Country risk: Italy is still the eurozone’s Achilles heel


Jeremy Weltman
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The eurozone is struggling with low growth again, just as Italian debt and a no-deal Brexit risk causing more pain.

European Parliament_780
The European Parliament maintains a safe pro-European majority following recent elections

Eurozone investor risk worsened in Q1 2019, according to Euromoney’s country risk survey, as contributing experts downgraded 10 of the region’s 19 member states, including Germany, France and Italy.

Uncertainty over economic prospects was largely to blame in the wake of disappointing economic growth figures for the second half of last year.

“The eurozone has been struggling with sluggish growth and sub-target inflation for some time now”, says Euromoney survey contributor, Constantin Gurdgiev, a professor at the Middlebury Institute of International Studies. “Despite an uptick in Q1 2019 to 0.4% on a quarterly basis, real GDP growth over the past 12 months averaged just 1.04%, well below the 1.14% average for the past 10 years, and 1.28% over 20 years.”

The Centre for Economic Policy and Research and Banca d'Italia’s joint growth indicator, Eurocoin, has been on a declining trend since March 2018 and has posted six consecutive monthly declines, while the European Commission’s monthly economic sentiment indicator has declined for the past 10 months through to April, weighed down mostly by negative manufacturing readings.

Increasing to 1.7% in April 2019, annual inflation is the highest since November 2018 and is “adding monetary policy uncertainty to the risk of a major economic growth slowdown”, Gurdgiev says, “with the ECB facing subdued but firming inflationary pressures at a time of volatile and lacklustre growth”.

Euro Zone Barometer, a monthly survey of independent economic forecasts, predicts just 1.1% real terms GDP growth for 2019 – the worst performance since 2013 following a recent downgrade – and 2020 growth of 1.3% is hardly anything to take comfort from.

Unemployment may be falling but remains high in Greece, Spain, Italy, France and other countries, which with public spending cuts and real wage stagnation, is still fuelling discontent among European voters.

“This is consistent with the growing gap between the more conservative attitudes of the older voters and younger generations,” Gurdgiev notes when analysing the recent European Parliament elections.

Older voters appear to be concerned with preserving the socioeconomic order that secures their pensions and social entitlements – as evidenced by the decidedly left-leaning economic policies adopted by the majority of even the right-wing populist movements, he explains.

Whereas, Europe's younger voters are leaning toward left-wing populism, driven by concerns for the environment and by economic policies favouring a state-centric approach to the redistribution of public resources – away from older voters and toward more public investment and spending on education, local infrastructure and the environment.

These divisions were evident in the elections, showing reduced voter support for the centre-right and centre-left political parties; a growing young vote share going to the Greens and extreme-left Greens; continued strong performance of populist parties in core European states, including Germany and Italy; and higher rates of voter turnout signalling increasing political participation by Europeans.

Bigger risks

The elections signal something, and could bring more discontent during the summer, but they are not the biggest risk, say other contributors to Euromoney’s survey, such as independent sovereign risk expert Norbert Gaillard, a eurozone specialist.

“The results of the recent European Parliament elections met expectations,” he says.

“The top three parliamentary groups are pro-European and account for 58% of seats. The consequence is that the European Parliament is safe.”

Neither is there any big risk likely to develop from the situation in Austria, where chancellor Sebastian Kurz was recently ousted in a no-confidence vote for his handling of a corruption scandal.

Fresh elections are to be held there in September, but risk experts like Gaillard do not envisage an anti-business party or coalition coming to power.

Even in Greece, where a change of government is in the offing at the elections in July – with New Democracy demanding less austerity than Syriza accepted and a debt haircut – an agreement with European authorities is more likely than not, without stirring too many tensions.

Greek elections and other political risks are considered mostly background noise.

The bigger issues involve a no-deal Brexit – the UK Parliament is against this, but it still seems to be the default option – and the Italian conundrum caused by an enormous debt burden, an economy in seemingly terminal decline, an unorthodox government resisting change and another conflict with European partners building.

Italy’s risk score has failed to improve as much as other highly indebted countries over the past five years, and has recently begun to fall again.

Although Greece has seen its score fall the most – a whopping 30 points since 2010 – Italy is second in line with a not-to-be-ignored 17-point drop, and if Italy falls it creates a bigger shock for the region as a whole.

Italy’s economy has shown some signs of recovery, but remains in the danger zone with business confidence still falling in April and the country about to be hit with a €3 billion fine for deficit and debt ratios that breach European rules.

With Italy struggling to contain a debt burden totalling 132% of GDP – the region’s second-largest – the financial markets are clearly spooked, resulting in a widening of 10-year yield spreads on Italian treasuries to the German benchmark.

“We need to scrutinize [League leader] Matteo Salvini’s reactions, and monitor sovereign and bank spreads,” Gaillard warns.

“The country will post negative GDP growth in 2019, and the government is in a stalemate but does not want to admit it.

“I remain convinced the Italian public debt is hardly sustainable in the medium term.”

Euro Zone Barometer has Italy’s economy crawling along over the next few years, with high unemployment persisting, the deficit increasing in 2020 and the debt burden rising without any further reforms.

With UK risks also heightened, it promises to be a turbulent ride for European investors.