Italy: Risk Assessment
Country Risk Rating
Business Climate Rating
- Manufacturing industry still important (automobile, pharmaceutical, textiles)
- Regained competitiveness and strengthened export sectors
- Bank asset quality has significantly improved
- Comparative advantage in high-end food products
- Vibrant tourist industry with still unexploited potential
- Public debt still very high, net international investment position very negative
- Very high youth unemployment motivates brain drain
- Large quota of small, low-productivity companies (more than 90% of firms have 10 employees or less)
- Fragmented political landscape, convoluted and unstable parliamentary system
- Strong regional disparities, organized crime still influential in the South
Salvini’s failed gamble paves the way for a centrist-populist coalition
Emboldened by positive results in the European elections and his rising popularity, then interior minister and leader of the far-right Lega Matteo Salvini attempted to trigger a snap election by breaking the coalition with the 5 Star Movement (5SM), led by Luigi Di Maio. The move backfired in September as 5SM and the center-left Democratic Party (DP) set aside their deep disagreements to oust the Lega from office and form a new government led by Giuseppe Conte, an independent technocrat. Former Prime Minister Matteo Renzi, who had a pivotal role in brokering the new coalition, quickly left the DP to found a new political party (Italia Viva), further fragmenting the political landscape. With the controversial Salvini out of office, the new government is looking to normalize relations with Brussels, both in fiscal and immigration policy. However, due to longstanding animosity between the DP and the 5SM, as well as the intrinsic instability of the Italian parliamentary system, the coalition is unlikely to last long. In the event of a snap election, Salvini would be poised to take power.
As usual, growth will be conspicuous by its absence
Though the outlook will improve marginally, 2020 will be another year of Italy’s decades-long economic stagnation. Italy suffers from chronic structural deficiencies that its volatile democracy is struggling to address. Failure to improve productivity in the absence of exchange rate adjustment means that Italy can only gain competitiveness by compressing labor costs. But, with per-capita income unchanged since the Euro’s inception, the electorate has become impatient and hostile to reform. Destocking, which weighed down on growth in 2019, has run its course and will not be an obstacle in 2020. Unemployment, which despite the slowdown has dipped below 10% for the first time since 2012, is set to rebound slightly as labor productivity is unlikely to improve. This will affect disposable income, but higher social transfers and lower energy prices will offset the effect on consumption. The worst difficulties will continue to be felt by the manufacturing sector, and in particular the automotive and steel industries, while pharmaceuticals will again perform well. The political normalization will give a slight boost to private investment through two channels: improved business confidence and better financing conditions, courtesy of a declining sovereign spread. But, because of the coalition’s short life expectancy, said boost will be short-lived. Due to a rise in imports, the growth contribution of the external sector will become neutral. With a much smaller bad loan stock, the banking sector is in better health, though it is still interfering with destructive creation by evergreening loans to unproductive firms. Nonetheless, Italian banks have the highest domestic sovereign exposure out of all major Eurozone economies, meaning the bank-sovereign doom loop remains a latent threat.
Despite the change of government, the fiscal stance will remain moderately expansive
Last year, the EU had demanded that the 2020 budget reduced the structural deficit by 0.6% of GDP. The budget proposed by the 5SM-DP coalition instead involves raising both the structural and overall deficit targets to 1.1 and 2.2%, respectively. Nonetheless, taking into account the recessionary context and the new government’s collaborative attitude, the EU has decided not to reject the budget. Importantly, the plan avoids a VAT hike (from 22 to 24.2%) that would have been strongly detrimental to purchasing power and aggregate demand. To compensate the associated €23 billion of lost revenue, as well as €3 billion in tax cuts for low-income households, the government will rely on a set of measures to combat tax evasion, which is estimated to cost more than €100 billion a year. These include measures to incentivize non-cash payments, such as fines for not accepting cards, stricter prison sentences and a lowering of the maximum threshold for cash transactions. In addition, a “web tax” for digital companies is expected to bring in €700 million. Due to the appeasement with Brussels and the ECB’s easing, debt-service costs are at record lows, which is fundamental for keeping the public debt dynamic under control. Owing to a deteriorating external environment (global trade tensions, European slowdown) and stagnant competitiveness, a modest contraction of the current account surplus is expected. Italy’s export basket is skewed towards machinery, automotive and food products; making the trade balance sensitive to the trade war. Foreign manufacturing orders have been declining somewhat faster than in competitor countries (ex: Spain), suggesting a slight loss of market share.