By Paolo von Schirach
May 21, 2011
WASHINGTON– The list of sick Euro-zone countries, comprising now Greece, (just readmitted to the financial rescue ward), Ireland and Portugal may soon comprise Italy as well, even if just an out patient. Standard & Poor’s just changed its outlook for Italy from “stable” to “negative”. The S&P A+ rating for Italy’s debt has not been changed. But it may be changed later on, if the rating agency does not see real progress in tackling the enormous Italian national debt, amounting now to 125% of GDP.
Weak economy, unstable government
It is true that the Italian Government has been relatively good at containing the annual deficit and thus the rate of growth of the overall debt. However, S&P notes a negative combination of structural economic weaknesses and political gridlock in Rome as factors inhibiting growth. The country would need a much more dynamic economy in order to generate the surplus necessary to start paying back at least some of its debt. So, Italy at the moment is not a candidate for intensive therapy by the EU and the European Central Bank. But, unless more vigorous pro-growth policies are enacted, it may become one.
Rome: not rue, government strong
The Italian Ministry of the Economy replied to this downgrade by stating that Italy will fulfil all its obligations and that there is no risk of political gridlock in Rome. Now, the latter point is a bit optimistic, if not preposterous. The ruling center-right coalition presided over by Prime Minister Silvio Berlusconi, barely survived a split and a recent no-confidence vote by a very thin margin in the Lower House. The Prime Minister spends time in court defending himself in a variety of trials. The coalition lost votes in recent local elections. While the Government is still there, it is not solid; and it is unlikely that relying only on this unstable base it can launch far reaching economic policy reforms.
Italy is not competitive
Italy is not very competitive and there is nothing that would indicate higher productivity in the years ahead. It is also believed that existing economic plans, as envisaged by existing government policies, will be unable to stimulate the economy. S&P is concerned that gridlock and political weakness at the top would make it more difficult for Rome to muster the consensus necessary to reduce public debt. If growth is even lower than the currently estimated 1.3%, in the 2011-2014 time frame, then we can expect lower revenue and inability to pay back more debt.
Long term, demographic trends also look very unfavorable. Italy has one of the lowest fertility rates among developed countries, (1.39 children per woman). Over time, this means fewer active people paying taxes and more retirees collecting benefits; thus progressively increasing the financial weight of entitlement programs for seniors on the rest of the economy. This is no recipe for lowering public spending.
The Government firmly denies any real deterioration that would support a change of outlook to “negative” on the part of S%P. They cite reforms, tax credits for setting up new businesses and more positive steps that would improve the fiscal outlook. But all this is unlikely. The Italians are experts at walking the tightrope. And this Government has managed to avoid disaster by tightening fiscal policies and thus annual deficits.
Italy needs structural economic reforms
Still, the structural shortcoming is Italy’s lack of overall competitiveness, while the enormous national debt overhang slows everything down even more. A very dynamic government, enjoying a vast consensus for reforms aimed at making the country nimble, could start a turn around process. But there is no such thing. If the center-right coalition supporting Berlusconi does not collapse, the present government may be able to hold this together for a while. If this government does not last, not much hope for a dispirited and disorganised opposition to take the lead on the economy. Italy’s outlook, while not disastrous a la Greece, is neither good nor promising.