italy’s financial standing that comes from the rising public debt, rising unemployment level, lowering consumptions and investments and ineffective redistribution of public funds (high corruption). We predict that mostly due to the political results of last election and lack of the willingness to implement the structure reforms the financial standing of Italy will be getting worse in coming years. The main threat is raising public debt that will require higher costs to serve it and can lead in the most negative scenario to the bankruptcy of Italy and excluding this country from the Euro zone.

Table of Contents:

CHAPTER 1. Introduction……………………………………………………. 2
CHAPTER 2. Materials and methods………………………………………. 2
CHAPTER 3. Results………………………………………………………….. 7
CHAPTER 4. Discussion: Reforms and outlooks……………………….. 8
CHAPTER 5. Conclusions……………………………………………………10
Literature cited and links……………………………………………………. 10

Chapter 1. Introduction

Italy became a nation-state in 1861 when the regional states of the peninsula, along with Sardinia and Sicily, were united under King Victor EMMANUEL II. An era of parliamentary government came to a close in the early 1920s when Benito MUSSOLINI established a Fascist dictatorship. His alliance with Nazi Germany led to Italy's defeat in World War II. A democratic republic replaced the monarchy in 1946 and economic revival followed. Italy is a charter member of NATO and the European Economic Community (EEC). It has been at the forefront of European economic and political unification, joining the Economic and Monetary Union in 1999. [1] Italy is also a member of the G8, G20 and NATO.

Italy has a diversified industrial economy, which is divided into a developed industrial north, dominated by private companies, and a less-developed, highly subsidized, agricultural south, with high unemployment. The Italian economy is driven in large part by the manufacture of high-quality consumer goods produced by small and medium-sized enterprises, many of them family owned. Italy also has a sizable underground economy, which by some estimates accounts for as much as 17% of GDP. These activities are most common within the agriculture, construction, and service sectors. [1] The country is well known for its influential and innovative business economic sector, an industrious and competitive agricultural sector (Italy is the world's largest wine producer), and for its creative and high-quality automobile, industrial, appliance and fashion design. [2]

According to the International Monetary Fund, the World Bank and The World Factbook, in 2011 Italy was the eighth-largest economy in the world, the fourth-largest in Europe and the third-largest in the Eurozone in terms of nominal GDP, and the tenth-largest economy in the world and fifth-largest in Europe in terms of purchasing power parity (PPP) GDP. [2] Despite these important achievements, the Italian economy today suffers from many and relevant problems. Its exceptionally high public debt and structural impediments to growth have rendered it vulnerable to scrutiny by financial markets.[1] Italy is one of the countries known as PIIGS ( the acronym identifying five states with bad budget situation: Portugal, Italy, Ireland, Greece and Spain). Public debt has increased steadily since 2007, topping 126% of GDP in 2012, and investor concerns about the broader euro-zone crisis at times have caused borrowing costs on sovereign government debt to rise to euro-era records.[1]

In our scientific paper, we would like to investigate in detail how looked Italy at the beginning of the financial crisis, how fared during his lifetime and how the economic situation looks today.

Chapter 2. Materials and methods

In order to closely examine the economic situation of Italy, we were looking for data and articles on the internet pages and in the press. Thanks to data of The World Bank, Eurostat, IMF we found a lot of important information concerning Italy especially about:

* GDP * Public debt * Budget deficit * General government expenditure * Unemployment * Inflation rate * Current account

Gross Domestic Product - Values are based upon GDP in national currency converted to U.S. dollars using market exchange rates (yearly average). (see Chart 2.1)

Chart 2.1 Source of data: IMF

* GDP Real growth rate (%) - This entry gives GDP growth on an annual basis adjusted for inflation and expressed as a percent.[3] (see Chart 2.2)

Chart 2.2 Source of data: CIA World Factbook

* GDP per capita (PPP) - This entry shows GDP on a purchasing power parity basis divided by population as of 1 July for the same year.[3] (see Chart 2.3)

Chart 2.3 Source of data: CIA WorldFactbook

Public debt -This entry records the cumulative total of all government borrowings less repayments that are denominated in a country's home currency. Public debt should not be confused with external debt, which reflects the foreign currency liabilities of both the private and public sector and must be financed out of foreign exchange earnings. [3] (see Chart 2.4)

Chart 2.4 Source of data: CIA World Factbook

Government budget deficit - Net lending (+)/Net borrowing (-) under the EDP (Excessive Deficit Procedure) (see Chart 2.5)

Chart 2.5 Source of data: Eurostat Chart 2.6 Source of data: IMF

General Government expenditure - Total expenditure consists of total expense and the net acquisition of nonfinancial assets. Note: Apart from being on an accrual basis, total expenditure differs from the GFSM 1986 definition of total expenditure in the sense that it also takes the disposals of nonfinancial assets into account.[4] (see Chart 2.6)

Unemployment rate -This entry contains the percent of the total labor force that is without jobs. (See Chart 2.7)

Chart 2.7 Source of data: IMF

Inflation rate * Consumer Price Index (CPI) - The chart shows annual inflation in Italy (dec vs. dec) based on the consumer price index [7] (see Chart 2.8) * Harmonised Consumer Price Index (HICP) - This inflation figure shows the change in price of a standard package of goods and services which Italian households purchase for consumption. To determine the rate of inflation the percentage increase in the HICP over a given period is calculated. HICP is published by Eurostat to compare inflation in European countries. [6] (see Chart 2.9)

Chart 2.8 Source of data: Istat Chart 2.9 Source of data: Eurostat

.
Current Account Balance - current account is all transactions other than those in financial and capital items. The major classifications are goods and services, income and current transfers. The focus of the BOP is on transactions (between an economy and the rest of the world) in goods, services, and income. [4](see Chart 2.10)

Chart 2.10 Source of data: IMF

Chapter 3. Results
The situation in Italy during the financial crisis worsened considerably. By analyzing main economic indicators we observed the following trends / phenomena: * GDP - The Gross Domestic Product (GDP) in Italy was worth 2194.75 billion US dollars in 2011. The GDP value of Italy represents 3.54 percent of the world economy. The highest value of GDP was recorded in 2008 and amounted to 2,318.162 billion US dollars. During the financial crisis we can observe a downward trend of GDP (see Chart 2.1). When we analyze GDP Real growth rate (%) we can see that the highest fall of GDP was recorded in 2009 (-5,5%). In 2012 GDP Real growth rate is at the level -2,3% (see Chart 2.2). Italian per capita GDP at purchasing power parity remains approximately equal to the EU average. (see Chart 2.3)

* Public debt - According to the EU's statistics body Eurostat and World Factbook, Italian public debt stood at 118,1% of GDP in 2011, ranking as the second biggest debt ratio after Greece (with 161.7%) During the financial crisis, Italy suffer from a very high and continuously expanding public deficit (see Chart 2.4).

* Budget deficit - During the financial crisis the highest budget deficit was recorded in 2009 - 5,4% of GDP. After that, as a result of austerity measures passed in December 2010, Italy is targeting a public budget deficit of 3.9% in 2011 and 2.7% in 2012, both among the lowest in the European Union (see Chart 2.5).[5]

* General Government expenditure - According to The International Monetary Fund (IMF), Italian general government expenditure remains approximately equal to the EU average. The highest level of government spending was recorded in 2009 and was 51,9% of GDP. As a result of a series austerity measures, government expenditure stood at the level 49,9% of GDP in 2011 (see Chart 2.6).

* Unemployment rate - During financial crisis unemployment rate in Italy increased steadily from 6,1 % in 2007 to 11.2 % in December of 2012(see Chart 2.7).

* Inflation rate- In Italy, the most important categories in the Consumer Price Index are: food and non-alcoholic beverages (16 percent of total weight); transport (15 percent); restaurants and hotels (11 percent) and housing, water, electricity and other fuels (10 percent). The index also includes: clothing and footwear (9 percent); furnishing and household equipment (8 percent); recreation and culture (8 percent) and health (8 percent). Communication, education, alcoholic beverages, tobacco and other goods and services contribute the remaining 15 percent. During the financial crisis the highest level of CPI was recorded in 2011 and was 3,29% (see Chart 2.8).The lowest level of HICP was recorded in 2009 (0,8%) and from this time tend to increase.(see Chart 2.9).

* Current account - The Current account balance as a percent of GDP provides an indication on the level of international competitiveness of a country. Italy recorded a Current Account deficit of 3.55% of the country's GDP in 2010 and 3,26% of GDP in 2011. At these levels Italy’s current account deficit is the largest recorded since 1997 and among the highest in the eurozone when excluding Spain, Greece and Portugal. This is the result of a long and steady deteriorating trend, which brought the current account balance (in % of GDP) from a large surplus (+2.8%) in 1997 to a 3.5% deficit in 2010 (see Chart 2.10).

Chapter 4. Discussion: Reforms and outlooks

The global financial crisis of 2008 decreased Italy’s economy by 6 percent. Growth recovered in 2010 but it went down in 2011 and 2012 again due to the rising of debt crisis. At roughly 120 percent of GDP Italy’s debt is second only to Greece’s among euro zone member. It is running self-running spiral that caused that Italian government spend about 16 percent of its budget on interest payment.

As Italy is the third-largest in the Eurozone in terms of nominal GDP thus is described as too big to fall. The amount of its debt held by the foreigners (nearly 800 billion euros) is more than that of Greece, Ireland and Portugal in total. The debt problem has been escalated by the Italy’s economic slowdown run in 2011 again.

Italy’s economy situation cannot be considered without mentioning the political conditions that are significantly unstable in comparison to other European countries. The crisis caused that Prime Minister Silvio Berlusconi resigned in November 2011. He was criticized that his government moved too slowly to implement fiscal reforms required by the European Union. His successor was Mario Monti, an economist who was asked to lead the government of technocrats until the economic situation was stabilized.

The economic measures that Mr.Monti applied during first weeks of his cadency partially moved Italy into right direction in term of squeezing budget debt. He managed increasing the retirement age, rising property taxes or simplifying the operating procedures of government agencies. On the other hand he was unsuccessful in changing inflexible labor rules that require painful changes and could improve the competitiveness of Italy’s industry.

The implemented reforms had also negative impacts and pushed Italy into the worst recession in the last decades. Consumer spending counted year over the year dropped to the most since World War II. Domestic sales were down 23% in the second quarter 2012 compared with the same period of the previous year. Unemployment reached almost 10% in the 2011 (over 30% for young people) and experts said it would be still growing.

Italy’s labor market was divided into two generations. The older workers had the guaranteed jobs with generous pensions and full benefits while the younger Italians (the best-educated in the country’s history) could not find a job. They were lucky to find temporary work which offered only a few benefits or stability. The government was proposing measures to make it easier for companies to hire and fire, and to create shorter-term contracts with greater pension and unemployment benefits. The labor unions are resisting some changes. Labor reform has been a long battle in Italy, where unions, business groups and countless governments have invested in the status quo to protect their benefits, at the expense of economic growth. Anyway without the labor reforms Italy was supposed to go toward an economic and social implosion, with a rise of black market work and risk of pensions payments. The Italy’s employment rate and productivity have been stunted by high labor costs and that lowering the cost of firing workers and increasing protections for shorter-term contracts would encourage companies to hire, stimulating growth.

With regard to fiscal policy the Monti government revised its medium-term fiscal targets to reflect the negative effects of weaker economic growth and higher interest rates in 2012-2015. It was initially predicted that government deficit would be eliminated in 2013 and after revision the government expects the deficit decreasing from 3,9% of GDP in 2011 to about 1,5% in years 2013-2015. In addition to already implemented tax increases and expenditures cuts to limit the deficit, the government plans to sell off the government owned assets to pay debt down, although it highly depends on market conditions. We are concerned about these possibilities especially having in mind the results of last February 2013 elections (this will be commented in the Conclusions chapter) and therefore we expect the government debt/GDP ratio to increase to 125%-135% in years 2013-2015 and then after the implementation of strict economic measures it would fall in years 2016-2017 to 120% back.

With regard to monetary policy the ECB cut its main refinancing rate to 0,75% in July 2012 and has kept it until 2013. The ECB announced in September 2012 that if necessary it would buy the bonds of troubled governments like Spain and Italy in unlimited quantities. The Monti government explained that Italy was not in rush to utilize such purchases and that would happen only under extraordinary circumstances. But as a matter of fact the ECB’s announcement brought the interest rates of Italy’s bonds down significantly and helped Italian government to finance their debt under lower interest costs.

Bearing in mind the combination of greater fiscal austerity, worsening of market conditions, weakening of external demand and results of last elections we expect that Italian recession which begun in 2011 it would last till 2013. We expect that Italian economy would return to growth of about 1% in years 2014-2017. The acceleration will depend on moderately stronger demand in other countries in Europe and on improvement in consumer consumption and business investments in Italy. The risks to growth prospect are fiscal consolidation in Italy, the decreasing demand in UE, or if business and consumer confidence remain low further delaying a recovery in domestic market. Another significant risk is instability in European Euro Zone that would cause interest rates on Italian debt to raise sharply and next a debt default and banking system collapse, mostly because Italian banks have large portion of government debt.

Chapter 5. Conclusions

The government debt, already at 126 percent of gross domestic product, will almost certainly continue to rise. The main factors that will drive Italy’s financial standing in the nearest future are the results of last elections in February 2013. The well market recognized Mr.Monti who led Italian government in 2012 trying to fix national finances received only a few percent of votes and the most of the votes went to central-social party of Pier Bersani and in the second order to former comedian Beppe Grillo expressing populist slogans. Under these circumstances it’s hardly to believe that Italy will recover its financial standing and will quickly implement significant market reforms that would limit the government expenditures, decrease the corruption level or liberalize the labor regulations. It’s rather probably that due to the political uncertainty the cost of serving of public debt is going to rise, there will be no saving plans implemented soon, the unemployment will remain high and the government deficit will remain negative in the next years of 2013-2015.

Having said that we estimate the period of few years of stagnation and following the slow period of growth recovery under the condition that Italian politicians would come step by step to the agreement to implement the structure reforms. Under the negative scenario if the politicians will not recover the Italy’s finances and debt risk will be getting worse then we can expect tremendous problems that would even exclude Italy from the euro zone.

Literature cited and links

[1] https://www.cia.gov/library/publications/the-world-factbook/geos/it.html
[2] http://en.wikipedia.org/wiki/Italy
[3] http://www.indexmundi.com
[4] http://www.imf.org/external/datamapper/index.php
[5] http://en.wikipedia.org/wiki/Economy_of_Italy
[6] http://www.global-rates.com/
[7] http://www.inflation.eu/inflation-rates/italy/historic-inflation/cpi-inflation-italy.aspx