Italy: Risk Assessment
Country Risk Rating
Business Climate Rating
- Manufacturing industry still important (machinery, pharmaceuticals, etc.)
- Increasing efforts to combat tax evasion and reduce informality
- Bank asset quality has significantly improved
- Comparative advantage in high-end food products
- European support creates opportunity for modernization
- Public debt still very high, net international investment position very negative
- Very high youth unemployment that motivates brain drain
- Prevalence of small, low-productivity companies (more than 90% of firms have 10 employees or less)
- Strong exposure to pandemic-sensitive sectors (tourism, automotive, textiles)
- Strong regional disparities, organized crime still influential in the South
After a historic contraction and an above-average rebound, the stage is set for recovery
Going into the pandemic, the Italian economy appeared more fragile than its Eurozone peers, featuring chronically stagnant growth. Surprisingly, it has performed better than Spain and France, with a slightly weaker Q2 2020 contraction (IT: -18% YoY, FR: -19%, ES: -21.5%) followed by a more durable summer rebound. Nevertheless, the 2020 contraction will be among the strongest in the industrialized world, creating considerable risk for the most vulnerable firms. The share of firms posting a profit for 2020 is forecasted to decline to 50-45%, down from 75% in 2019. The government has deployed extraordinary measures to safeguard viable firms, most notably a robust furlough scheme (covering 28% of the private sector workforce at its peak) and a loan guarantee program (8% of GDP in attributed financing). It is estimated that the pandemic created a liquidity shortfall of EUR 48 billion for 142,000 firms, which was reduced to EUR 17 billion for 32,000 firms thanks to public intervention. Firm leverage (debt/assets) will grow to 45%, lower than the 53% peak reached under the Euro crisis. Nonetheless, some sectors will see their expected probability of default increase substantially, including tourism (from 4.3 to 7.3%), entertainment (4.4 to 6%), construction (6 to 6.9%), and energy (3.5 to 5.2%). All components of demand are in for a double-digit contraction in 2020 (consumption: -10%, investment: -14%, exports: -17%), before a rebound in 2021 (consumption: 4%, investment: 7%, exports: 11%). Only government spending will have a positive contribution over 2020-2021. The rebound should be driven by manufacturing exports to a recovering EU (machinery, automotive, food products) and, more gradually, domestic services.
Public debt reaches new heights, but a radical shift in EU-ECB policy mitigates its risk
Emergency measures cost around 5.5% of GDP. These include several grant programs for vulnerable households and firms, selective suspension of social security contributions, the aforementioned furlough, substantial health spending, and tax deferrals. Overall, expenditure will increase by 11%, less than compensated by a 4% decline in 2021. While much of the emergency spending will be dialed back, the fiscal stance will remain expansionary, with continued support for the most vulnerable pockets of industry, a new “family bonus” transfer, and poor region tax cut (combined cost of 1% of GDP), and sustained strengthening of research, education and health spending. Revenue will contract by 11% before a resounding 8% rebound. Public debt will reach a level comparable to that of Greece in 2012 but under a very different European context. The ECB has expanded QE by EUR 2.5 trillion and is now engaged in open-ended purchases of bonds of weaker member states. Italy will be the main beneficiary of the EUR 750 billion Next Generation EU fund, receiving EUR 209 billion over 2021-2027. As long as this new consensus holds, the effect of cheap debt service will overcompensate fiscal and economic weaknesses. However, this leaves public finances exposed in a scenario of returning inflation. The pandemic will have a broadly neutral effect on the structural external surplus, with both imports and export of goods and services plunging. Banks remain relatively fragile, but bad loans are not expected to reach the Euro crisis peak.
A fragile executive, a collapsing populist left, and a steadily rising nationalist right
Italy is governed by a coalition government led by the center-left Democratic Party (DP, 13% of seats) and the populist-left 5-star movement (5SM, 29%), with the support of minor parties. Originally a marriage of convenience set up to displace rising right-wing politician Matteo Salvini from power, the coalition was emboldened by PM Giuseppe Conte’s rising popularity during the pandemic. But political uncertainty has returned after Italia Viva, one of the minor parties, withdrew its support. Until the pandemic allows for elections, a succession of fragile governments is the likelier outcome. To recover their dwindling support, 5SM lawmakers tend to attack business interests. This has been the driving force behind the fight over ArcelorMittal’s legal protections in the Taranto steel plant, as well as the dispute over Atlantia’s motorway concession, both of which have involved intense legal confrontations between the state and investors. Between the resilience of Salvini’s Lega and the rise of Giorgia Meloni’s Fratelli, the electorate is shifting to the nationalist right.