September 16, 2014
The most striking part of the OECD’s revised Economic Outlook is the sheer pessimism for Italy. We would like to focus on this aspect in particular. The OECD says the Italian economy will decline by 0.4% this year, and grow by only 0.1% next year. In other words, Italy’s Great Depression which started in 2008 will not end at least until 2016.
Here is the summary table of the OECD’s main findings for the largest economies in the world:
The data for the eurozone – while hardly surprising – constitute a big downgrade from the May forecast, down from 1.2% to 0.8% for 2014 and from 1.7% to 1.1% for 2015. We are still in a period where one-year-ahead forecasts are consistently wrong in the same direction – all of the forecasts are always too optimistic, which renders them not just useless but potentially dangerous.
As the often excitable Ambrose Evans-Pritchard rightly notes, the persistence of stagnation in Italy will pose serious risks for debt sustainability. He quotes Antonio Guglielmi of Mediabanca as predicting a rise in debt-to-GDP to over 145% - pushing Italy closer to a level at which it is seen by markets to be insolvent (which is not the same as the level where the country actually is insolvent, a number we simply don’t know). Guglielmi said it would take a “nuclear bomb” – to be launched out of Frankfurt - to solve the Italian problem.
What struck us about the media coverage in Italy was Matteo Renzi’s defensiveness. “I don’t take orders from anybody,” Corriere della Sera quotes him in the presentation of his 1000 day agenda, and: “Whoever thinks that I am in distress is wrong”.
Most of importantly, he remains determined to frontload the political reforms – or at least implementing economic reforms at the same time as political reforms, something that would overload the political system. We recall well that the economic reforms in Germany pre-occupied the government for the better part of a whole year because implementation is absolutely crucial. It may be possible to reform the Italian political system, the justice system, the fiscal system and the labour market within three years, given a super-human effort, but these reforms cannot conceivably be done simultaneously if they are done right.
Fitch Ratings, meanwhile, writes that the TLTROs won’t have much of an effect on bank lending in southern Europe. While the initial take-up may be high, banks’ appetite for lending will be weak. So how is this possible since TLTROs are linked to lending? From Fitch:
“TLTRO funding in 2014 is allocated as a fixed percentage of outstanding corporate loans at April 2014, and the take-up may be high during this period. Banks have to keep lending above a given benchmark level to be eligible to tap the TLTRO from 2015 and to keep the funding until maturity. If a bank has been deleveraging, as is the case with most banks in southern Europe, the benchmark assumes the loan contraction continues from April 2014 to April 2015 and is then set at zero. This means that many southern European banks will be able to tap the TLTRO and still keep a flat or slightly contracting loan book, although at a slower rate than in the previous 12 months.”
Our main story deals with the latest economic forecasts for Italy, and the likely implication for debt sustainability; we also have a long discussion on the future of Catalonia, also in view of the Scottish vote for independence this week; in France, Manuel Valls is to hold another confidence vote; and Germany is preoccupied with the aftermath of the AfD victories in two state elections on Sunday.