Experts Warn Italy Recession Would Be Catastrophic for EU

According to data from the International Monetary Fund in April, Italy is the eight biggest economy in the world and fourth largest in Europe at $2.18 trillion.

But earlier this month, Europe was put on high alert as risk-spreads on 10-year Italian debt rocketed to a five-year high of 290, Yahoo Finance reported.

Italy already has a debt of €2.3 trillion ($2.68 trillion)—equivalent to 132% of GDP and the second highest in the eurozone behind Greece.

Bank of America has warned that Italy’s GDP growth is “flirting with zero” in the third quarter of 2018, adding that risk spreads could “easily rise to 400 basis points” if the country’s budget breaks financial rules.

Markets have become increasingly nervous over the country’s recently appointed coalition government’s plans to introduce huge tax cuts and welfare spending in its forthcoming budget in early 2019.

The government’s flat tax plans would cost €50 billion a year and a basic income for the poor would set Italy back €17 billion, while a pension reform would cost €8 billion with a suspension in VAT rises costing 0.7 of GDP.

Over recent weeks, the Lega and Five Star Movement coalition has also threatened an all-out war with Brussels as it demands more money to implement its plans.

Earlier this month, Italy’s Deputy Prime Minister Luigi Di Maio put the eurozone on the edge after announcing his populist government would ignore agency ratings’ warnings and carry on with its hefty reforms, putting “Italians first”.

Italy’s Finance Minister Giovanni Tria also warned the country would suffer “repercussions” when quantitative easing ends—an expansionary monetary policy whereby central banks buy predetermined amounts of government bonds in order to stimulate the economy.

  Two Alternatives

Professor Vassals K. Fouskas of the School of Business and Law at the University of East London, argued that Italy is in fact already in recession due to its flat growth over recent years and spiraling debt pile.

He said there are two alternatives for Italy—the first is it ignores European Central Bank rules on monetary discipline and raise inflation—the consequence of which would be it exiting the Economic and Monetary Union.

The second, and perhaps more damaging path, would be to extend the austerity process similar to what Greece did, which saw the ECB and IMF committee more than €288 billion in loans to keep it afloat—making it the world’s biggest financial rescue.

But Fouskas warned that if Italy was to follow either of these paths, it could prove catastrophic not only for the country itself, but for the European Union and other major global economies.

He said: “Italy is already in recession. It has been having zero percent growth for several years now, an unmanageable debt spiral, a declining population while experiencing a widening of the gap between the north and the south, hence the rise of authoritarian and populist movements.

“Italy faces the predicament of either brushing off the ECB rules of austerity and monetary discipline and inflate, the consequence being exit from the EMU; or deepen the austerity process and follow a path similar to that of Greece.

“Both paths are catastrophic for both Italy and the EU, especially the Italian people. Globally, too, the consequences will be catastrophic. Italy may well insert itself into those forces that undermine and eventually undo the process of globalization altogether.

“Italy is a very large economy, and seeing it leaving the EU or eurozone would have immense and negative consequences on both Europe and the world.”

  Damaging Conflict

Jon Cunliffe, chief investment officer at financial firm Charles Stanley, fears an increasing conflict between Italy and the EU over the coalition government’s budget plans.

Interior Minister Matteo Salvini said earlier this month that Italy would “gently brush” the 3% limit of GDP of the Maastricht criteria—a set of rules that EU member states need to meet to enter the third stage of the Economic and Monetary Union.

Cunliffe still thinks a resolution between Italy and the EU can be reached, but warned of serious volatility in Italian and eurozone assets.

He said: “There are fears that the populist coalition will seek an increase in public sector spending which could push next year’s budget deficit above the 3% EU ceiling. Should this occur, the markets are fearful that through the ECB the EU authorities will play hardball, in much the same way that occurred with Greece, which wanted to ease up on austerity.

“In this situation, the ECB could choose to restrict funding to the Italian banking system and, by extension, the Italian state. Our expectation is that there will be an eventual budget agreement between Italy and the EU, but that in the short term there will be volatility in Italian—and eurozone—financial assets reflecting the size of Italy’s state debt and its banking system.”

In IHS Markit’s August report—data collected from 400 companies in the Italian service sector—the manufacturing gauge for Italy was recorded at 50.1 in August—only just above the 50-mark which indicates steady output.

Business confidence fell to its lowest level since August 2013 and although a quarter of the survey panel indicated positive growth expectations, around 7% of companies expected a contraction.