Sunday, August 31, 2008

Have We Seen "Peak" Italian Retail Sales?

Well, since Ugo Bardi recently raised the question of whether Italy had not in fact passed its own historical "peak oil" and "peak mafia" points, I thought it might be interesting to ask what else has peaked in Italy, and what better place to start than with retail sales?

Sharp Drop In June Sales

Italian retail sales fell sharply in June, posting their sharpest drop on the year in more than three years, as sales fell across the board, according to data last week from the national statistics office Istat, but what many observers seem to fail to be taking note of is that Italian retail sales have been dropping steadily for some years now. Even more importantly - as will be argued in this post - there are serious theoretical grounds (in the context of Italy's ageing population problem) for postulating that Italy's retail sales may NEVER rebound again on more than a conjunctural basis, that is we may see local "peaks" and "troughs" but the secular decline may now not reverse. This is a point which most of consensus analysts who look to a cyclically driven "rebound" in domestic consumption appear to fail to take into account.

But before going further with this point, let's take a look at some data. Compared with June 2007, Italian retail sales fell by 3.4% on a current price (ie non inflation corrected basis), thus registering the steepest decline since April 2005, following a 0.5% rise in May. But since annual consumer price inflation stood at a 4% in June, retail sales in real terms declined very sharply indeed in June (more or less comparable to Spain).

ISTAT put it like this:



Per una migliore interpretazione degli indicatori qui presentati occorre considerare che essi si riferiscono al valore corrente delle vendite e incorporano, quindi, la dinamica sia delle quantità sia dei prezzi.


(Which loosely translated say that in order to better understand the data it is important to bear in mind that it refers to the current price value of sales and thus incorporates both the volume and the price dynamic. Of course, to help us better understand the data it would be nice if ISTAT could provide us with some price corrected index, but in the absence of this I have prepared a rough and ready one, but deflating the seasonally adjusted index with the CPI one, thus reducing the sales index to 1995 prices, see charts which follow).





Slight Improvement In The Rate Of Contraction In The August PMI

Now applying the CPI deflator to the index in fact gives us reading which match quite closely the Bloomberg PMI data for retail sales. The latest Bloomberg eurozone Purchasing Managers' Index, based on a mid-month survey of economic conditions in the euro area retail sector, pointed to a continuing contraction in retail sales across the eurozone for the third consecutive month in August. While the PMI rose to a three-month high of 47.7 it remains below the crucial 50.0 zero growth mark.




There was some, however, some variance in retail sales trends across the three largest euro area economies. Italian sales continued to fall, extending the current period of month on month consecutive declines to a year-and-a-half. However we did hit a nine month "high" with sales contracting at the slowest pace since last November, rising to 44.8 (or minus 5.2) from 38.2 (or minus 11.8). Thus August revealed a significant eeasing in the rate of contraction (a finding which is completely in harmony with the rather better consumer confidence index reading for August. Indeed the fall in Italian retail sales in August was not as strong as the one in Germany, where the rate of decline - 44.1 - accelerated to its strongest pace so far this year. So things in Italy are bad, and they are getting worse, but they are now getting worse more slowly than they were. The fact that in August oil prices were significantly down from the July peak obviously has something to do with this situation.

The August PMI data also revealed a rather higher level of pessimism amongst retailers with regard to September sales, with the index for the sales outlook registering 48.0, down from 49.5. The data revealed some variance across countries, while French and Italian retailers expect sales to come in below target next month, which reflects underlying concerns that the economic downturn will continue, German retailers were more positive, forecasting a stronger than previously expected performance.

Indeed Italian consumer confidence bounced back in August from a 15-year low in July as oil prices fell from record highs. The Rome-based Isae Institute's index, calculated from a survey of 2,000 families, rose to 99.5 from 95.8 in July. The index, however, continues to remain at a very low level.




"Peak" Retail Sales

So the question we are faced with now, is whether or not we are faced with a "peak" retail sales phenomenon? The theoretical basis for this assumption is on reasonably solid ground, and there is evidence to show the phenomenon exists in other ageing economies (Germany, Hungary, possibly Japan). In the Italian case, I have constructed my own makeshift index, and the performance of this index since 2003 can be seen below. It seems Italian retail sales may have "peaked" in early 2003, and since that time the decline has been continuous, although sales did stabilise during 2005 and 2006 (I will come to this point later).




Now Italy's population is not in fact contracting at this point, although the natural population change is negative, and has been since 1993. But Italy has been receiving immigrants - an estimated 450,000 in 2007 - and thus Italy's population is still increasing.



But Italy's population is ageing, and we know from basic life cycle theory (Modigliani) that saving and spending patterns change across the life cycle, with the propensity to borrow against future income in order to buy now declining significantly among the over 50s, and since it is increasing consumer credit that drives retail sales growth in the dyamic internal consumption economies, then it is highly likely that ageing will now act as a drag on sales growth in countries like Italy with very high median population ages (43, along with Germany and Japan). As we can see in the chart below (which comes from the US Census Bureau database), Italy's median population age has been rising steadily, and at a very rapid rate (over 1 year's increase in median population age for each calendar year, of course historically this type of rapid ageing is quite unprecedented), with the only real substantial unknowns between now and 2020 being life expectancy, which may accelerate more than anticipated (in which case the population ageing will be even more rapid), and immigration, which will slow ageing down a bit.

The data in the above chart come from the US Census Bureau, and it appears to me they have only made a very slight allowance for the impact of migration, which may mean that the ageing curve has not been so steep in the last three or four years, but equally, and despite the fact that population has risen by nearly 2 million since 2003 due to substantial immigration, the retail sales have barely shown an impact (which means I would hate to see what they would have looked like without the immigants). Although, might we postulate the some of the stability we saw in retail sales in 2005 and 2006 could be the impact of the arrival of the immigrants?


EU Sentiment Index Down In August

Other indicators also seem to confirm the idea that things in Italy continued to get worse more slowly in Italy in August, one of these was the EU Economic Sentiment Indicator (ESI) which fell in both the Eurozone and EU, falling by 1.9 points in the EU and by 0.7 of a point in the Eurozone, to 86.9 and 88.8 respectively. For the EU as a whole the ESI reached its lowest level since December 1993. However, unsurprisingly, perhaps, in view of all the above, while the ESI fell for the zone as a whole in August, in Italy it bounced back slightly to 89.5 from July's 85.4 low.


One of the reasons for this change is undoubtedly the shift in consumer confidence, and one of the underlying reasons for this shift in consumer confidence is the easing in petrol prices and inflation, which fell back to an annual 4% in August from an annual 4.1% in July.

It is to be hoped that producer prices, which were up at their highest rate since September 1995 in July - an annual 8.3% - will now follow the same path. There is some evidence of a moderating trend, since month on month, the index rose 0.5% over June compared with a 0.8% increase the previous month.


Istat said that energy prices in July surged 25% on the year and 1.6% on the month. The price of refined petroleum products continued to drive the index higher year-on-year, since they were up by an annual 31.1% and 1.2% on the month. Excluding energy, producer prices only rose 4.1% on the year and 0.1% on the month in July.

So is it all about energy, well obviously not completely, but it is to some significant extent. Years of declining competitiveness and a complete disregard for the problems that population ageing were going to represent have left the Italian economy completely "groggy", like the proverbial boxer leaning on the ropes, waiting for the knock-out blow. And in it has come, in the shape of an unprecedented and sharp spike in oil prices. Italy is now, as we can see, extremely sensitive to any strongish movement, one way or the other, in oil prices. Thus it seems it may well be worth asking ourselves, along with Professor Bardi, the awkward question of whether Italy's economy can in fact learn to live with oil prices which remain over $100 a barrel in the longer term? The answer is not at all obvious.

An airline is a small economic system that uses fuel derived from oil in
order to carry on activities that generate profits. If oil is too expensive,
profits disappear and, eventually, the system must disappear, too, bankrupted.
Low cost airlines have appeared during the period of relatively low oil prices
that ensued after the first oil crisis, in the 1980s. Can these airlines exist
with oil over $100 per barrel?

A country is larger than an airline but it, too, needs fuel for its
economic activities. And, if deficits run too high, countries can go bankrupt as
well. Italy's industrial economy had its moment of maximum growth in the 1950s
and 1960s; in a period of low and stable oil prices. Can Italy's industry exist
with oil prices over $100 per barrel?
Posted by Edward Hugh at 1:29 PM

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Italy At A Glance - January 2008

Welcome to the Italian Economy Watch Blog. Below you will find the normal chronological blog posts. But first we would like to present some charts which provide background data which we hope will help the first time reader better assess and get to grips with the argument being presented on the blog. In what follows you can find charts for Italian male life expectancy, median age, quarterly GDP growth, inflation, household demand, retail sales, and import and exports growth. Basically this data provides a summary of the argument which we are presenting on this blog, which is that in order to understand Italy's long term and ongoing economic malaise you need to understand something about Italian demography, and it's macroeconomic consequences. Please click on thumbnails for better viewing.

On the left you can see a chart for Italian male life expectancy, and on the right there is one showing the evolution of the Italy's median age between 1990 and 2020. Just why such factors are important, and need to be taken into account along with more standard macro economic data in accounting for Italy's stubbornly low growth rate since the mid 1990s is explained in the posts.

With such weak internal consumption growth Italy badly needs to run a trade surplus to obtain the economic growth necessary to make public finances sustainable. In this Italy is similar to Germany and Japan, and different from domestic consumer driven economies like the UK, France and Ireland. Long term fertility and life expectancy really do matter, since they condition labour force growth



and consumption patterns, and with these productivity and the growth of internal credit and consumer demand. Above left you can find Italy's ferility rate, and above right the evolution of the 25 to 49 age group, which has just passed it historic peak. On either side here you can see charts for recent quarterly GDPand long run annual GDP.


Next on the left we have a chart for recent movements in Italian inflation while on the right we can see changes in the trade gap between exports and imports. Inflation is reasonably tamed in Italy (now why?), despite the recent slight uptick, but it is Italy's inability to generate a trade surplus which is the main problem structurally.


Now on the left we have the chart for household consumption and on the right the recent retail sales data. Finally the chart on the bottom left shows recent movements in Italy's business confidence index,while the chart on the right shows the equivalent data for consumer confidence.Bottom line, the evidence of growing weakness is everywhere.

Arguably these are all the data points you need to understand my lengthy post on The Euro Area and Italy's De-Facto Dependence On Exports, as well as why it is that the danger Italy may once more fall into recession presents us with the difficulty of what the credit ratings agencies will say about the resulting impact on the government debt situation.


2008 Forecasts: The OECD in December revised their 2007 Italian forecast down to 1.8%, and the 2008 one down to 1.3%. Confindustria also revised their forecast down in December, arguing that growth would slow to 1 percent in 2008 from an 1.8 percent this year, citing factors like the rising cost of food and oil and the rise of the euro against the dollar. Such numbers are clearly not encouraging, but arguably downside risk for 2008 is greater even than either the OECD or the Confindustria forecasts reflect Morgan Stanley's Vladimir Pillona is somewhat more sanguine. While presenting the MS central forceast for Italian economic growth to slow to 1.0%Y in 2008, from 1.8%Y in 2007, he goes on to note that "even annual GDP growth of 0.5%Y next year has a significant possibility of occurring, as shown by our model’s forecast error bands".

I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows. During 2007 the Italian govenment has been running a fiscal deficit of comfortably below the 3% of GDP required by the EU commission. But since this fortunate situation was in part acheieved by the use of one off measures, and in part by the strong tax inflow from the above trend growth, the government will need to maintain a comparatively tight fiscal stance to keep things on course, and any attempt to further loosen may run into real problems with the EU commission and the credit rating agencies. And as I keep arguing, it is very hard to see an accomodative monetary posture from the ECB in the near future. The IMF in their October World Economic Outlook came in with a similar figure of 1.3% for 2008, the Economist Intelligence Unit is forecasting 1.7% in 2007 and 1.4 in 2008, and the latter 2008 figure was also endorsed by the EU commission in its November forecast.

As I indicate, my own view is well to the downside of all this. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Italy's ageing workforce this will work through as some are hoping, as I expain at some considerable length in this post here. My opinion is that Italy will enter recession at some point during 2008, and that we may well have 2 consecutive quarters of negative growth. The continuing high euro will maintain pressure on Italian exports, and high oil and food prices will maintain pressure on the inflation front, at least in the firts half of 2008. At the same time, and despite rumours that Romano Prodi's government is compemplating a large tax cutting package, I anticipate that the fiscal environment will remain tight. Italy's large (106% GDP) accumulated debt, and the vigilance from the gentlmen at Standard and Poor's and the other credit rating agencies more or less guarantee that.

As most of the forecasts suggest, we have been seeing growth which is somewhat above trend during the upswing in the last couple of years, so it would not be surprising if we now saw some below trend growth. Trend growth (over a 5 year average) in Italy may even have fallen into the 0.5 to 1% range, so if I have to put a number I would say 0.7% with a definite "downside risk" tag attached. The nearest forecast to this that I have seen is the 1% one from the Morgan Stanley GEF team. The implications of such sustained low growth are, I think, important, since if Italy cannot find the way to raise trend growth up towards the 2% mark there is simply no way the government debt can be stabilised and sustained. And with each passing year we have one year less to crunch time.