15/5/2013: Italy v Spain in Big 4's Sickest Economy contest

More unpleasant stuff from the Euro zone. Headlines in the morning today:

• Italian banks suffer the worst credit crunch in their history with banks credit down 2.12% in March 2013 y/y, according to the Italian Banking Association (ABI);
• Meanwhile, bad loans have reached €64.3bn in March, rising by 4.3% y/y and by 33% m/m. 
• Italian banks loans to households and non-financial companies dropped 3.1% in March y/y, falling to €1.46bn. 
• Italian industrial production fell 5.2% in March y/y, the worst figure in the Eurozone’ Big 4 economies. Industrial production was down 1.5% in Germany in March and 1.6% in France.
• The Italian housing market activity its now at lowest level since 1985. Last year 448,364 properties were sold, or 27.5% fewer than in 2011 and only 18,000 ahead of 1985 sales. 

It looks like Italy is going head on into competing with Spain for the title of the Big 4's sickest economy.

6/3/2013: BlackRock Institute Economic Cycle Survey 03/2013

BlackRock Investment Institute has released the latest results from its Economic Cycle Survey for EMEA and North America & Western Europe.

Before looking at the results, note:

1. The survey represents the summary of the views of a panel of economists polled by the BlackRock Investment Institute, and not the view of the Institute itself
2. In some instances, survey covers small number of responses (see two tables below detailing the depth of coverage), with low coverage corresponding to survey results being indicative, rather than consensus-conclusive.

So core results for North America and Western Europe regions:

In effect, little change from the previous surveys for Ireland, which remains solidly decoupled in terms of economists consensus from the peripheral states (the latter are all clustered in the upper RHS corner, corresponding to both high expectations of continued recession and current indicator of the present recession). In the case of Ireland, it is obviously very hard to tell whether or not Ireland is currently in a recession. Both GDP and GNP changes q/q and y/y do not warrant official designation of a recession, but nonetheless the economy is running at well below its potential capacity.

Per chart above, it is clear that despite the Eurostat projections for 2013 growth, Ireland does not lead the Euro Area in terms of forward expectations for economic growth when it comes to the economists' assessment.

Now on to EMEA results:

Pretty much predictable weakening of Russian growth for 2013 is reflected in the above. Two other interesting points:

1. The weakest performing states in terms of current conditions and expectations are the ones with closest ties to (and membership in) the Euro zone;
2. Weak performance for the Ukraine is reflective of the country continued political mess and the lack of sustainable fundamentals in terms of the country orientation vis-a-vis its main trading partners (the contrasting reality of the private sector closely tied into the CIS and more precisely Russian markets for investment and trade, juxtaposed by the political re-orientation toward Europe).

Note: here are the tables detailing the extent of the survey coverage depth:

6/1/2013: Italy's Growth, Reforms & Austerity Conundrum

I've written before about the Italian Dilemma and the debt trap on a number of occasions (see this article for example) and my basic view remains the same - Italian economy needs structural reforms to escape the debt overhang trap and increase productivity in non-exporting firms. That gap, in productivity, between the exporters and non-exporters in the Italian case is vast.

Now, it is great to see BCA Research wading in with the similar concern about Italy's productivity problem and the issue of structural reforms: link here.

A chart from BCA:

Alas, the problem is that Italian economy is saddled with rapidly ageing population and the fact that the extent of it has been somewhat masked by the artificial inflow of lower-skilled migrants during the 2000-2007 years (link here) and underemployment of Italian younger workers.

Italian workplace structures (from hiring to firing) and firm ownership (especially smaller family firms, but also unionised larger or legacy employers) actively obstruct promotion of non-Italians to management and higher professional grades. Non-EU citizens with higher skills and their residency in Italy have been regulated by antiquated laws until August 2012 (see here). These are non-meritocratic (see here and here for examples) systems that cannot be sustained in younger societies, let alone in Italy, where emigration and ageing are forcing the workforce to become older and less productive (see an early study here on effects of migration on Italian labor force comparative to other EU countries).

On underemployment of Italian younger workers, here's a chart from 2012 OECD study:

None of this is new, as this study from James Heckman dating back to 2001 illustrates. And none of it is being addressed in Italy so far through the crisis. Monti Government has tinkered along the edges (see here and here), but failed to tackle the real causes of the long-term (decades long in fact) crisis so far - lack of merit in Italian promotion, hiring and firing structures. Monti has tried, but so far failed to push through more ambitious reforms (link here) and Italy remains trapped in the high debt - low growth scenario.

The issue, of course, is whether austerity (cuts and taxes) is in itself structurally reformist. 

In and by itself - it is not, especially if the balance of taxes v cuts is shaded toward the former rather than the latter. 'Shaded' here depends not so much on some set rule (as the Irish Government, for example, likes to pretend) of 40% v 60% or 50% v 50%, but on the starting point for the reforms and the nature of the reforms, as well as other conditions. 

Italian economy is already weighted heavily by huge taxes and indirect charges. For example, Italy has the sixth highest income tax wedge for single average wage earners with no children, per OECD. It is also suffering from a massive demographic problem that exacerbates taxation policy inefficiencies (younger workers are saddled with higher long term tax bills, while older workers are looking forward to a cushioned retirement). Between 2012 and 2016, the IMF expects Italian Government spending to run above 50% of the country GDP, and there was not a single year since 1988 when the Italian Government spending dropped below 47% of the country income. These figures are 1-2 ppts above the Euro area average, but full 15% above the average for advanced economies ex-G7 and Euro area - in other words, the economies with which Italy competes for global markets in skills and exports.

Thus, IMF assessment of the Italian reforms in July 2012 stated: "The government’s near-term fiscal plans are ambitious and critical for sustainability, but more can be done over the medium term to strengthen the fiscal outlook. To support growth, the composition of adjustment should be rebalanced more towards expenditure cuts and lower taxes". 

In other words, austerity is needed (if only to deflate the burden of debt servicing for the Government debt and provide some breathing room for structural reforms that will require much longer-term approach than currently envisioned). But not austerity-for-the-sake-of-austerity alone. Deficit targets are meaningless, in the case of Italy. Reduction in expenditure targets are necessary, and alongside these, reforms of the labour markets.

24/9/2012: Italy's debt overhang effect

Via @FGoria on twitter, this chart on Italy's potential GDP and output gap:

Shows brilliantly the cost of Italy's public debt overhang as a steadily falling potential GDP growth and sustained structural recession since ca 1990-1992. Better yet, shows that even cheap liquidity in the naughties failed to produce any real effect on the economy.

Now, keep in mind, Italy is suffering solely from the Government debt overhang, with relatively benign debt levels on household and corporate balancesheets, and with relatively functioning banking system.

21/7/2012: Globe & Mail July 2012: Italian dilemma

My article on Italian debt v growth dilemma for Globe & Mail: link.

15/08/2011: Italian "reforms" 2011

So Mr Berlusconi's plan for Italy is now clearly outlined, but as usual with Italian government, it remains to be seen if:

1. There will be effective government push to implement it, and
   
2. There will be a government to implement it.

Italy's new austerity budget is the country only political and macroeconomic response to the increase in bond spreads and its reliance on ECB purchases of the Government paper. In a clear concession to the emergency of the situation, the new budgetary measure were passed by decree, and are now subject to a 2 months-long debate and amendments by the Parliament. Which, of course, is risk number one – the Parliament amendments can significantly reduce the bill effectiveness.

Overall, the bill plans for budgetary savings of €20bn in 2012, and €25.5bn in 2013.

Majority of the reductions will be driven by higher taxes, which means:

• They will have a longer-lasting adverse impact on growth, and
• Cannot be seen as permanent or even long-term, as point (1) above implies that for an already heavily taxed economy (with General Government total revenue accounting for 45.5-46% of the country GDP in 2010-2011 against G7 average of 35.2-35.4%), Italy will have to come off higher tax path sometime in the near future.
  

Given that the country already runs low rates of economic growth (with IMF latest projections for the average growth of under 1.3% per annum in 2011-2016), low personal income base (with GDP per capita adjusted for price differentials expected to return to pre-crisis levels some time in 2013 – the latest of all Big-4 Euro area economies), high unemployment (8.6% in 2011 against G7 average of 7.6%), the gross government debt of 119% this year, and the worst current account deficit of 3.4% this year amongst the Euro area Big-4 economies, it is hard to imagine that the country can actually master these tax increases.

Overall, based on IMF data, the estimated impact of the budgetary plan announced yesterday will take out roughly €1,980 per working person in new taxes and spending cuts, which amounts to 9.3% reduction in the per capita income, adjusted for price differentials. Accounting for this, IMF projections for Italy suggest that Italian real disposable incomes will not return to their pre-crisis peak anytime before 2016. And this is based on IMF's rather rosy assumptions for growth in 2011-2013, which were compiled prior to the onset of the recent economic slowdown.

Of course, in a typical Italian fashion, the new plan is virtually devoid of the structural spending cuts and reforms on the spending side. Overall spending cuts include:

• Central government ministries cuts of €6bn in 2012 and €2.5bn in 2013.
• Savings on the funds allocated to town councils, regions and provinces of €6bn in 2012 and €3.5bn euros in 2013.
• State pension system savings of €1bn in 2012 alongside the increase in retirement for women in the private sector by 5 years to 65. In addition, there will be restrictions on retirement funds for public sector workers who retire early.
• Burden sharing with senior politicos was achieved by restricting MP's reimbursements for flights only to the economy class costs.
• All public bodies with fewer than 70 employees will be abolished (excluding economics and finance functions).
• Provincial governments with less than 300,000 inhabitants and covering less than 3,000 square kilometres will be abolished. Town councils with less than 1,000 inhabitants will be merged. It is estimated this will mean the abolition of up to 29 of Italy's 110 provincial governments.

In terms of revenue increases:

• There is a new "solidarity tax" on high earners, to be levied for three years from this year, as an additional 5% on income above €90,000 per year and 10% on income above €150,000
• Increase in taxation of income from financial investments from 12.5% to 20% - which is a regressive measure for Italy, where investment is running at 19.9% of GDP this year, down from the average of 21.6% of GDP in pre-crisis years
• Increases on a so-called "Robin Hood" tax on energy companies
• Increase in the base rate for corporation tax
• Higher tax on lotteries and betting and higher excise duties on tobacco – the latter being a personal blow to the devotees of the Italian MS (aka Morto Sicuro) cigarettes, like myself
• Further curbs in tax evasion – a set of policies that has been promised more often than the Italian Governments' went to elections, and yet to be delivered in any meaningful measure. Of course, the tax increases above are only going to add incentives to evade taxes in the future, and
• Finally, in a silly season way, all non-religious public holidays will be celebrated on Sundays, to reduce their disruptive effects on national output (note to Berlusconi - outlawing Italian siesta hours in services would do some marvels to output too).
  

According to the IFC Paying Taxes 2011 report, Italy's total tax rate stands at 68.6%, compared to the EU rate of 44.2% and the world-wide average rate of 47.8%. The country ranks 128 in the world in Ease of paying taxes, 49th in the world in terms of Tax payments, 123rd in the world in terms of the time cost of complying with the tax codes and 167th in the world in total tax rate burden. (www.pwc.com/payingtaxes)

The only structural reform promised by Berlusconi emergency measures is, as of yet completely unspecified liberalisation of national labour contracts.

Good luck to all who would go long Italy on the back of these 'measures'. In my opinion, there is about 25% chance of the Italian Government actually delivering on revenue raising targets from this package and about 10% chance we will see noticeable reductions in the costs of the state sector in Italy, with one slight exception – the local and regional reforms. However, there is a good 75-90% chance that Italy will slide into a recession in Q3-Q4 2011 and its 2011-2016 average growth rate will likely slide from 1.31% projected by the IMF back in April 2011, to ca 1.02%. Which, of course, will mean that its debt will top 120% of GDP mark in 2012 and is
unlikely to alter the path set out for it in the IMF projections.

Here are few charts: