Optimists Say Recovery In Italy Will Start In 2014

Includes: EWI
by: Alberto Abaterusso

The most evident symptom of the Italian recession is the high unemployment rate that has exceeded 12% in June 2013. The youth unemployment rate (15-24years) is 39.1% in June 2013, up 0.8 percentage points compared with May and 4.6 percentage points on an annual basis, according to the last Istat's interim seasonally adjusted data.

There are 642,000 people under 25 who are looking for a job. If we consider that the population of young people between 15 and 24 years is about 5,919,051 inhabitants living in Italy in 2012, then 642,000 is about 10.81% of this population and 17% of the population of individuals between 20 and 24 (the denominator of the quotient is not all work force). If Istat calculated that 39.1% is the youth unemployment rate, then it means that the labour force is about 1.64 million of young people (15-24) and that the rest (4.28 million, 72.3% of the entire young population) is not either actively looking for a job or employed. The reasons are that many of them are still at school, at university, etc.. And many others feel discouraged to look for a job.

In a nutshell, a way to encourage enterprises to increase production and so absorb unemployment is through an expansionary monetary policy.

The Governing Council of the ECB, after reducing the interest rate on the main refinancing operations, bringing it to a record low of 0.50 percent (May 2013), announced at the beginning of July 2013 that it plans to keep official interest rates at levels equal or lower than the current ones for a period of time, in view of the prospects for low inflation, a generally weak economy and very low monetary growth.

Through this expansive monetary policy, the ECB provides liquidity to the whole euro zone and in particular to banks by adjusting the cost of the euro and loans across the single currency area with 360 degree effects on the economy: the decrease of the rate on main refinancing operation will cause decrease in the rate of interest on loans that banks give to their clients: households and businesses.

However, according to bulletin no. 73 of the Bank of Italy the conditions in the credit markets remain strained at the moment.

In the first four months of the year we saw a more marked decline in loans to households.
The tightening of lending conditions to households for house purchase stopped, by reflecting less unfavourable prospects for the real estate market.

An Istat's study shows a recovery (albeit slight) of the real estate market in the last three months of 2012. However, the real estate is increasingly in crisis as certified by the latest data released by Istat for the second half of 2012: the number of residential building permits collapsed, with tumbles on an annual basis to 28.3% on new housing and to 26.4% for the habitable useful surface areas. On the negative side are also permissions for non-residential construction, even though the fall is less pronounced (-17.9%).

The decrease in bank interest rates will determine the rush of investors towards short term State securities (e.g. Treasury bills), causing their yield to decrease.

With reference to the treasury bills market, the Italian Treasury Department recently allocated all of the new Bot (Buoni Ordinari del Tesoro), for a gross amount of 8.5 billion euro, with maturity of 6 months (January 2014) and yield back below 1%. The average yield fell to 0.799% from 1.052% (auction of June for Bot).

At the moment the main Italian banks are paying on certificates of deposit (CD) interest rates ranging between 0.20% (with a maturity of 3 months) and 1.50% (with a maturity of 2 years).

Furthermore, in Italy the tax on Buoni Ordinari del Tesoro is 12.5%, while the tax on certificates of deposit [CD] is 20%.

The liquidity provided to the system through the monetary policy of the ECB is expected to stimulate the demand for goods. According to bulletin no. 73 of the Bank of Italy:

household spending remains weak and after a further decline in the current year, will stagnate in the next.'

The recovery in consumption (in 2014) should therefore encourage enterprises to increase production i.e. the supply of goods.

Meanwhile, according to the Bank of Italy, the industrial production already stopped in diminishing:

According to our assessments, Italian GDP would be declined less intensively in the second quarter than in the first. The latest polls suggest a possible stabilization of companies' investment activities in the second half of the year. Industrial production would cease to decline in the recent months.

The Bank of Italy's estimates on industrial production are supported by Istat and the Esi (Economic Sentiment Indicator) that detect a recovery in confidence about the Italian economy:

Business confidence climate is growing, according to Istat: it rose to 79.6 in July from 76.4 in June. The increase in the overall index reflects the improvement in confidence spread to all sectors of the economy observed: from manufacturing and construction to those in the retail and services market.

In July Italy has been leading the recovery of confidence in the prospects of the economy recorded in the euro zone. The Esi has in fact recorded an increase of 2.9 points compared to more than 1.2 of the average euro zone, France, Spain and 0.7 in Germany.

The results of July, which are in a note issued by the EU Commission, confirm the recovery trend of the Esi since May 2013. A recovery in all the EU countries was even more marked (2.4 points on average) and the euro zone was determined mainly by increased confidence in the prospects of the economy recorded between consumers and managers in the industries of manufacturing, services and retail trade. The EU Commission informs that also the employment levels have generally been revised upwards, particularly in manufacturing, construction and retail trade industries. The BCI (business climate indicator) of the EU Commission that measures the expectations on businesses in the countries of the euro area also rose by 0.14 points in July.

To increase production, the Italian companies have to hire unemployed people, but the recovery of the conditions of the labor market will take place only at the end of 2014, according to the bulletin from the Bank of Italy:

The conditions of the labor market, which typically reacts with delay to changes in production, would continue to deteriorate, showing a slight recovery in the second half of 2014. The number of employees will decrease with about 1.5 percent in 2013-14, the unemployment rate would almost be 13 percent over the next year.

The greater amount of money in circulation will, partly, be deposited in banks, which will then have a larger amount of money to lend to businesses. So there will be more funds to finance the expansion of production. However, according to the focus on the country by the Bank of Italy the policies for the provision of loans by banks to businesses have become"slightly more restrictive." A further tightening of credit supply:

mainly reflects the unfavourable prospects for economic activity and an associated higher credit risk.

The situation should improve as the Ministry of Economic Development expects to pay all the debts of the public administration to companies by the end of 2014. And this should at least reduce the credit risk.
Meanwhile, there is still a situation of generalized difficulties and it is even larger for small and medium enterprises that apart from bank loans have no other way to finance the production.

What about inflation: According to the Bank of Italy's bulletin

The balance of payments on current account should return to surplus in 2014 for about one percentage point of GDP, by reflecting, in addition to the slowdown in imports, the fall in oil prices and the growth in exports mainly to the markets outside the area.

The growth in exports means that the inflation rate will remain low. The expected data on inflation is confirmed by the rest of the bulletin:

In our evaluations, incorporating the technical assumption of VAT increase currently scheduled for next October, inflation is expected to remain around 1.5 per cent on average in 2013 and the next year.

If the optimistic forecasts are plausible, although Italy is the weakest link in the group of European countries that are struggling because of the economic crisis, the road to recovery seems to be not so long and we should be able to see the light at the end of the tunnel already in 2014.

ECB's monetary policy, said Mario Draghi:

provides support to a gradual recovery in economic activity in the remaining part of the year and in 2014. Looking ahead, our monetary policy stance will remain accommodative for as long as necessary.

Let us hope there will not be a political crisis because this might be the last train to the recovery for Italy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.