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Italy Prometeia Brief September 2016 — No. 16/5 Executive summary ▶▶ After halting in 2016q2, we project a very slow resumption of growth in q3 and q4 ▶▶ Weak domestic and external demand over the summer led us to revise 2016 and 2017 GDP growth down by 0.1pp ▶▶ Our first InFocus looks at the financial position of Italian firms (compared to Spain) ▶▶ The second InFocus is on the recent difficulties of the Italian export sector GDP and inflation The Italian GDP growth rate in the second quarter was slightly lower than expected (zero instead of 0.1 per cent q-o-q). The growth rate in 2016 and 2017 is expected to be 0.7 and 0.8 per cent respectively, one of the weakest in the EMU. The 2016q2 slowdown is due to weaker domestic demand, which reduced its contribution to growth compared to the previous quarter (from 0.4 per cent q-o-q in 2016q1 to -0.1 in 2016q2). In particular, private consumption of durable goods was weak and investment declined (from +0.8 per cent q-o-q in 2016q1 to -0.3 in 2016q2), mainly because of a decline in machinery and equipment. Net exports contributed positively (+0.2 per cent, from -0.3 in 2016q1). Looking to the second half of this year, households and company economic climate indicators continued to decline in July and August (they fell more than in Spain and France; in Germany Table 1 GDP growth quarterly profile GDP (% change q-o-q) in bold historical data. 2016q2 2016q3 2016q4 2017q1 0.0 0.1 0.1 0.2 these indicators increased). The uncertainties related to the solidity of the financial sector and to the upcoming constitutional referendum (to be held on December 4th) are taking a toll on activity. The labour market shows a different picture. Even if the unemployment rate decreased only marginally (from 11.6 per cent in 2016q1 to 11.5 in 2016q2), the increase in employment is remarkable. In contrast to the very slow recovery of GDP, hours worked increased (+0.5 per cent q-o-q in 2016q2, and +2.1 y-o-y), as did full-time equivalent employment (+0.4 per cent q-o-q and +1.3 y-o-y) and the number of employees (+0.8 q-o-q and +1.7 y-o-y). In the first 6 months of the year, employees increased by 220 thousand and all the economic sectors contributed positively to this growth, with the sole exception of construction. Consumer inflation was still negative in August, largely driven by the energy component. In the rest of the EMU consumer inflation is positive since June. Core inflation in Italy remains positive but low (+0.8 per cent), due to weak domestic demand and unit labour costs. ▪ 2 Italy – Prometeia Brief prometeia Public finances The Update of the Economic and Financial Document (presented on September 27th) revises downwards the GDP growth for 2017 to 1 per cent (from 1.4 per cent in the Economic and Financial Document of last April) and upwards the public deficit up to 2.4 per cent (from 1.8 per cent). Although the government has revised also the 2016 GDP growth rate down by 0.4 percentage points (from 1.2 per cent to 0.8), it has increased the 2016 deficit target only marginally, to 2.4 per cent from 2.3 per cent. This year the low interest rates on government debt should bring savings of €3 billion and, on the revenue side, the increase of direct and indirect tax revenues (2.3 per cent y-o-y in the first semester of this year) appears to be significant. The Update of the Economic and Financial Document takes into account the new challenges presented by the weaker macroeconomic scenario, revising the targets accordingly. In particular, the deficit to GDP ratio for 2017 is now set at 2.4 per cent (from 1.8 per cent), including expenses related to the recent migration and earthquake events for about 0.4 percent of GDP. The document cancelled the so called “safeguard clause” (an automatic increase in VAT and other taxes of €15 billion in the event of lower than targeted public expenditure savings) and it has only partially compensated it by lower expenditure (€8.2 billion). Based on this new information, the fiscal stance will still be expansionary in 2017, but less so than in 2016. In summary, for 2017 the Government has acknowledged that the targets set in April were unrealistic in view of both the weaker macroeconomic scenario and the tight fiscal stance. The new targets in terms of both the GDP growth rate and the deficit as a GDP ratio are now closer to our forecast (Tab. 2). ▪ Table 2 Italy: macroeconomic scenario (% change) GDP Imports Household consumption Government expenditure Gross fixed capital formation: - machinery and equipment - constructions Exports 2015 2016 2017 0.6 5.8 0.9 -0.7 0.7 2.6 1.1 0.4 0.8 2.9 0.7 -0.4 2.1 -0.9 2.7 0.7 2.1 1.3 General government fiscal balance* Structural balance* General government debt* 4.1 1.7 2.8 10 year government bond yield Consumer prices Household disposable income Total employment 2015 2016 2017 0.0 0.8 0.8 -0.1 2.3 1.0 1.1 1.0 0.4 -2.6 -0.9 132.7 -2.4 -1.3 133.3 -2.5 -1.4 133.9 1.71 1.37 1.26 * % of GDP National Accounts Aggregates are ESA 2010. Credit and banks Credit market shows a dual path: credit to households continued to increase in July, while in June credit to firms inverted the positive trend that began in 2014. The creation of new bad loans decreased in July, following the trend of the previous months. In July, credit to households1 increased by 1.4 per cent y-o-y, getting closer to the EMU average. Consumer credit and mortgages, thanks to improved 1 ECB statistics, adjusted for statistical discontinuities and securitizations. loan conditions, supported this growth. Since the beginning of the year, the flow of loans to households reached €7 billion. The growth rate of loans to firms decreased in both June and July, by 0.1 and 0.5 per cent y-o-y respectively. Loan growth in Italy was 1.1pp lower than the EMU average at the end of 2015, while 2.4pp lower in July 2016. The growth of bad loans decreased further in July (0.6 per cent y-o-y, the stock was €198 billion), following a path already started in the previous months. This dynamic is due to two components: first, formation of new bad loans in both corporate prometeia and household sectors decreased; second, securitizations increased. As for the future, credit expansion will also crucially depend on the improvement of the conditions of the Italian banks, whose vulnerability to shocks was exposed during last summer turmoil following Brexit and the publication of the EBA stress test September 2016 results. We expect that the Italian banking system will conduct a process of securitisation and disposal of a substantial amount of bad loans, which should almost halve the outstanding NPLs over the next three years. According to our estimations, the Italian banking system has the resources to afford this process. But it is crucial that banks have the time to do so. ▪ Risks to the projection ▶▶ ▶▶ ▶▶ 3 The constitutional referendum to be held in Italy on December 4th might increase political instability, adding to the level of uncertainty Uncertainty might be further fuelled by the total standstill on several European dossiers ahead of the French and German elections next year World demand has bottomed out during the summer and should regain momentum next year. If this is not the case, the already fragile Italian recovery would be at risk Figure 1 Prometeia forecast of annual GDP growth (central projection and confidence levels) 2.0% 1.5% 1.0% 0.5% 0.0% 2015 99% 2016 95% 90% 2017 central projection Prometeia calculations (see December 2015 Brief for methodology). Firms’ financial resources during the recovery: Italy vs Spain InFocus In Italy and Spain, the access to credit for companies has improved in the last two years. The “Survey on the Access to Finance of Enterprises”1 confirms that, after a long period of contraction, the trend has reversed. Specifically, large firms acknowledged an improvement since 2013 of the terms and conditions of bank financing (such as loans, overdrafts and credit lines, Fig. 2), more pronounced in Spain than in Italy. On the other hand, small and medium-sized firms reported slower progress, that started only one year later and was weaker in Italy in any case. The widening of credit availability, more evident in Spain than in Italy, can also be due to different starting levels. In fact, credit flows to Spanish companies have experienced, between 2011 and 2013, a much steeper decline than in Italy. Since 2014, the credit fall slowed down in both countries, especially in Italy, consistently with the credit flow that in 2016 became positive (+€5.2 billion until July), while in Spain is still negative (-€3,4 billion). In Spain, the still weak credit flow can be explained by the drop in loan demand of companies, possibly offset by an improvement of their internal financing. The increase in capitalization in Spain (Fig. 3, lines) has made available new resources for investment, in addition to those arising from improved profitability (Fig. 3, bars). Italian firms experienced an increase in capitalization after 2011, albeit of lower intensity than in Spain. However, Italian firms experienced a decline in profitability since the early 2000s, and they continue to lose ground compared to the Iberian ones. 1 Survey conducted every six months (September and March) by the ECB on a sample of enterprises excluding those from the education and health sectors. 4 Italy – Prometeia Brief Figure 2 Firms’ bank financing terms and conditions (net percentages*) 60 Italy - large 40 Spain - large Italy - small and medium Spain - small and medium prometeia Figure 3Capitalization and profitability of non-financial companies 0.55 0.50 0.45 20 0.40 0 0.35 0.30 -20 1999 2002 2005 2008 2011 2014 Italy - EBITDA / Added Value -40 set-09 mar-10 set-10 mar-11 set-11 mar-12 set-12 mar-13 set-13 mar-14 set-14 mar-15 set-15 mar-16 Spain - EBITDA / Added Value Italy - Equity / Liabilities Spain - Equity / Liabilities Prometeia calculations based on ECB data, SAFE (Survey on the Access Source: Prometeia calculations based on Eurostat data to Finance of Enterprises) * difference between the percentage of enterprises that experienced an increase and those that declared a decrease in the available size of loans and credit lines Spanish firms appear to be better able to diversify the sources of funding than Italian ones, especially Spanish medium and large size firms, considering their easier access to non-bank credit channels. The deleveraging process that both economies have experienced reflects the will of companies to decrease their dependence on bank credit. If this phenomenon proves to be structural, economic recovery will not be accompanied by a corresponding growth in demand for credit. In Italy, however, since low profitability does not allow small businesses to replace bank loans with self-financing, the improvement of access to credit remains crucial not only for larger firms, but also for smaller companies. Italian export, struggling to keep up Although the Italian export of goods increased more (in real terms) in the second quarter than those of Germany and France (but not of Spain), the export growth gap continues to be notable since after the Great Recession. While Italian exports reached pre-crisis levels only in 2015 (and now are just 4 per cent above), the French, German and Spanish exports have already substantially exceeded their pre-crisis levels (by 9.8 per cent, 19.4 per cent and 30.8 per cent respectively). Italian export dynamic appears indeed weak in comparison with the European partners (in Fig. 4 positive values indicate a worse export performance of Italy compared to the other countries).2 This weakness was already present before the Great Recession and Italian firms tried to address it by implementing profound structural changes. These changes fostered a process of export quality upgrading as well as of export market diversification, gaining access to new and more dynamic markets.3 The relative weakness of the performance of Italian exports in strategic areas is particularly evident when compared to the export performance of Spain (Fig. 5). More specifically, Spain fared better not only in the traditional sectors (“supplier dominated”4 in the graph), but also in the others. In addition, in the “specialized 2 However, due also to the euro depreciation, in the period 2011-2015 Italian exports on average grew more than foreign demand. 3 Prometeia Forecast report, October 2014, chapter 9. 4 The areas were divided into four categories according to the Pavitt taxonomy, which classifies products on the basis of technological and market structure. prometeia September 2016 5 Figure 4Exports of manufactured goods: growth rate Figure 5Exports: growth rate differences between differences between the mentioned countries the mentioned countries and Italy, 2014-2016 and Italy (pp, current prices) cumulated (pp, current prices) 8 45 6 36 4 27 2 18 0 9 -2 0 -4 -9 -6 -18 -8 2001 2004 2007 Germany 2010 2013 France Spain Source: Prometeia calculations based on Eurostat data * First semester 2016* science supplier scale based dominated intensive Germany France specialized suppliers Spain Source: Prometeia calculations based on Eurostat data suppliers” areas, which comprise the engineering industry, the differences compared to Germany, which shares high comparative advantages with Italy, are high. Furthermore, the important changes implemented by Italian companies do not seem to be sufficient to close the gap with other countries, especially with Spain which managed to “sell caviar to Russians, shoes to Chinese and cars to Germans”.5 The success of Spain, combined with lower labour costs and a draconian labour market reform, has certainly contributed to the high inflows of foreign direct investments (FDIs) experienced by the Spanish economy (while in Italy FDIs have still a low importance compared to other countries). 5 Moffet, M., Export Prowess lifts Spain from Recession, The Wall Street Journal (30th October 2013). Copyright © 2016 by Prometeia, Bologna, Italy Disclaimer: This material is intended as a source of information and research and cannot, under any circumstances, be considered as an offer or solicitation for the purchase or sale of any financial instruments. Every statement of financial markets trend is based on past and current market conditions. Any reference to future returns of a financial market does not constitute an estimate of the actual returns that the financial market may achieve in the future. The information and opinions contained herein are compiled or arrived at from sources by third parties. Prometeia does not accept responsibility for their use or make any representation as its accuracy and completeness. All rights are reserved by Prometeia Associazione. Any reproduction is authorized only if indicated the copyright owner. See more on www.prometeia.com prometeia associazione per le previsioni econometriche via g. marconi 43, 40122 bologna, italia — tel. +39 051 648 0911 — fax +39 051 220 753 [email protected] — www.prometeia.com based on data available on 28 September 2016 contact person: Stefania Tomasini tel. +39 051 648 0927 —