Euromoney article on the continued evolution of the Italian crisis: http://www.euromoney.com/Article/3712913/Country-risk-Italy-is-the-volcano-waiting-to-erupt.html, quoting - amongst others - myself.
Showing posts with label Italian economy. Show all posts
Showing posts with label Italian economy. Show all posts
Friday, April 28, 2017
28/4/17: Euromoney on Italian Risks
Euromoney article on the continued evolution of the Italian crisis: http://www.euromoney.com/Article/3712913/Country-risk-Italy-is-the-volcano-waiting-to-erupt.html, quoting - amongst others - myself.
Thursday, September 25, 2014
25/9/2014: IMF Dished Out Some Bad News on Italy... here's a snapshot...
Recently IMF released Article IV
consultation paper on Italy. I have missed posting this note for some days now
due to extensive travel, so here it is, with slight delay.
A depressing read both in terms of current
situation assessment and prospects for the medium term future. Which is hardly
surprising.
Key struggles are, per IMF: "Exports have held steady,
led by demand from non-EU countries, but investment continues to decline and
remains 27 percent below pre-crisis levels."
Err… actually no… exports are still below
pre-crisis levels by volumes, never mind price effects on value. Exports of
goods and services grew by 6.2% in 2011, but then growth collapsed to 2.1% in
2012 and 0.1% in 2013. 2014 projected growth is for healthier 3.0%, and
thereafter the Fund forecasts exports to continue expanding annually at just
under 3.6% pa on average between 2015 and 2019. Which is handy, but not exactly
'booming'. And worse, net exports having grown by 1.5% and 2.6% in 2011 and
2012 have shown decline in the growth rates to 0.8% in 2013 and projected 0.5%
in 2014. Thereafter, net contribution of external trade to GDP is forecast to
grow at 0.4% in 2015 and 0.1% every year from 2016 through 2019. Again, this is
weak, not strong. And keep in mind: GDP does not grow with Exports, it grows
with Net Exports.
Fixed investment is, of course, still
worse. In 2011 gross fixed capital formation shrunk 2.2%, followed by an
outright collapse of 8% in 2012 and topped by a decline of 4.7% in 2013. Now,
the Fund is projecting contraction of 1.1% in 2014, but return to growth in
2015 (+1.8%) and in 2016-2019 (average annual rate of expansion of ca 2.6%).
Which means one simple thing: by the end of 2019, investment in Italy will
still be 6.2% below the pre-crisis levels.
Now, the IMF can be entertaining all sorts
of reforms and changes and structural adjustments, but there is one pesky
problem in all of this: investment is something that the young(er) generations tend
to do. And Italian young (people and firms) have no jobs and little churn in
the marketplace to allow them grow, let alone invest. IMF notes low churn of
firms… but misses the connection to investment.
And, of course, it misses the
Elephant in the proverbial Room: Italian families are settled with 30-40 year
old sons and daughters still living on parental subsidies. Now, parents are
heading for retirement (tighter cash flows) and retirement funds are heading
for if not an outright bust, at least for gradual erosion in real value terms.
What happens when retired parents can’t nurse their children’s gap between
spending and earning?..
Things get uglier from there on. Not
surprisingly, due to debt overhang already at play, credit supply remains poor
and NPLs continue to strain banks balance sheets. This is holding back the
entire domestic demand and is exacerbating already hefty fiscal disaster.
There is no life in the credit market and
with this there is no life in the economy. Which, obviously, suggests that
credit is the core source for growth. This is not that great when you consider
that there are four broadly-speaking sources of investment (and capacity
expansion):
- Organic revenues growth (exports are barely growing, domestic consumption is dead, so that's out of the window);
- Direct debt markets (bond markets for corporate paper, open basically only to the largest Italian corporates and no smaller firms access platforms in place, which means no real debt markets available to the economy at large);
- Equity (forget this one - tightly held family firms just don't do equity, preferring to cut back on production) and
- Banks credit (aka, debt, glorious debt).
Chart above shows the relationship between
Financial Conditions Index (FCI) and economic growth. FCI breakdown is shown in
chart below:
All of which confirms the above:
improvements in the credit volume and credit standards are being chewed up by
the ugly nominal rates charged in the banking system that is now performing
worse (in terms of profitability) than its other Big Euro 4 + UK counterparts.
And the IMF notes that: "Financial
conditions are closely correlated with growth and FCI shocks have a significant
impact on growth. For example, a bivariate VAR under the identifying assumption
that the FCI affects growth with a one-quarter lag suggests that a negative
shock that raises real corporate lending rates by 260bps through a 200bps
increase in nominal rates and a 60bps decline in inflation expectations (to 0.5
percent), would lower growth by a cumulative 0.4 percentage point over three
quarters. As a reference, real rates have increased by around 300 bps since
mid-2012." No sh*t Sherlocks, you don’t need VAR to tell you that growth
in Europe = credit. It has been so since the creation of the Euro, and actually
even before then.
Now, do the math: in 2013, Italian banks
have posted profitability readings that are plain disastrous:
The swing between ROE for Italian banks and
Spanish & French counterparts is now around 21 percentage points. While NPLs are still climbing:
But real lending rates are above those in
France and below those in Spain:
Taken together, charts 4-6 show
conclusively that nominal rates will have to rise AND deleveraging out of bad
loans will have to either drag on for much longer, or worse (for the short run)
accelerate. All of which means (back to the above IMF quote) continued drag
from the financial sector on growth in quarters ahead. Everyone screams
'austerity' but really should be screaming 'deleveraging':
IMF notes: "The analysis suggests that
measures to normalize corporate financial conditions would support a robust and
sustained recovery, mainly through investment. Since bank lending rates account
for the lion’s share of the tightening in the FCI, domestic and euro area
measures to address financial fragmentation, mend corporate balance sheets, and
strengthen banks’ capacity to lend would minimize the risk of a weak,
creditless recovery."
This is all fine, but totally misses the
problem: financial 'normalisation' in the above context is not about
investment, but about investment via debt. And more debt is hardly a feasible
undertaking for Italian firms and for Italian banks. Supply IS closer to demand
that we think, because tight supply (banks deleveraging) is coincident with
tight demand (once we control for the risks of poorly performing corporates
seeking debt rollovers and refinancing).
And, of course, the IMF optimism for “domestic
and euro area measures to address financial fragmentation, mend corporate
balance sheets, and strengthen banks’ capacity to lend” capacity have just hit
a major brick wall at the TLTROs placement last.
As subsequent data showed, Italian banks just started re-loading their hoard of
Government bonds instead of repairing the corporate credit system.
Who could have imagined that
happening, eh?
Sunday, August 24, 2014
24/8/2014: Italy: A Lifeless Liner on Economic Growth Rocks: Part 2
This is part 2 of two-parts series on Italian economy. Part one is available here: http://trueeconomics.blogspot.com/2014/08/2482014-italy-lifeless-liner-on.html?spref=tw
In Italy, SMEs represent over 80% share of the total economy in terms of employment and almost 70% of value added. In North-East, family businesses hold an even larger share of economic activity. But SMEs credit performance for the economy as a whole is third worst in the euro area, as highlighted in the July note by the IMF:
A baker running three busy shops in the area raises as his first complaint high taxes on business, second - high taxes on households and third - lack of credit. For generations, his family owned the bakeries that supply local communities with fresh goods, working from 3 am through evening 6 days a week. Now, the banks with which they have been dealing over the decades are no longer lending, equipment is starting to experience more frequent failures, and customers are slipping into arrears. He holds a ledger of customers credit, like many other shops around, and says majority of businesses in towns are bartering food for small work.
Overall debt levels in the Italian economy are relatively high, as noted in the chart below from the IMF (2014):
And deleveraging is slow (same source):
Which means that the current state of affairs (tight family budgets, lack of discretionary spending and dire lack of investment) is here to stay. With it, as IMF shows, there is a negative relationship between total private sector debt and subsequent growth rates in the economy:
But this relationship in Italy's case also shows that structural problems in the economy (as in the case of Slovenia, Finland and to a lesser extent Ireland and Portugal) compound the adverse effects of debt overhang. In other words, private sector debt overhang appears to account for smaller share of growth pressures in Italy than in other EU states. Which is, actually, bad news for two reasons:
One of the structural drivers for slower growth in Italy, as opposed to other comparable economies is labour cost competitiveness:
Charts above clearly show that crisis-related improvements in Italian economy's labour cost competitiveness are lagging those in other 'peripheral' countries in absolute terms. In relative (to EA17) terms, the country has posted a loss in productivity over the years of crisis that is deeper than for any other country covered in the IMF sample above. This loss in productivity was not offset by the declines in direct labour costs. Thus, in the nutshell, while Italian labour became less productive it also became lower paid - a twin problem, as the former reduces economy's capacity to compete in the international markets, while the latter hammers domestic demand (consumption and investment). It is a tale of 'head sinks, tail sinks' dynamic.
The relationship between high private sector debt levels and weak economic performance, alongside financial and fiscal repression measures suggests that Italian corporate default rates would be somewhere around, but below, those of Spain and Portugal. This is supported by the data:
And the above does not reflect credit deterioration in trading sector that can be expected under the Russian sanctions. One of the largest producers of prosciutto in the famed city of San Daniele spots rows and rows of ham legs drying out labelled for the Russian market. The curing facility stretches over 1/4 of a mile and 'Russia-bound' ham is about as dominant as that set for the U.S. The final destination of the former is now highly uncertain, but trade and production credits used to fund it are going to come due.
Back in the piazza of the regional capital - at the junction of the North and South main streets mentioned in the first post - five banks once stood opposite of one another. Two branches are gone completely, the third one has shrunk to about 1/4 of its original footprint. All remaining beaches' windows are peppered with offers of mortgages and business loans at seemingly benign rates of around 2-2.5% above the 3mo EURIBOR. None, according to the local business people and ordinary homeowners I spoke to are actually lending. While diffusion index for lending standards in Italian banks has finally posted some signs of easing at the end of Q2 2014 (see chart below based on Banca d'Italia data), overall conditions remain tight and the recent easing itself is statistically weak. Meanwhile, Banca d'Italia lending surveys show that aside from nominal pricing of the loans, loans approvals conditions continued to tighten at the end of Q2 2014 for collateral requirements, and remained unchanged for margins, non-interest costs and charges, size of loans issued and covenants.
All of which is showing up in the aggregate credit supply statistics:
As the chart above shows, domestic resident enterprises stock of credit has failed to recover from the crisis-period decline that set on in late 2011, while domestic households loans (relating to consumption) have remained on the gently declining trajectory since early 2012.
Lacking consumer spending, suffering from high taxes and prohibitive regulatory environments, credit-less and wanting for structural reforms, majority of which, even when enacted, are not followed through, Italian economy is now an ageing liner listed lifeless on the rocks with no tide coming in to lift it off and no repair crews dispatched to make it right.
Per latest Eurostat estimates, Italy's real GDP H1 2014 was 9.1% below its pre-crisis peak and 9.2% below the levels registered at the end of 2006. Country real GDP index now stands at a historical low - performance only comparable to that of Cyprus with every other euro area economy having seen at least modest increases in real GDP compared to the crisis trough.
A telling sign of the decline is a small piazza in the regional town, sporting a busy local cafe previously frequented by the local families with kids drawn to a small pet shop next to it, a fountain, previously a focal point for migrants' families working in nearby factories producing luxury goods and high value-added manufactures, and a quiet small grocery store, beloved by the older families and the retired folks. Today, the piazza is quiet: migrant families gone. Local residents tell me that the 'Indians' have moved out, leaving behind falling rents and family-friendly social vibe they helped to define. The cafe is nearly completely empty, with no traditional noise and bustle of local families under the big umbrellas. The grocery store - in place since the 1970s - has gone out of business. One can, for the first time ever, hear the water trickling in the fountain and enjoy a glass of local, brilliantly unique, wines in solitude and calm... a somehow sad calm... a calm of something something gone, something irreparably missing...
Either a heavenly slice of economic hell or a hellish corner of cultural haven, Italy is a society which is facing into a prospect of economic non-future within the euro area. That this conclusion is obvious in the heart of its once vibrant corners - the proudly work- and family-centric North East - is simply damning and infinitely sad.
In Italy, SMEs represent over 80% share of the total economy in terms of employment and almost 70% of value added. In North-East, family businesses hold an even larger share of economic activity. But SMEs credit performance for the economy as a whole is third worst in the euro area, as highlighted in the July note by the IMF:
A baker running three busy shops in the area raises as his first complaint high taxes on business, second - high taxes on households and third - lack of credit. For generations, his family owned the bakeries that supply local communities with fresh goods, working from 3 am through evening 6 days a week. Now, the banks with which they have been dealing over the decades are no longer lending, equipment is starting to experience more frequent failures, and customers are slipping into arrears. He holds a ledger of customers credit, like many other shops around, and says majority of businesses in towns are bartering food for small work.
Overall debt levels in the Italian economy are relatively high, as noted in the chart below from the IMF (2014):
And deleveraging is slow (same source):
Which means that the current state of affairs (tight family budgets, lack of discretionary spending and dire lack of investment) is here to stay. With it, as IMF shows, there is a negative relationship between total private sector debt and subsequent growth rates in the economy:
But this relationship in Italy's case also shows that structural problems in the economy (as in the case of Slovenia, Finland and to a lesser extent Ireland and Portugal) compound the adverse effects of debt overhang. In other words, private sector debt overhang appears to account for smaller share of growth pressures in Italy than in other EU states. Which is, actually, bad news for two reasons:
- It is bad news because it implies that much of the deleveraging-related pain is yet to come; and
- It is bad news because Italy is not very good at structural reforms front. Historically and currently.
One of the structural drivers for slower growth in Italy, as opposed to other comparable economies is labour cost competitiveness:
Charts above clearly show that crisis-related improvements in Italian economy's labour cost competitiveness are lagging those in other 'peripheral' countries in absolute terms. In relative (to EA17) terms, the country has posted a loss in productivity over the years of crisis that is deeper than for any other country covered in the IMF sample above. This loss in productivity was not offset by the declines in direct labour costs. Thus, in the nutshell, while Italian labour became less productive it also became lower paid - a twin problem, as the former reduces economy's capacity to compete in the international markets, while the latter hammers domestic demand (consumption and investment). It is a tale of 'head sinks, tail sinks' dynamic.
The relationship between high private sector debt levels and weak economic performance, alongside financial and fiscal repression measures suggests that Italian corporate default rates would be somewhere around, but below, those of Spain and Portugal. This is supported by the data:
And the above does not reflect credit deterioration in trading sector that can be expected under the Russian sanctions. One of the largest producers of prosciutto in the famed city of San Daniele spots rows and rows of ham legs drying out labelled for the Russian market. The curing facility stretches over 1/4 of a mile and 'Russia-bound' ham is about as dominant as that set for the U.S. The final destination of the former is now highly uncertain, but trade and production credits used to fund it are going to come due.
Back in the piazza of the regional capital - at the junction of the North and South main streets mentioned in the first post - five banks once stood opposite of one another. Two branches are gone completely, the third one has shrunk to about 1/4 of its original footprint. All remaining beaches' windows are peppered with offers of mortgages and business loans at seemingly benign rates of around 2-2.5% above the 3mo EURIBOR. None, according to the local business people and ordinary homeowners I spoke to are actually lending. While diffusion index for lending standards in Italian banks has finally posted some signs of easing at the end of Q2 2014 (see chart below based on Banca d'Italia data), overall conditions remain tight and the recent easing itself is statistically weak. Meanwhile, Banca d'Italia lending surveys show that aside from nominal pricing of the loans, loans approvals conditions continued to tighten at the end of Q2 2014 for collateral requirements, and remained unchanged for margins, non-interest costs and charges, size of loans issued and covenants.
All of which is showing up in the aggregate credit supply statistics:
As the chart above shows, domestic resident enterprises stock of credit has failed to recover from the crisis-period decline that set on in late 2011, while domestic households loans (relating to consumption) have remained on the gently declining trajectory since early 2012.
Lacking consumer spending, suffering from high taxes and prohibitive regulatory environments, credit-less and wanting for structural reforms, majority of which, even when enacted, are not followed through, Italian economy is now an ageing liner listed lifeless on the rocks with no tide coming in to lift it off and no repair crews dispatched to make it right.
Per latest Eurostat estimates, Italy's real GDP H1 2014 was 9.1% below its pre-crisis peak and 9.2% below the levels registered at the end of 2006. Country real GDP index now stands at a historical low - performance only comparable to that of Cyprus with every other euro area economy having seen at least modest increases in real GDP compared to the crisis trough.
A telling sign of the decline is a small piazza in the regional town, sporting a busy local cafe previously frequented by the local families with kids drawn to a small pet shop next to it, a fountain, previously a focal point for migrants' families working in nearby factories producing luxury goods and high value-added manufactures, and a quiet small grocery store, beloved by the older families and the retired folks. Today, the piazza is quiet: migrant families gone. Local residents tell me that the 'Indians' have moved out, leaving behind falling rents and family-friendly social vibe they helped to define. The cafe is nearly completely empty, with no traditional noise and bustle of local families under the big umbrellas. The grocery store - in place since the 1970s - has gone out of business. One can, for the first time ever, hear the water trickling in the fountain and enjoy a glass of local, brilliantly unique, wines in solitude and calm... a somehow sad calm... a calm of something something gone, something irreparably missing...
Either a heavenly slice of economic hell or a hellish corner of cultural haven, Italy is a society which is facing into a prospect of economic non-future within the euro area. That this conclusion is obvious in the heart of its once vibrant corners - the proudly work- and family-centric North East - is simply damning and infinitely sad.
24/8/2014: Italy: A Lifeless Liner on Economic Growth Rocks: Part 1
This is part 1 of the two-parts post on the current economic conditions in Italy.
A North-Eastern Italian provincial capital - a normally buzzing and lively medieval city with proud Roman history and previously vibrant high value-added industries and high tech services sits quiet and semi-deserted on the weekend afternoon. This August, a slow month by normal metrics of shoppers numbers and restaurants and cafe's patrons counts, is marked by the waves of recent closures of small businesses across the province. It is also marked by the official return of Italy to a recession - its third one since 2008.
The two halves of the pedestrianised main street tell the tale of the country-wide economic demise.
On the South side of the old piazza, the main street is dotted with few empty shop fronts. Established as a trading centre of the city centuries ago, this section of the city centre is primarily occupied by shops and businesses that owned their buildings over generations. No rent to pay means the businesses remain open, even as international and Italian brands are shutting down their local operations. The vacancy rate of shopfronts is running at around 10% here.
The Northern side of the street is smarter, better designed and more modernised. It was 'regenerated' in the mid-2000s and populated by trendier shops and eateries catering to Yuppie customers. Back in 2007-2008, the street was abuzz with activity: well-dressed patrons, predominantly under the age of 40 browsing in the cutting edge designer stores and boutiques, while visitors from the province and beyond soaked in the atmosphere of the new social hub in cafes, enoteche and trattorie. This year, more than three out of four businesses are shut, empty windows and closed doors greet a rare passerby. Unable to fund rents, as well as high taxes and charges, smaller business owners have gone under. Those supplying locally-demanded daily goods, such as fresh groceries, are trading elsewhere, some dealing exclusively in cash with their established customers. Majority are simply gone.
Consumer demand is weak. As the result, Italy's HICP inflation is down to 0.0% in July 2014 - the fifth weakest inflation performance in the euro area and down from 1.2% in July 2013 and 12 months average of 0.6% for the 12 months period through the end of last month. At -2.1% monthly rate of HICP inflation in Italy is the worst of all euro area states. Aptly, Italy's retail sales PMI remains below 50.0 line without interruption since Q2 2011. July reading was 43.4 down from 43.8 in June. Since January 2014, through May 2014, retail sales have risen by 0.1% cumulatively, with may posting 0.3% m/m decline. In real (inflation-adjusted) terms, turnover index in the retail trade in May 2014 stood at 92.6 below 93.8 recorded in June 2011 (based on working day adjusted non-seasonally adjusted data), but ahead of June 2013 level of 88.9.
Few kilometres down the road, another wealthy Northern Italian town is showing the same signs of decline. A builder, having completed an apartment block in 2009, was forced out of business by the city authorities saddling his business with the staggering cost of rectifying a planning error committed by… you guessed it, the city authorities. After sitting on the market for 4 years with no takers, the apartments went for auction earlier this spring. Guiding prices ranged from EUR20,000 for a one-bedroom to EUR46,000 for three bedroom flats. Back in 2004-2006 these properties would be sold off-plans for around EUR150,000 one-beds and EUR280,000 for three-beds. The auction flopped: out of 21 properties on the market, only 9 sold. Prime city-centre retail space on the ground floor of the building remains only 1/5th occupied.
Country construction sector activity is still down 43% on the pre-crisis peak (the sixth largest decline in the euro area) with Q1 2014 reading marking all-time low, the only country in the euro area with construction posting historical low in 2014. And housing markets are singing blues. From the beginning of Q2 2013 and through the end of Q1 2014, Italian house prices fell 4.43%, while euro area as a whole experienced house price deflation of just 0.3%. Within the euro area, only Cyprus and Slovenia posted worse 12 months cumulative performance.
Four internationally trading factories, including two suppliers of high-tech household equipment with export markets around the world, have shut doors since the onset of the Great Recession - all employed more than 200 people each at the peak and all have been in business for decades. In a telling sign of the times, one smaller family firm, counting five generations in business and trading with some exports, closed down while the proprietors continue to trade on a highly reduced volume. New trade is all local and cash-only. Across the area, work supplied directly to consumers is now being routinely quoted priced 'with receipt or without' and in many cases, even registered sales of goods and services are openly under-declared on invoices to avoid VAT and profit taxes.
Italy's industrial production stood at 106.6 in H1 2011, by H1 2014 this fell to 97.2. On average, industrial production fell in Italy at an annual rate of 2.98% between the first half of 2011 and the end of June 2014. Italian Manufacturing PMIs fell from 52.6 in June to 51.9 in July although index remains above 50 line continuously since Q3 2013. Ditto for services PMI which fell from the 43-month high of 53.9 in June to 52.8 in July.
Activity down and margins are slipping. Industrial production prices rose 0.1% in June 2014 m/m marking the first month of positive inflation after four consecutive months of producer prices deflation. Since January 1, 2014, industrial producer prices are down 0.5% cumulatively, which is not helping companies profitability or their ability to sustain debt servicing and employment. How bad profitability margins are? In June 2014, index of industrial producer prices for domestic market in Italy stood at 106.5. This is below June 2012 reading (109.2) and June 2013 reading (108.6). Industrial producer prices excluding energy sector are virtually flat in June 2014 compared too June 2013.
Industrial parks strewn across rural countryside - once sporting new buildings and full parking lots for staff cars - are half-empty, with weeds taking over front gardens and previously carefully landscaped lots. Empty crates, unsold inventories and rusting machinery still sit around the worker-less buildings bearing the names of larger family businesses.
An area once a magnet for labour migrants from Italian South, Eastern Europe and Asia is now once again sending emigrants to Germany, the UK, US and Australia.
On the good news side, Italy's trade surplus (goods only) is up from EUR8.2 billion in January-May 2013 to EUR14.1 billion in January-May 2014, but more than half of this improvement (EUR3.7 billion) was down to decline in imports, with exports increases accounting for just EUR2.2 billion. On a seasonally-adjusted basis, Italian exports were down 3% m/m in June 2014 and country trade balance has deteriorated from EUR1.9 billion surplus in May 2014 to EUR1.7 billion in June.
These figures are not reflective of the Russian sanctions against the EU that came into effect in July 2014. In my conversations with a number of local residents, sanctions loom large. Local area businesses supply higher-end luxury household goods to Russia and via Russia, the rest of the CIS. Some - such as producers of luxury bathtubs and bathroom equipment - are impacted only indirectly, via general slowdown in Russian demand. Others - such as suppliers of premium food and wine - are fearing for their business in the wake of Russian government retaliatory sanctions of agricultural and food imports from EU. All are worrying about energy costs impact of the Ukrainian mess.
Then there's Italian Government. The country fiscal problems are epic even by already stretched euro area standards. IMF forecasts 2014 General Government debt to reach 134.5% of GDP even before the latest data pointing to a possible economic contraction for the full year GDP. That is the second highest public debt burden in the common currency area after Greece. Between 2012 and 2014, Italy's Government debt is forecast to increase by EUR144.2 billion with cumulated Government deficits amounting to EUR193.9 billion in 2011-2014, of these EUR105 billion is structural deficits. Country structural deficits are rising, not falling, up from EUR5.5 billion in 2013 to the projected EUR13.3 billion in 2014. At current bond yields, Italy needs ca 2.5% annual growth in GDP just to stay on a flat debt trajectory. Based on its current outstanding debt mix (referencing maturities and associated yields), this number rises to over 3.3%.
While on debt topic, corporate indebtedness is not improving either, despite years of austerity and financial repression. Here's the latest summary from the IMF (July 2014) covering leveraging levels across main euro area economies. Italy's corporate leverage is getting worse faster than any other euro area economy, save Greece and Portugal.
And while the nominal cost of capital to corporates has declined over time from the crisis peak levels, owing to extraordinary monetary accommodation by the ECB, real cost of capital is now trending above the crisis peak and well above long-term averages:
This means two things: firms are having difficulties funding replacement and expansion capital, technological modernisation stalled productivity across factors of production is going nowhere; and employment is unlikely to improve as cash flows are constrained by the need to sustain amortisation and depreciation in the environment of the high real cost of funding capital (which in part reflects also depressed margins).
Continued in the second part http://trueeconomics.blogspot.ie/2014/08/2482014-italy-lifeless-liner-on_24.html
A North-Eastern Italian provincial capital - a normally buzzing and lively medieval city with proud Roman history and previously vibrant high value-added industries and high tech services sits quiet and semi-deserted on the weekend afternoon. This August, a slow month by normal metrics of shoppers numbers and restaurants and cafe's patrons counts, is marked by the waves of recent closures of small businesses across the province. It is also marked by the official return of Italy to a recession - its third one since 2008.
The two halves of the pedestrianised main street tell the tale of the country-wide economic demise.
On the South side of the old piazza, the main street is dotted with few empty shop fronts. Established as a trading centre of the city centuries ago, this section of the city centre is primarily occupied by shops and businesses that owned their buildings over generations. No rent to pay means the businesses remain open, even as international and Italian brands are shutting down their local operations. The vacancy rate of shopfronts is running at around 10% here.
The Northern side of the street is smarter, better designed and more modernised. It was 'regenerated' in the mid-2000s and populated by trendier shops and eateries catering to Yuppie customers. Back in 2007-2008, the street was abuzz with activity: well-dressed patrons, predominantly under the age of 40 browsing in the cutting edge designer stores and boutiques, while visitors from the province and beyond soaked in the atmosphere of the new social hub in cafes, enoteche and trattorie. This year, more than three out of four businesses are shut, empty windows and closed doors greet a rare passerby. Unable to fund rents, as well as high taxes and charges, smaller business owners have gone under. Those supplying locally-demanded daily goods, such as fresh groceries, are trading elsewhere, some dealing exclusively in cash with their established customers. Majority are simply gone.
Consumer demand is weak. As the result, Italy's HICP inflation is down to 0.0% in July 2014 - the fifth weakest inflation performance in the euro area and down from 1.2% in July 2013 and 12 months average of 0.6% for the 12 months period through the end of last month. At -2.1% monthly rate of HICP inflation in Italy is the worst of all euro area states. Aptly, Italy's retail sales PMI remains below 50.0 line without interruption since Q2 2011. July reading was 43.4 down from 43.8 in June. Since January 2014, through May 2014, retail sales have risen by 0.1% cumulatively, with may posting 0.3% m/m decline. In real (inflation-adjusted) terms, turnover index in the retail trade in May 2014 stood at 92.6 below 93.8 recorded in June 2011 (based on working day adjusted non-seasonally adjusted data), but ahead of June 2013 level of 88.9.
Few kilometres down the road, another wealthy Northern Italian town is showing the same signs of decline. A builder, having completed an apartment block in 2009, was forced out of business by the city authorities saddling his business with the staggering cost of rectifying a planning error committed by… you guessed it, the city authorities. After sitting on the market for 4 years with no takers, the apartments went for auction earlier this spring. Guiding prices ranged from EUR20,000 for a one-bedroom to EUR46,000 for three bedroom flats. Back in 2004-2006 these properties would be sold off-plans for around EUR150,000 one-beds and EUR280,000 for three-beds. The auction flopped: out of 21 properties on the market, only 9 sold. Prime city-centre retail space on the ground floor of the building remains only 1/5th occupied.
Country construction sector activity is still down 43% on the pre-crisis peak (the sixth largest decline in the euro area) with Q1 2014 reading marking all-time low, the only country in the euro area with construction posting historical low in 2014. And housing markets are singing blues. From the beginning of Q2 2013 and through the end of Q1 2014, Italian house prices fell 4.43%, while euro area as a whole experienced house price deflation of just 0.3%. Within the euro area, only Cyprus and Slovenia posted worse 12 months cumulative performance.
Four internationally trading factories, including two suppliers of high-tech household equipment with export markets around the world, have shut doors since the onset of the Great Recession - all employed more than 200 people each at the peak and all have been in business for decades. In a telling sign of the times, one smaller family firm, counting five generations in business and trading with some exports, closed down while the proprietors continue to trade on a highly reduced volume. New trade is all local and cash-only. Across the area, work supplied directly to consumers is now being routinely quoted priced 'with receipt or without' and in many cases, even registered sales of goods and services are openly under-declared on invoices to avoid VAT and profit taxes.
Italy's industrial production stood at 106.6 in H1 2011, by H1 2014 this fell to 97.2. On average, industrial production fell in Italy at an annual rate of 2.98% between the first half of 2011 and the end of June 2014. Italian Manufacturing PMIs fell from 52.6 in June to 51.9 in July although index remains above 50 line continuously since Q3 2013. Ditto for services PMI which fell from the 43-month high of 53.9 in June to 52.8 in July.
Activity down and margins are slipping. Industrial production prices rose 0.1% in June 2014 m/m marking the first month of positive inflation after four consecutive months of producer prices deflation. Since January 1, 2014, industrial producer prices are down 0.5% cumulatively, which is not helping companies profitability or their ability to sustain debt servicing and employment. How bad profitability margins are? In June 2014, index of industrial producer prices for domestic market in Italy stood at 106.5. This is below June 2012 reading (109.2) and June 2013 reading (108.6). Industrial producer prices excluding energy sector are virtually flat in June 2014 compared too June 2013.
Industrial parks strewn across rural countryside - once sporting new buildings and full parking lots for staff cars - are half-empty, with weeds taking over front gardens and previously carefully landscaped lots. Empty crates, unsold inventories and rusting machinery still sit around the worker-less buildings bearing the names of larger family businesses.
An area once a magnet for labour migrants from Italian South, Eastern Europe and Asia is now once again sending emigrants to Germany, the UK, US and Australia.
On the good news side, Italy's trade surplus (goods only) is up from EUR8.2 billion in January-May 2013 to EUR14.1 billion in January-May 2014, but more than half of this improvement (EUR3.7 billion) was down to decline in imports, with exports increases accounting for just EUR2.2 billion. On a seasonally-adjusted basis, Italian exports were down 3% m/m in June 2014 and country trade balance has deteriorated from EUR1.9 billion surplus in May 2014 to EUR1.7 billion in June.
These figures are not reflective of the Russian sanctions against the EU that came into effect in July 2014. In my conversations with a number of local residents, sanctions loom large. Local area businesses supply higher-end luxury household goods to Russia and via Russia, the rest of the CIS. Some - such as producers of luxury bathtubs and bathroom equipment - are impacted only indirectly, via general slowdown in Russian demand. Others - such as suppliers of premium food and wine - are fearing for their business in the wake of Russian government retaliatory sanctions of agricultural and food imports from EU. All are worrying about energy costs impact of the Ukrainian mess.
Then there's Italian Government. The country fiscal problems are epic even by already stretched euro area standards. IMF forecasts 2014 General Government debt to reach 134.5% of GDP even before the latest data pointing to a possible economic contraction for the full year GDP. That is the second highest public debt burden in the common currency area after Greece. Between 2012 and 2014, Italy's Government debt is forecast to increase by EUR144.2 billion with cumulated Government deficits amounting to EUR193.9 billion in 2011-2014, of these EUR105 billion is structural deficits. Country structural deficits are rising, not falling, up from EUR5.5 billion in 2013 to the projected EUR13.3 billion in 2014. At current bond yields, Italy needs ca 2.5% annual growth in GDP just to stay on a flat debt trajectory. Based on its current outstanding debt mix (referencing maturities and associated yields), this number rises to over 3.3%.
While on debt topic, corporate indebtedness is not improving either, despite years of austerity and financial repression. Here's the latest summary from the IMF (July 2014) covering leveraging levels across main euro area economies. Italy's corporate leverage is getting worse faster than any other euro area economy, save Greece and Portugal.
And while the nominal cost of capital to corporates has declined over time from the crisis peak levels, owing to extraordinary monetary accommodation by the ECB, real cost of capital is now trending above the crisis peak and well above long-term averages:
This means two things: firms are having difficulties funding replacement and expansion capital, technological modernisation stalled productivity across factors of production is going nowhere; and employment is unlikely to improve as cash flows are constrained by the need to sustain amortisation and depreciation in the environment of the high real cost of funding capital (which in part reflects also depressed margins).
Continued in the second part http://trueeconomics.blogspot.ie/2014/08/2482014-italy-lifeless-liner-on_24.html
Wednesday, August 6, 2014
6/8/2014: Italy's New Old Recession...
In Q1 2014, Italian GDP shrunk 0.1%, in Q2 2014 it fell 0.2% just as all indicators were suggesting that the Italian economy was starting to regain some growth momentum.
Meanwhile, latest data for new orders in Germany posted a fall of 3.2% in June compared to May.
Much has been made of the effects of Russia-EU trade sanctions on both figures. And much has been made of the effects of slower global growth on both figures. Little has been made of the fact that absent foreigners' demand for European goods, there is no real growth in Europe. That is because this fact hides horrific truth - European consumers and households have been hit by a freight train of banks bailouts, Government deficits adjustments and the need to support EU and national politically connected cronies - corporate, sectoral and individual. While pensions provisions for currently working middle classes shrink, taxes rise, indirect taxes, crates and levies climb sky high, there is hardly any decline in subsidies pots distributed by Europe to predominantly wealthy landowners, industrialists and an entire class of NGOs/R&D/Social Enterprises.
Thus, European investors' confidence is a feeble organism so vulnerable to shocks that a war in Ukraine's East can knock it out of its tracks. Thus, the only hope still remaining in European capitals is for the ECB to prime the proverbial printer. On the eve of the ECB monthly interest-rate-setting meeting, European banks still prefer to lend to the Governments rather than to the real companies. Why? May be it is because of some technical mumbo-jumbo of 'markets fragmentation' or may be it is because the real economy is left holding the bag for banks bailouts and Governments bailouts and cronies bailouts and as the result, European producers need Russian, Ukrainian, Chinese, Turkish and so on consumers?
Spanish economy, in contrast with Italian, posted 0.6% growth in GDP, but much of this (and previous 3 quarters) growth is down to the rate of economic activity destruction in previous years.
Meanwhile, Bundesbank is prepping the public to what might be a lacklustre growth release for Q2 figures due on August 14. Consumer and producer confidence indicators in Germany are pointing to a slowdown in economic activity there. Ifo German business sentiment indicator posted three consecutive months of declines in July 2014, falling to the levels last seen in October 2013. German investor confidence index published by ZEW has been now on the decline for seven consecutive months.
All in, the much-publicised recovery in euro area economy remains fragile and prone to reversals on foot of external shocks. Meanwhile, internal growth dynamics remain weak and unyielding to the PR blitz promoting the reversals of the crisis. Italy is just a proverbial canary in the mine… the only question is whether it is motionless from something that hit it before it was brought to the ICU in 2013, or from something new it caught in the ICU…
Tuesday, April 15, 2014
15/4/2014: Flat Tax for Italy? Ask PIN...
Last week Italy sold EUR3.5 billion in 2016 Bonds today at an average yield 0.93% and with bid cover of 1.41, delivering a record low yield. At these yields, it is easy to think that the Italian fiscal and economic crises are over. Or at least that they are easing substantially enough to allow for the repricing of risks and some breathing space when it comes to markets expectations concerning euro area's third largest economy.
However, despite the positive news, Italy's economy remains a 'sick man' of Europe and it has been such for some time now. More importantly, the problem is unlike to go way unless Italian economy is reformed; dramatically and radically.
Chart below shows very clearly sustained, long-term underperformance of the Italian economy in terms of real growth since 1980. In addition, Italian economy has been a significant laggard in terms of growth during the current crisis. For example, if the Great Recession resulted in the G7 economies regaining their pre-crisis peak real GDP of 2007 by the end of 2011, Italian economy is not expected to regain pre-crisis peak levels of real output (2007) until at least 2020.
Growth weaknesses in the economy, running over the long periods of time, drive persistent structural decline in multi-annual, generational trends. One of particular note is the trend relating to employment ratios and unemployment.
The key takeaway from the above is that Italy is structurally (or in other words long-term, very long-term) sustaining economic development model that is associated with persistently higher unemployment and dependency ratios. Coupled with relatively high emigration, this model is driving generational momentum toward loss of human capital.According to the World Bank data, Italy had one of the highest rates of net emigration of population with at least tertiary education in the 1990s and 2000s - averaging around 10 percent and unemployment rate for those with tertiary education well in excess of the euro area and G7 averages.
This relatively poor performance, when it comes to the country ability to create, attract, retain and enable human capital is a core weakness and challenge for Italian economy that I recently was asked to address by the new political party, PIN: Partito Italia Nuova (https://www.facebook.com/partitoitalianuova) in Milan.
The core argument of my presentation was focused on the thesis that I started developing at IBM (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2001907) and summarised in my TEDx talk last year (https://www.youtube.com/watch?v=y1sueM_jhSk).
In my presentation in Milan, I looked at Irish experience from the 1980s through present in the context of developing a human capital-intensive economy. Here are some slides from the presentation:
From the point of view of Italian policies, post-crisis structural reforms require refocusing Italy's economy toward facilitating:
As argued in my analysis of the Irish situation, changes along these lines are required not only to bring domestic economy to pre-crisis levels of competitiveness and growth generation, but also address the pressures arising from international markets and from the transition of the global economy toward greater dependency on Human Capital as the core driver for growth.
The above objectives can be partially addressed via reforms of tax codes that act to simplify tax compliance, reduce tax burden on income from work, and increase transparency of tax systems. Flat tax is one of the best ways to achieve these, but flat tax is just the first step on aligning global realities of Human Capital intensive growth with national institutional and policies frameworks.
However, despite the positive news, Italy's economy remains a 'sick man' of Europe and it has been such for some time now. More importantly, the problem is unlike to go way unless Italian economy is reformed; dramatically and radically.
Chart below shows very clearly sustained, long-term underperformance of the Italian economy in terms of real growth since 1980. In addition, Italian economy has been a significant laggard in terms of growth during the current crisis. For example, if the Great Recession resulted in the G7 economies regaining their pre-crisis peak real GDP of 2007 by the end of 2011, Italian economy is not expected to regain pre-crisis peak levels of real output (2007) until at least 2020.
Growth weaknesses in the economy, running over the long periods of time, drive persistent structural decline in multi-annual, generational trends. One of particular note is the trend relating to employment ratios and unemployment.
The key takeaway from the above is that Italy is structurally (or in other words long-term, very long-term) sustaining economic development model that is associated with persistently higher unemployment and dependency ratios. Coupled with relatively high emigration, this model is driving generational momentum toward loss of human capital.According to the World Bank data, Italy had one of the highest rates of net emigration of population with at least tertiary education in the 1990s and 2000s - averaging around 10 percent and unemployment rate for those with tertiary education well in excess of the euro area and G7 averages.
This relatively poor performance, when it comes to the country ability to create, attract, retain and enable human capital is a core weakness and challenge for Italian economy that I recently was asked to address by the new political party, PIN: Partito Italia Nuova (https://www.facebook.com/partitoitalianuova) in Milan.
The core argument of my presentation was focused on the thesis that I started developing at IBM (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2001907) and summarised in my TEDx talk last year (https://www.youtube.com/watch?v=y1sueM_jhSk).
In my presentation in Milan, I looked at Irish experience from the 1980s through present in the context of developing a human capital-intensive economy. Here are some slides from the presentation:
From the point of view of Italian policies, post-crisis structural reforms require refocusing Italy's economy toward facilitating:
- Closure of the human capital gap (education, immigration and emigration)
- Stimulation of growth at the SMEs levels (family firms incentives and investment, professionalisation of management, enterprise reforms)
- Reforms of incentives structures in labour markets (increase returns to Human Capital, reduce disincentives to work, increase incentives to take up self-employment and entrepreneurship)
- Closer alignment of tax rates with tax compliance and enforcement
- Conversion of 'black economy' into legally and tax compliant transactions
- Reducing distortions from outflows of savings and investment from private sectors to public debt.
As argued in my analysis of the Irish situation, changes along these lines are required not only to bring domestic economy to pre-crisis levels of competitiveness and growth generation, but also address the pressures arising from international markets and from the transition of the global economy toward greater dependency on Human Capital as the core driver for growth.
The above objectives can be partially addressed via reforms of tax codes that act to simplify tax compliance, reduce tax burden on income from work, and increase transparency of tax systems. Flat tax is one of the best ways to achieve these, but flat tax is just the first step on aligning global realities of Human Capital intensive growth with national institutional and policies frameworks.
Wednesday, January 22, 2014
22/1/2014: Tale of Two Italian Earthquakes: Long-Term Effects of Institutional Capital
A very interesting paper from Banca d'Italia on the two divergent outcomes of similar earthquakes in two Italian regions.
The paper, titled "Natural disasters, growth and institutions: a tale of two earthquakes" by by Guglielmo Barone and Sauro Mocetti (Number 949 - January 2014: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td14/td949_14/en_td949/en_tema_949.pdf) is worth reading.
Here is a summary of findings:
"We examine the impact of natural disasters on GDP per capita by applying the
synthetic control approach. Our analysis encompasses two major earthquakes that occurred in two different Italian regions in 1976 and 1980."
Regions covered: Friuli (1976 quake) and Irpinia (1980 earthquake).
"We compare the observed GDP per capita after the quake (which is an exogenous and largely unanticipated shock by definition) in each area with that which would have been observed in the absence of the natural disaster. We carry out this comparative analysis using a rigorous counterfactual approach, the synthetic control method, proposed by Abadie and Gardeazabal (2003) and Abadie et al. (2010)."
"According to our findings there are no significant effects of the quake in the short term. However, this result can be largely attributed to the role of financial aid in the aftermath of the disaster. Using different assumptions regarding the magnitude of the fiscal multiplier, we estimate that the yearly GDP per capita growth rate in the five years after the quake, in the absence of financial aid, would have been approximately 0.5-0.9 percentage points lower in Friuli and between 1.3-2.2 points lower in Irpinia."
Note that the above suggests that even at lower levels of impact, fiscal transfers played less importance in Friuli than in Irpinia.
This, however, is not what happens in the long run. While financial aid was effective in reducing impact of the earthquakes in their short-term aftermath, the same aid was not sufficient to counter longer term adverse effects. "In the long term, we find two opposite results: the quakes yielded a positive effect in Friuli and a negative one in Irpinia. In the former, 20 years after the quake, the GDP per capita growth was 23 percent higher than in the synthetic control, while in the latter, the GDP
per capita experienced a 12 percent drop."
What drove these divergent effects? "After showing that in both cases, the dynamics of the GDP per capita largely mirrors that of the TFP, we provide evidence that the institutional quality shapes these patterns. In the bad-outcome case (Irpinia), in the years after the quake fraudulent behaviors flourished, the fraction of politicians involved in scandals increased, and the civic capital deteriorated. Almost entirely opposite effects were observed in Friuli. Since in Irpinia the pre-quake institutional quality was ‘low’ (with respect to the national average) while in Friuli it was ‘high’, we argue that the preexisting local economic and social milieu is likely to play a crucial role in the sign of the economic effect of a natural disaster. Consequently, our results also suggest that disasters may exacerbate differences in economic and social development."
See these the map highlighting the quality of institutions differences:
Or in more succinct terms: "Consistently with these findings, we offer further evidence suggesting that an earthquake and related financial aid can increase technical efficiency via a disruptive creation mechanism or else reduce it by stimulating corruption, distorting the markets and deteriorating social capital. Finally, we show that the bad outcome is more likely to occur in areas with lower pre-quake institutional quality. As a result, our evidence suggests that natural disasters are likely to exacerbate differences in economic and social development."
Thursday, November 14, 2013
14/11/2013: With banks or without, things are heading for desperate in Italy...
The banks stress tests are coming up and the Euro periphery system is quickly attempting to patch up the massive cracks in the facade. The key one is the continued over-reliance of banks on sovereign-monetary-banking loop of cross-contagion. The banking system weakness is exemplified by Italy: Italian banks are the main buyers of Italian sovereign debt, which in turn means that Italian government stability rests on the banks ability to sustain purchasing, which implies that the ECB (with an interest of shoring up Italian economy) is tied into continuing to provide cheap funding necessary for the Italian banks to sustain purchasing of Italian Government debt… and so on.
Three key facts are clouding this 'stability in contagion' picture:
If all 3 risks play out at the same time or close to each other, things will get testy for the Euro.
Point 1: Banks in the euro zone continue to carry assets that amount to three times the size of the euro area economy. This puts into question the core pillar of banking sector 'reforms' that the ECB needs to see before the banking union (BU) comes into being. The ECB needs to have clarity on quality of assets held by banks and, critically, needs to see robust deleveraging by the banks before th BU can be launched. If either one of these conditions is not fully met, the ECB will be taking over the banking system that is loaded with unknown and unpriced risks.
Per recent ECB data, Banks in the euro zone held EUR29.5 trillion in total assets by the end of 2012. That is down 12% on 2008. Too slow of a pace for a structural deleveraging. Worse, the bulk of the adjustments was back in 2009 and little was done since. Which makes the level of assets problem worse: on top of having too many assets, the system has virtually stopped the process of deleveraging. Knock on effect is that the firming of asset markets in Europe in recent two years was supported by a slowdown in assets disposals by the banks. In turn, this second order effect means that many banks assets on the books are superficially overvalued due to their withholding from the market. Nasty, pesky first and second order effects here.
Worse. Pressure on assets side is not limited to the 'periphery'. German banks held EUR7.6 trillion in total assets at the end of 2012, followed by the French banks with EUR6.8 trillion. Spain and Italy's banking sectors came in distant second and third, with EUR3.9 trillion and EUR2.9 trillion in total assets.
Capital ratios are up to the median Tier 1 ratio rising from 8% in 2008 to 12.7% in 2012. Quality of this capital is, however, subject to the above first and second order effects too - no one knows how much of the equity valuation uplift experienced by the euro area banks in recent months is due to banks reducing the pace of assets deleveraging…
Point 2: Assets quality in some large banking systems is too closely linked to the sovereign bonds markets. Italy is case in point. ECB tests are set to exclude sovereign debt risk exposures, explicitly continuing to price as risk-free sovereign bonds of the peripheral euro area states. But in return for this, the ECB might look into gradually forcing the banks to limit their holdings of sovereign bonds. This would be bad news for Italian banks and the Italian treasury.
The problem starts with a realisation that Italian banks are now primarily a vehicle for rolling over Government debt. Italy's Government debt is over EUR2 trillion. EUR397 billion of that is held by Italian banks. Another EUR200-250 billion can be safely assumed to be held by Italian banks customers who also have borrowings from these banks. Any pressure on the Italian sovereign and the ca EUR600 billion of Italian debt sloshing within the banking system of Italy is at risk. That puts 20.7 percent of Italian banks assets at a risk play. [Note: by some estimates, Italian banks directly hold around 22% of the total Italian Government debt - close to the above figure of EUR397 billion, but way off compared to Spanish banks which are estimated to be holding 39% of the Spanish Government debt, hence all of the arguments raised in respect of Italy herein also apply to Spain. A mitigating issue for Spain is that it's debt levels are roughly half those of Italy. An exacerbating issue for Spain is that its deficit is second highest in Europe, well ahead of Italain deficit which is relatively benign).
Worse, pressure cooker is now full and been on a boiler for some time. In the wake of LTROs, Italy's banks loaded up on higher-yielding Italian Government debt funded by cheap LTRO funds - Italian banks took EUR255 billion in LTROs funds. In August 2013, Italian banks exposure to Italian Government debt hit EUR397 billion, just shy of the record EUR402 billion in June and double on 2011 levels. I
Either way, with or without explicit ECB pressure, Italian banks have run out of the road to keep purchasing Italian Government debt. Which presents a wee-bit of a problem: Italy needs to raise EUR65 billion in new debt in 2014. Italy is now in the grip of the worst recession since WWII and its debts are rising once again.
Chart below shows that:
1) Italian Sovereign exposures to external lenders declined in the wake of the LTROs, but are back to rising in recent quarters;
2) Italian banks reliance on foreign funding rose during the LTROs period, declined thereafter and is now again rising; while
3) Other (non-financial and non-state) sectors remain leveraged at the levels consistent with late 2006.
Point 3: Overall, Italian Treasury is now competing head on with the banks for foreign lenders cash and Italian corporate sector is being forced to borrow abroad in absence of domestic credit supply. Foreign investors bought almost 2/3rds of the last issue of Italian bonds, but how much of this appetite can be sustained into the future is an open question. Foreign investors currently hold slightly over a third of Italy's debt, or EUR690 billion, down from more than EUR800 billion back in 2011. The Italian Government is now turning to Italian households to mop up the rising supply. Italy issued EUR44 billion worth of inflation-linked BTP Italia bonds with 4 year maturity. As long as inflation stays low, the Government is in the money on these.
Next in line - desperate measures to raise revenues. Per recent reports, there is a proposal working its way through legislative corridors of power to raise tax on multinational on-line companies trading in Italy. The likes of Google, Amazon and Yahoo will be hit with a restriction on advertisers to transact only with on-line companies tax-resident in Italy, per bill tabled by the center-left Democratic Party (PD). The authors estimate EUR1 billion annual yield to the state - a tiny drop in the ocean of Italian government finances, but also a sign of desperation.
Three key facts are clouding this 'stability in contagion' picture:
- Banks in Italy and elsewhere are not deleveraging fast enough to allow them repay in full the LTROs coming due January and February 2015;
- Banks in Italy are now fully saturated with italian Government debt, posing threats to future supply of Italian bonds and putting into question the robustness of the banking stress tests; and
- Italian Government is running out of room to continue rolling over its massive debts.
If all 3 risks play out at the same time or close to each other, things will get testy for the Euro.
Point 1: Banks in the euro zone continue to carry assets that amount to three times the size of the euro area economy. This puts into question the core pillar of banking sector 'reforms' that the ECB needs to see before the banking union (BU) comes into being. The ECB needs to have clarity on quality of assets held by banks and, critically, needs to see robust deleveraging by the banks before th BU can be launched. If either one of these conditions is not fully met, the ECB will be taking over the banking system that is loaded with unknown and unpriced risks.
Per recent ECB data, Banks in the euro zone held EUR29.5 trillion in total assets by the end of 2012. That is down 12% on 2008. Too slow of a pace for a structural deleveraging. Worse, the bulk of the adjustments was back in 2009 and little was done since. Which makes the level of assets problem worse: on top of having too many assets, the system has virtually stopped the process of deleveraging. Knock on effect is that the firming of asset markets in Europe in recent two years was supported by a slowdown in assets disposals by the banks. In turn, this second order effect means that many banks assets on the books are superficially overvalued due to their withholding from the market. Nasty, pesky first and second order effects here.
Worse. Pressure on assets side is not limited to the 'periphery'. German banks held EUR7.6 trillion in total assets at the end of 2012, followed by the French banks with EUR6.8 trillion. Spain and Italy's banking sectors came in distant second and third, with EUR3.9 trillion and EUR2.9 trillion in total assets.
Capital ratios are up to the median Tier 1 ratio rising from 8% in 2008 to 12.7% in 2012. Quality of this capital is, however, subject to the above first and second order effects too - no one knows how much of the equity valuation uplift experienced by the euro area banks in recent months is due to banks reducing the pace of assets deleveraging…
Point 2: Assets quality in some large banking systems is too closely linked to the sovereign bonds markets. Italy is case in point. ECB tests are set to exclude sovereign debt risk exposures, explicitly continuing to price as risk-free sovereign bonds of the peripheral euro area states. But in return for this, the ECB might look into gradually forcing the banks to limit their holdings of sovereign bonds. This would be bad news for Italian banks and the Italian treasury.
The problem starts with a realisation that Italian banks are now primarily a vehicle for rolling over Government debt. Italy's Government debt is over EUR2 trillion. EUR397 billion of that is held by Italian banks. Another EUR200-250 billion can be safely assumed to be held by Italian banks customers who also have borrowings from these banks. Any pressure on the Italian sovereign and the ca EUR600 billion of Italian debt sloshing within the banking system of Italy is at risk. That puts 20.7 percent of Italian banks assets at a risk play. [Note: by some estimates, Italian banks directly hold around 22% of the total Italian Government debt - close to the above figure of EUR397 billion, but way off compared to Spanish banks which are estimated to be holding 39% of the Spanish Government debt, hence all of the arguments raised in respect of Italy herein also apply to Spain. A mitigating issue for Spain is that it's debt levels are roughly half those of Italy. An exacerbating issue for Spain is that its deficit is second highest in Europe, well ahead of Italain deficit which is relatively benign).
Worse, pressure cooker is now full and been on a boiler for some time. In the wake of LTROs, Italy's banks loaded up on higher-yielding Italian Government debt funded by cheap LTRO funds - Italian banks took EUR255 billion in LTROs funds. In August 2013, Italian banks exposure to Italian Government debt hit EUR397 billion, just shy of the record EUR402 billion in June and double on 2011 levels. I
Either way, with or without explicit ECB pressure, Italian banks have run out of the road to keep purchasing Italian Government debt. Which presents a wee-bit of a problem: Italy needs to raise EUR65 billion in new debt in 2014. Italy is now in the grip of the worst recession since WWII and its debts are rising once again.
Chart below shows that:
1) Italian Sovereign exposures to external lenders declined in the wake of the LTROs, but are back to rising in recent quarters;
2) Italian banks reliance on foreign funding rose during the LTROs period, declined thereafter and is now again rising; while
3) Other (non-financial and non-state) sectors remain leveraged at the levels consistent with late 2006.
Point 3: Overall, Italian Treasury is now competing head on with the banks for foreign lenders cash and Italian corporate sector is being forced to borrow abroad in absence of domestic credit supply. Foreign investors bought almost 2/3rds of the last issue of Italian bonds, but how much of this appetite can be sustained into the future is an open question. Foreign investors currently hold slightly over a third of Italy's debt, or EUR690 billion, down from more than EUR800 billion back in 2011. The Italian Government is now turning to Italian households to mop up the rising supply. Italy issued EUR44 billion worth of inflation-linked BTP Italia bonds with 4 year maturity. As long as inflation stays low, the Government is in the money on these.
Next in line - desperate measures to raise revenues. Per recent reports, there is a proposal working its way through legislative corridors of power to raise tax on multinational on-line companies trading in Italy. The likes of Google, Amazon and Yahoo will be hit with a restriction on advertisers to transact only with on-line companies tax-resident in Italy, per bill tabled by the center-left Democratic Party (PD). The authors estimate EUR1 billion annual yield to the state - a tiny drop in the ocean of Italian government finances, but also a sign of desperation.
Thursday, July 25, 2013
25/7/2013: BlackRock Institute latest survey results for global economic outlook: June 2013
The latest summary of the global growth conditions from the BlackRock Investment Institute. Click on the chart to open larger version. I have highlighted Ireland on the chart.
Blue bars reflect consensus on current phase of economic development (for example, in Ireland's case, current phase is seen as being recessionary by roughly 25% of respondents to the survey). Red dot corresponds to 6mo forward expectation (in Ireland's case, 50% of respondents expect recession in Ireland to either continue or to present itself again in 6 months time).
Note: this is the view of surveyed economists and not the view of the BlackRock II. The chart is based on the "trailing 3 survey reports for the other regions we poll. In our first month of this initiative, we collected the views of over 430 economists from more than 200 institutions, spanning over 50 countries"
Blue bars reflect consensus on current phase of economic development (for example, in Ireland's case, current phase is seen as being recessionary by roughly 25% of respondents to the survey). Red dot corresponds to 6mo forward expectation (in Ireland's case, 50% of respondents expect recession in Ireland to either continue or to present itself again in 6 months time).
Note: this is the view of surveyed economists and not the view of the BlackRock II. The chart is based on the "trailing 3 survey reports for the other regions we poll. In our first month of this initiative, we collected the views of over 430 economists from more than 200 institutions, spanning over 50 countries"
Tuesday, July 16, 2013
16/7/2013: Italian Government Debt: All Is Going According to 'Plan'
Today's news:
ITALY'S GENERAL GOVERNMENT DEBT: €2.074 trillion (setting a new all-time record) and up on €2.0413 trillion prior… in other words, all is going according to the EU 'sustainability' plan.
A gentle reminder, back in April 2013, IMF forecast for Italy's 2013 GGD was EUR2.0405T, so that fiscal consolidation, then, is outperforming the targets, clearly… In fact, IMF forecast for 2014 GGD was EUR2.08055, so Italy is well into getting to 2014 target by the end of 2013. Keep digging, folks. Perhaps a French solution of raising taxes? Just for 'fairness' sake.
A chart via Ioan Smith @moved_average :
To update: via @lemasabachthani two charts:
Notice in the above chart the evolution of debt over years. And recall that Italy is cutting and cutting deficits. Clearly, something is amiss: there is austerity and there are continued increases in debt in levels terms, as well as in GDP-referenced terms. In other words, forget growth effects of austerity - Italian-styled policies are not cutting Government spending.
Also, notice the effect of the absurd Euro area 'solution' system whereby already over-indebted country like Italy is forced to take on more debt to fund 'adjustment' programmes for the peripheral states.
But even disregarding the above absurdity, there is a new spiking in funding requirements for the Italian Treasury.
Subscribe to:
Posts (Atom)
