Italy`s long road to economic recovery

Italy has slid into recession for the 3rd time since Q2 2008, after contracting for two quarters in a row. GDP shrank 0.2% in the second quarter of the year, following a 0.1% contraction in the first quarter. The Bank of Italy released figures last month confirming that GDP had contracted by 9% since the start of the global financial crisis in 2007.

Posting only one quarter of growth since mid-2011, expanding 0.1 percent in late 2013, Italy appeared to be emerging from recession, after three quarters of fractionally improving growth. However, news that the economy has failed to sustain growth, leaves Prime Minister Matteo Renzi's strategy struggling to gain credibility.

Reforms

This latest unpredicted contraction in GDP is a further setback for Prime Minister Matteo Renzi, who only came to power in February promising to reform and revive the economy. But the reforms so far have been an €80 monthly tax break for low income workers, which have had little visible effect on bolstering domestic consumption. When compared to Spain, which underwent huge amounts of austerity and labour market reforms, Italy hasn’t done that much to revive their economy and there is also speculation that the government may still require another budget to keep the deficit below the European Union's limit of 3% of GDP. Italy still has a large pile of government debt, and without any signs of growth it is unlikely they will be able to bring their debt stock down. Bond yields have also plummeted since the ECB promised to save the euro at the peak of the crisis, but data highlights the lack of development made in addressing the problems of the Italian economy that has now stagnated for more than a decade.

Countries unwilling and slow to embrace reforms such as Italy have been a drag on the wider Eurozone economy. Pressure for reform has increased after President of the European Central Bank, Mario Draghi urged faster action to take place on overhauling Italy’s economy. Draghi said the lack of structural reform was holding Italy back. This prompted widespread media speculation that could see European authorities pushing to impose a form of special administration on Italy.

Renzi has yet to translate into action his promises to revive growth and boost Italy’s economy made when he took office in February. Beyond the above mentioned tax break, more structural reforms are urgently required to at least bring hope to a profoundly disheartened nation that had thought the worst was over.

Future Outlook

It is likely the slow recovery from recession will continue during the remainder of 2014. Gains in confidence should provide boosts to consumption and investment in the economy, which will likely translate into growth further into 2015. Even with the attempted boost from the modest tax cuts, public expenditure will still remain constrained, with price inflation set to remain low until 2016. With the prospect of weak growth combined with low inflation, it is likely the public debt-to-GDP ratio will not begin to fall until 2016, leaving Italy still vulnerable to market fluctuations and further quarters of declining growth. It is therefore viewed as essential to continue fiscal restraint, to reduce public expenditure as a share of GDP. However this leaves Italy in an apparent paradox. Italy has growth initiatives in place to resume building projects to kick-start growth, but without the financial resources needed it is unlikely these infrastructure projects will materialise. The Italian government was struggling to fund such initiatives before this week’s GDP set-back, and if Italy is to adhere to the ECB’s budget reduction commitments without the aid of tax increases, huge spending cuts will be required. This runs the risk of further subduing demand in an already trapped economy, the government must somehow once again install confidence back in the markets.

Article by Hannah Ben-Halim