ITALY DOESN'T LOOK TOO GOOD RIGHT NOW

Having started the year in complete chaos with the incompetent and theatrical introduction of the Euro - remember the Foreign Minister had to resign due to lack of support for the currency among his colleagues, Italy's star has not stopped going down. Of course we can all remember the sight of Italy's 'immigration minister' Umberto Bossi threatening to sink a shipload of stateless Kurds in mid-sea. Well in the light of all this the latest news that the Italian economy will only grow by 0.6% this year will perhaps be seen by some as disappointing but for others it is all too predictable. At a time when everyone else is obsessed with deflationary fears, the Italian economy continues to reveal mild inflationary tendencies. This plus a productivity performance below the European average don't add up to anything good. It remains to be seen how this all pans out in time. However if I am only halfway right that demographic factors have an important part to play in the unfolding Japanese story, then, against all expectations, it is to Italy that we should look for the next chapter to be written. Remember this year - despite all promises to the contrary - the Italian public debt as a percentage of GDP will once more start to rise.

Italy's centre-right government on Thursday cut its economic growth forecasts for this year and 2003 but insisted it would respect its European Union commitment to bring the budget close to balance. Giulio Tremonti, finance minister, told parliament that the government was reducing its 2002 growth forecast to 0.6 from 1.3 per cent. Growth next year would be 2.3 rather than 2.9 per cent, he said. Italy's darkening outlook was underlined by a survey which showed consumer confidence falling in September to its lowest level since July 1997. In addition, annual inflation has begun to edge upwards and, according to the harmonised EU index, now stands at 2.6 per cent, compared with a eurozone average of 2.1 per cent.

The government is due in the next 10 days to present its 2003 budget, a document that will indicate how it plans to square its promise of tax cuts for lower-income Italians and no reductions in welfare expenditure with its pledge to the EU to bring down its budget deficit. Mr Tremonti said the government would honour its deficit-cutting pledge. But he said Italy's deficit this year would be just under 2 per cent of gross domestic product, a higher estimate than the 1.1 per cent forecast sent to Brussels this month.
Source: Financial Times
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Italy's Deficit Fails to Impress

The lack of serious about economic numbers, which seems to be a permanent feature of how economic policy is conducted over there, is again making its presence felt.

The economic reform programme of Italy's ruling centre-right coalition suffered a setback on Monday when official figures showed a sharp rise in the public sector budget deficit in the first eight months of this year. According to data from the finance ministry, the deficit rose by more than 60 per cent from €22.2bn to €34.1bn (£14.1bn to £21.6bn) in the same period of 2001. The ministry blamed the increase largely on slower economic growth, which had depressed tax receipts. The figures represent a potentially damaging blow to the European Union's stability and growth pact, a cornerstone of Europe's monetary union. Like France, Germany and Portugal, Italy may find it impossible to meet deficit reduction targets agreed with the European Commission for this year and 2003 under the pact's terms.

Luigi Buttiglione, an economist at Barclays Capital, said there was a clear risk that Italy's deficit would next year overshoot the limit of 3 per cent of gross domestic product set by the EU's Maastricht Treaty. Almost as worrying, Italy's public sector debt, which stood at 109.4 per cent of GDP last year, could rise this year to 110 per cent or higher, recording its first increase since 1994. Although this would not disqualify Italy from eurozone membership, an increase in debt would go in the opposite direction to that stipulated by the Maastricht Treaty as a condition for eurozone entry in the 1990s.
Source: Financial Times
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So let's get this clear, not only is the stability pact about to become what the Spanish call 'papel mojado' (in plain English find itself in tatters) as France and Germany are also queueing up to get permission to go outside the limits, but the whole Maastricht Treaty process is about, in the case of Italy, to be put in reverse gear. The agreement to bring down debt to GDP ratios was not simply justified by aesthetic values, Italy has a spiraling demographic process which is going to make the present public finance structure unsustainable if something major isn't done. And far from doing anything they're letting things get worse. Of course a certain amount of counter cyclical juggling would be in order if that was all this represented, but as I've said Italy's problem is as much structural as it is cyclical. At the same time if the Euro zone finance system is about to fail at its first test. What is this going to mean for the Euro?

Morgan Stanley's Eric Chaney is asking the same set of questions. The politicians are under pressure from electorates who have never really understood (because no-one has ever really taken the time out to explain the details to them) the Maastricht process, hence they are under real pressure to make light of the dilemena. Institutional Europe can take more distance. In today's post he states:

As the first real test of the Stability Pact occurs, it is crucial that governments take action to reduce their deficits, regardless of the short-term consequences on growth and employment. Since these institutions (the Commission, the ECB EH) are not directly accountable to EMU electorates, they can afford to give greater place to long-term credibility, vis-à-vis financial markets, in particular. Quite correctly, they stress that governments confronted with aging populations and large unfunded pension liabilities will be punished sooner or later if they give up pursuing rigorous fiscal policies when encountering their first post-EMU difficulties.

The Single Market and its logical postscript, the Monetary Union, were based on the forward-looking view that a deeper integration of European economies was critical for Europe's long-term political stability and constituted a convenient constraint to push through structural reforms. However, it was not sold as such to European electorates; instead, the EMU and the euro were presented to the layman as warranting more prosperity, stronger growth, lower unemployment and a more influential Europe. In other words, the implementation of the Stability Pact is as much a political issue as it is aan economic one.
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Finally, one last point. Italy has just introduced an extremely draconian law to discourage all manner of immigration. The question could be asked as to whether a country where there is such a shortage of young people, and where there is such an acute problem of finding the resources to fund the long term retirement and health systems was in any position to implement such a law, even were it not totally ethically reprehensible?

Eurostat and Italian Accounting

ITALY'S NATIONAL ACCOUNTING

The Italian mystery deepens. Now it seems we're using Enron style special purpose vehicles to move debt off balance sheet to meet EU stability pact requirements:

Italy and the European Union Commission clashed Thursday over controversial accounting practices, another sign of increasing tensions over Europe's strict budget rules.

Like other European countries, Italy has promised to balance its budget by 2003 and has been leveraging state-owned assets to help it reach its goal. Wednesday, the Commission's statistics arm, Eurostat, outlawed this practice, ruling that borrowings secured on future government revenues can no longer be pushed off the national balance sheet.Under the Italian financing program, Rome parked state assets such as real estate and lottery revenues in special-purpose vehicles, which then issued debt. Since the government didn't issue the bonds itself, the debt didn't end up in the national accounts and inflate the deficit.
Source: Yahoo News
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Now if Italy had a nicely balanced population structure, then probably none of this would matter. But this isn't the case, so one day this debt is going to make itself felt on balance-sheet, and then this particular bubble is going to burst. Don't say you haven't been warned.

Incidentally, following the story I blogged earlier this week, Italy's Interior Minister has now resigned following his comments that the assasinated government economic adviser was a pain in the neck. I don't really know what the definition of a 'banana republic' really is, but if there was such a thing would the current Italian administration fit the description?

ITALY'S DEGENERATE POLITICS FURTHER DEGENERATES

A top Italian politician called on Saturday for the castration of rapists in the wake of a series of rapes in northern Italy.

"It is an intolerable situation. To avoid these shameful crimes there is only one solution -- the physical castration of these delinquents," Roberto Calderoli, the vice president of Italy's Senate (upper house), said in a statement. "Once upon a time one spoke of chemical castration, but personally I tend more toward simpler methods: scissors, and ones that are not necessarily sterilized," Calderoli, a member of the rightist Northern League, added.
Source: Yahoo News LINK

No comment, but unfortunately today there's more news in a similar vein:

Italy's Interior Minister offered to resign on Sunday as a row flared over comments he reportedly made about a murdered government aide. But Prime Minister Silvio Berlusconi said he had not accepted Interior Minister Claudio Scajola's resignation.

Scajola tendered his resignation after two respected newspapers reported comments he had made about the assassinated aide in which he called the murdered man "a pain in the ass who wanted to have his contract renewed.............. Biagi's assassination became front-page news again last week when letters written by the economist to a number of government officials, were published, highlighting his security concerns over a decision to withdraw his police escort. The Interior Ministry has launched an internal investigation into the decision to withdraw Biagi's bodyguards, but Scajola has defended the decision saying not everyone could be escorted.
"If (Biagi) had been protected there would have been three dead," Il Corriere quoted Scajola as saying.
Source: Yahoo News LINK

The continuing question mark over the judgemental capacity of Italy's political class which is once again re-inforced by the above must also raise the serious doubts about this country's capacity to rise to the challenges which are undountedly waiting just around the corner.

ALL IS NOT WELL AT FIAT

One of the reasons I am a skeptic about the possibility of a sustained rise in the Euro against the dollar is that I just don't see the European companies as sufficiently dynamic or profitable to elbow aside their US counterparts. Here's one example of why I feel like this:

Fiat's long-term debt rating was downgraded on Wednesday to just a notch above junk status after Moody's Investors Services warned that the Italian industrial group's future could hinge on exercising an option to sell its automotive unit by 2004. Moody's downgraded some €15bn ($14.9bn) in Fiat bonds by one notch to Baa3 with a negative outlook. Moody's also recommended that Fiat carry through the restructuring plan's significant asset-sale and debt-reduction plans "in order to avoid pressure on the rating and limit the risk of a further downgrade".People who worked on the restructuring plan said Moody's actions were in line with expectations following numerous discussions with the ratings agency during the plan's elaboration.
Source: Financial Times LINK

In another part of the strong European reform story I don't buy, it's worth pointing out that Italy has the toughest restrictions in Europe on firing workers, according to the Organization for Economic Cooperation and Development.

Article 18 of the Labor Code, passed in 1970, mandates that after a short probationary period, an employee fired from a company with 15 or more employees can bring a lawsuit challenging the dismissal. If the suit is successful, as is often the case, the employer is forced to rehire the worker and pay back wages and social insurance contributions, as well as a large fine.

When given a hypothetical choice of a labor market where it is hard to find a job but hard to be laid off or one where it is easy to find a job but easy to be laid off, 71 percent of Italians preferred the former in a poll of 1,000 individuals conducted in April by Tito Boeri, an economist at Bocconi University in Milan, for the Debenedetti Foundation. So Italians value job security — and have lots of it.


Even worse, the uncertainty and expenses associated with dismissals have a chilling effect on hiring. A study led by Stefano Scarpetta of the O.E.C.D. released last week found that the average American company that survives two years increases its employment 160 percent, while the average Italian one that survives as long grows only 20 percent. Although many factors are undoubtedly at work, stiff firing restrictions probably account for some of Italy's lower job growth. Firing protections also affect worker performance. Examining data on 858 newly hired bank employees, Andrea Ichino, an economist at the European University in Florence, found that the absenteeism rate more than doubled after workers had completed the three-month probationary period. "The cost of the job security of the father," Professor Ichino argues, "is the insecurity of the son." Italy's jobless rate hovered around 10 percent in the last decade. Because its safety net has as many holes as Swiss cheese, high unemployment contributes to the remarkable fact that more than half of people in their 20's — and nearly a quarter of men age 30 to 39 — live with their parents. "The family is the main institution that provides unemployment insurance benefits," Professor Ichino said."

Source: New York Times LINK

And bearing in mind that Italy is soon about to enter into serious competition with Japan as to who is going to be the oldest country on the planet, what might also be at risk are papa's pensions, and much, much more.