Italy Economic Forecast

Italy Economic Outlook

May 31, 2022

The economy runs a serious risk of falling into a recession in Q2. Italy is one of the non-eastern, Euro area countries most economically vulnerable to the war in Ukraine, due to its large dependence on Russian gas imports. Harmonized inflation remained at record levels in April, while the manufacturing and services PMIs also fell that same month. Likewise, business and consumer confidence deteriorated. Meanwhile, government bond spreads have continued to increase, posing a risk to financial stability given Italy’s large public debt—151% of GDP at the end of last year. That said, government measures seem to be stopping the rot somewhat, with a 15 EUR billion package unveiled in May helping both business and consumer confidence to rebound in that same month. Activity will also be supported by the further relaxation of pandemic-related restrictions, including on tourism, from 1 May.

Italy Economic Growth

Our panelists continued to downgrade their 2022 growth forecasts this month. EU funds and an expansionary fiscal policy will be insufficient to compensate for the drag coming from higher energy prices. Further disruption to Russian gas supplies, as well as rising bond spreads—due to the ECB’s increasing hawkishness—cloud the outlook. FocusEconomics panelists project activity to expand 2.6% in 2022, which is down 0.2 percentage points from the previous month’s projection, and 1.9% in 2023.

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Italy Economy Overview

Italy Economic Overview

Italy is the world’s ninth biggest economy. Its economic structure relies mainly on services and manufacturing. The services sector accounts for almost three quarters of total GDP and employs around 65% of the country’s total employed people. Within the service sector, the most important contributors are the wholesale, retail sales and transportation sectors. Industry accounts for a quarter of Italy’s total production and employs around 30% of the total workforce. Manufacturing is the most important sub-sector within the industry sector. The country’s manufacturing is specialized in high-quality goods and is mainly run by small- and medium-sized enterprises. Most of them are family-owned enterprises. Agriculture contributes the remaining share of total GDP and it employs around 4.0% of the total workforce.

The country is divided into a highly-industrialized and developed northern part, where approximately 75% of the nation’s wealth is produced; and a less-developed, more agriculture-depended southern part. As a result, unemployment in the north is lower and per capita income in higher compared to the south.

Italy suffers from political instability, economic stagnation and lack of structural reforms. Prior to the 2008 financial crisis, the country was already idling in low gear. In fact, Italy grew an average of 1.2% between 2001 and 2007. The global crisis had a deteriorating effect on the already fragile Italian economy. In 2009, the economy suffered a hefty 5.5% contraction—the strongest GDP drop in decades. Since then, Italy has shown no clear trend of recovery. In fact, in 2012 and 2013 the economy recorded contractions of 2.4% and 1.8% respectively.

Going forward, the Italian economy faces a number of important challenges, one of which is unemployment. The unemployment rate has increased constantly in the last seven years. In 2013, it reached 12.5%, which is the highest level on record. The stubbornly high unemployment rate highlights the weaknesses of the Italian labor market and growing global competition. Another challenge is presented by the difficult status of the country’s public finances. In 2013, Italy was the second biggest debtor in the Eurozone and the fifth largest worldwide.

Economic History

After World War II, Italy experienced a shift in its economic structure. It transformed itself from an agricultural country to one of the most industrialized economies in the world. The force behind the post-war economic miracle was the development of small- and medium-sized companies in export-related industries. In the following decades, the economy has had both ups and downs.

Being a country with very few natural resources, Italy is strongly dependent on oil imports. The economy was hit hard by the two oil crises during the 1970s. As a result, it experienced a stage of stagflation—weak economic growth combined with high unemployment and a high inflation rate. The economy began to recover in the early 1980s due to the implementation of a recovery plan. Restrictive monetary policies brought inflation down, while fiscal- and growth-oriented policies reduced public spending and tightened the budget deficit.

Before the 1980s, most of the Italian state-owned companies were a key drivers of growth. However, in the mid-1980s, the state sector started to create distortion in the economy. The mismanagement of public spending led to a deterioration of public finances and triggered excessive corruption. A round of privatization was carried out at the end of the 1980s and beginning of the 1990s. The diminishing role of the state in the economy created more space for private investment. In 1999, Italy qualified to adopt the euro and entered the European Monetary Union (EMU). The Euro was officially introduced into the economy on 1 January 2002.

Italy was hit by the financial crisis in 2007. Since then, the economy has underperformed. In a bid to face the recession, the government has passed two major austerity packages. The first one, under the administration of Silvio Berlusconi, was implemented on May 2010 and totaled EUR 24 billion. Later, in December 2011, the government led by Mario Monti introduced a EUR 30 billion austerity package. While the former package was focused on a reduction of government spending in order to reduce the nation’s budget deficit and public debt, the latter introduced, among other measures, a series of tax increases.

The incumbent government of Matteo Renzi is focusing on mitigating the effects of the financial crisis. His administration has introduced economic and structural reforms; the most important are the senate reform, labor reform and electoral law. Ensuring that the reforms that have been promised actually materialize is vital to supporting growth and strengthening Italy’s position in the global market.

Italy’s Balance of Payments

Italy has been an international debtor in most years during the past decade. Following the financial crisis in 2008, Italy, like the other periphery countries, experienced a sudden stop in private capital inflows as the level of government debt became unsustainable.

Since Italy is part of the Eurozone, it cannot rebalance its current account by adjusting the exchange rate. As a result, the country entered a system of adjustment called TARGET2. TARGET2 replaced the private capital flows with public capital flows and allowed the troubled countries to run current account deficits and avoid balance of payments crises. This gave Italy the opportunity to gradually adjust its current account balance.

The current account deficit shrank from a 3.4% deficit in 2010 to almost zero in 2012. This adjustment mainly reflects a fall in imports while exports performed quite steadily. In addition, private capital flows have increased lately, as confidence in Italian sovereign bonds has improved. However, a positive balance was not seen until 2013, when the country incurred a current account surplus of 1.0%. The main contributor to the surplus was the trade balance. In fact, in 2013, trade balance incurred a surplus three times larger than in the previous year.

Italy’s Trade Structure

Against the backdrop of a weak domestic demand, the external sector’s performance is crucial for the Italian economy. One of the most important pillars of the economy is the production of high-quality products such as in the machinery, textiles, industrial designs, alimentary and furniture sectors. These products contribute substantially to the country’s exports. However, as a country poor in national resources, its energy and manufacturing sectors are highly dependent on imports. This makes Italy’s external position vulnerable to changes in import prices such as fuel. The county recorded trade deficits from 2004 until 2011. However, in the last two years, falling imports have helped to turn the balance into positive figures.

Italy’s trade volumes increased significantly after the country joined the Eurozone. Despite growing global competition, in 2013 Italy ranked as the world’s 10th largest exporter and 11th largest importer. Italy’s main trading partners are inside the Euro area, in particular Germany, which is the country’s main exports destination and accounts for around 12.6% of Italy’s total exports and France, accounting for 11.1% of total exports. Other important export destinations are the United States, with a share of 6.9% of total exports, and Switzerland with 5.2%. Germany and France are Italy’s top imports partners, accounting for 12.4% and 10.8% share of total imports respectively.

Exports from Italy

Since the country’s manufacturing sector is specialized in high-quality goods, Italy plays an important role in the global market of luxury goods. The country’s main exports are mechanical machinery and equipment, which account for around 24% of total exports, as well as motor vehicles and luxury vehicles (7.2%). Home to some of world’s most famous fashion brands, Italy occupies a special niche in the global market of fashion and clothing. In fact, exports of clothing and footwear account for around 11.0% of the country’s total exports. Other important exports include electronic equipment (5.6%) and pharmaceutical products (4.6%).

Since 2008, the country has experienced anemic growth in merchandise exports of 1.6% annually. In nominal terms, merchandise exports have gradually outsized imports, which caused the last two years (2012 and 2013) to close with a trade balance surplus.

Imports to Italy

Italy’s main imports are fuels, which account for around 17% of total imports. This is due to the country’s lack of natural resources, which makes it highly dependent on energy imports. Other imports include machinery (14.2%), raw materials (10.0%) and food (7.0%)— Italy is a net food importer because the landscape is not suitable for developing agriculture.

Since the financial crisis, merchandise imports have expended at a slower rate on average than merchandise exports. In fact, in the last six years merchandise imports have grown a meager 0.4%.

Italy’s Economic Policy

In the past seven years, the focal point of the Italian economic policies has been to mitigate the effects of the financial crisis. Two main austerity packages have been introduced since the crisis started in 2007. Both packages aimed at reducing the country’s soaring public debt and government deficit.

Regarding structural reforms, few changes have been made over the years. The government has sought to reform public administration and public education in an attempt to improve the competitiveness of its human capital. However, the investment climate remains poor mainly due to its rigid labor laws, high labor cost, inefficient public service and the judicial system.

Italy’s new Prime Minister Matteo Renzi took office in March 2014 and promised to revive the economy by passing one reform each month in the first 100 days of his term. In a bid to boost growth, he proposed a cut in the income tax with a cost to the government of around EUR 10 billion. The PM also announced a broad labor reform that aims at changing Italy’s unemployment welfare scheme, reforming job contracts and improving job agencies. However, Renzi’s key reform was the transformation of the Senate into a non-elected chamber, putting an end to the country’s two-chamber system. The PM also pledged changes in the judiciary system, public administration and electoral law.

Italy’s Fiscal Policy

Following the crisis years, the Italian economy underwent a sizable fiscal adjustment. The country exited the EU’s Excessive Deficit Procedure in 2012, when its deficit fell to 3.0% of GDP. Italy has to keep its deficit below the threshold ceiling of 3.0% as this is one of the EU convergence criteria, also known as Maastricht criteria. The 2013 figure followed an average deficit of 4.6% that was recorded in the three preceding years. However, the primary balance has registered only one deficit since 1995, and that was in 2009. In 2012, the country reached a primary surplus of 2.5% of GDP—one of the highest surpluses in the Euro area. The high positive balance was key to improving public confidence.

Despite the fiscal adjustment, which put the fiscal balance on track, the government debt as percent of GDP has been above 100% since 1991 and has been on upward trend since 2004. In 2013, government debt stood at 132.6% of GDP, which represented the second-largest public debt among Eurozone countries and the fifth largest worldwide. Doubts about Italy’s debt sustainability triggered the downgrade of the country’s debt rating over the past three years by all three rating agencies: Standard and Poor’s, Moody’s and Fitch. Sovereign debt risk premium surged to record high levels in November 2011. However, in September 2012 it started to moderate after the European Central Bank’s (ECB) announcement of the Outright Monetary Transactions (OTM) scheme. More recently, the European Union has urged the Italian government to advance with economic and structural reforms due to the excessive macroeconomic imbalances of the country.

Italy’s Monetary Policy

At the beginning of the 1980s, the Central Bank of Italy raised its interest rate to a record high of 19.0% in order to fight the high rate of inflation. After this policy adjustment, which is seen as a “milestone” in the evolution of monetary policy in the country, the inflation rate decreased constantly. More decisive monetary policies that were conducted in the 1990s brought the inflation rate down further. In 1998, the rate fell to 1.8%.

The Central Bank of Italy is completely separated from the influences of the government and has to comply with the rules dictated by the ECB, which are the same for all the member countries of the union. The main aim of these rules is to protect the common currency.

The Bank of Italy, as part of the Eurosystem, helps to draft the monetary policy for the Euro area. The primary objective of the Eurosystem is price stability. To achieve price stability, the European Central Bank controls short-term interest rates. Changes in interest rates accommodate the financial needs of the banking system.

Lately, in June 2014, the ECB reduced the official interest rate and introduced a negative deposit rate. The impact of these monetary-policy decisions in the Italian economy is expected to be observed in the short term.

Italy’s Exchange Rate Policy

The lira was Italy’s currency from 1861 until 2002, when the country officially introduced the euro. In 1979, Italy became part of the Exchange Rate Mechanism (ERM)—a system which links the currencies of most of the European Economic Community (EEC) nations. In order to prevent big fluctuations relative to the other EEC countries, Italy had to maintain its exchange rate stable within threshold bands of +/-2.25%. However, in 1992, Italy had to devalue the Italian lira by 7.0% and as a result entered into a system where the fluctuation bands was wider.

Nowadays, the Bank of Italy, as part of the Eurosystem, participates in foreign exchange market interventions along with the ECB and the other National Central Bank of Eurozone.

The Bank conducts foreign exchange operations to keep its foreign currency reserves under control. In order to balance inflows and outflows of foreign currency without changing the composition of foreign currency reserves, the Bank of Italy buys or sells foreign currency with market counterparties.

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Italy Facts

Value Change Date
Bond Yield1.31-0.40 %Jan 01
Exchange Rate1.120.65 %Dec 31

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