Today has brought the economy of Italy back into focus and before I look at the economics let me express my deepest sympathy for also those affected by the Corona Virus there.
Like a soul without a mind
In a body without a heart
I’m missing every part, ( Massive Attack)
Returning to the economics there were hopes from Italy of some financial and economic relief from the overnight Eurogroup meeting so let me hand you over to its President Mario Centeno.
After 16h of discussions we came close to a deal but we are not there yet. I suspended the #Eurogroup & continue tomorrow, thu. My goal remains: A strong EU safety net against fallout of #covid19 (to shield workers, firms &countries)& commit/ to a sizeable recovery plan
Let us consider what it could do? There are essentially four topics at play. Firstly there is the issue of extra spending.
Diplomatic sources and officials said a feud between Italy and the Netherlands over what conditions should be attached to euro zone credit for governments fighting the pandemic was blocking progress on half a trillion euros worth of aid. ( Reuters)
Although actually in a copying of the Juncker Plan that regular readers will recall a lot of this is borrowing and money from Special Purpose Vehicles.
Further proposals under discussions include credit lines from the euro zone bailout fund that would be worth up to 2% of a country’s economic output, or 240 billion euros in total. The conditions for gaining access to this money remain a sticking point.
Granting the European Investment Bank 25 billion euros of extra guarantees so it can step up lending to companies by a further 200 billion euros is another option.
The third is support for the EU executive’s plan to raise 100 billion euros on the market against 25 billion euros of guarantees from all governments in the bloc to subsidise wages so that firms can cut working hours rather than sack people. ( Reuters).
Actually there were apparently requests for even more money to be deployed.
ECB urges measures worth 1.5 trillion euros this year to tackle virus crisis . ( @TradingFloorAudio )
The next issue is how this will be paid for? We have already tip-toed onto that subject because the reference to the Euro bailout fund refers to the European Stability Mechanism or ESM. The catch with it is the issue of conditionality or if you prefer terms. This is awkward on two counts as the two main bits are that a country has to have lost access to market financing which is not true and that it is supposed to present a macroeconomic adjustment programme of austerity when in fact the plan would be to “Spend! Spend!Spend!”
The use of the European Investment Bank is complicated by the UK still being a 14% shareholder.
Finally in this sweep we have the elephant in the room which is the issuing of joint Euro area bonds or as they have been rebranded Corona Bonds. This has collided with a regular problem which is that the countries which would in effect be financing this are not keen at all whereas those that would benefit are very keen but cannot persuade the former. We have been down this road so many times now and have always ended up singing along with Talking Heads.
We’re on a road to nowhere
Come on inside
Taking that ride to nowhere
We’ll take that ride
Before I look at the impact of the above on Italy we need to see where it stands in economic terms. The opening salvo was fired by the IHS Markit survey from only five days ago which now feels a bit like forever.
The Composite Output Index* dropped from 50.7 in February to 20.2 in March, falling a record 30.5 points and signalling the sharpest contraction in Italian private sector output since the series began in January 1998.
The downturn was most marked in the service sector,
although both services providers and manufactures reported record reductions in output during March.
This came with the lowest PMI number I can recall which was 17.4 for the services sector. We have learnt over time to take these surveys with several pinches of salt but it was clear we were seeing a large fall in economic output which in the case of Italy comes on the back of at best stagnation.
Yesterday the Italian Statistics Office produced its Monthly Report.
First signals of COVID -19 economic effects are displayed by March consumer and business surveys -which deteriorated sharply- and February extra EU trade and retail trade.
Okay let’s look back to February.
Extra Eu trade preliminary figures were influenced by the sharp fall of exports towards China (-21.6% with respect to
the same month of the previous year) were the epidemic originated. Retail trade improved possibly due to the
increase of precautionary expenditure for food in the first phases of the health emergency.
So the only good news was some precautionary buying of food and other essentials.
Now March and as BBC children’s TV used to say, are you sitting comfortably?
In March, the consumer confidence climate slumped. The heavy deterioration affected all index components. More
specifically, the economic climate current and future and the expectation on unemployment plummeted. These
negative signals suggest that there might be in the coming months a deterioration in income, consumption and labour
They have modelled what they think the impact will be from this.
We provide two different scenarios, the first in which the lockdown will be concentrated in March and April and
the second in which the lockdown will last until June. In the first case consumption will be reduced by 4.1% on
yearly basis in the second case by 9.9% . The consumption fall would determine a value added contraction by 1.9% and 4.5% respectively.
If we now add in the other sectors we get an even larger GDP fall for example there is this.
More precisely, for sectors in lockdown or for which we assume that the turnover is near zero
(i.e. tourism) we evaluate the overall reduction of production and its impact on consumption.
If we factor in tourism as being virtually zero then the fall in GDP implied above doubles at least as it would be seen in the exports numbers rather than consumption.
If we look at the Italian situation we see that its own spending plans dwarf the Euro area ones. Here is Prime Minister Giuseppe Conte from Monday via Google Translate.
Today’s decree brings 400 billion of liquidity for businesses, with the #CuraItalia we had freed 350. We are talking about 750 billion, almost half of our GDP. The state is there and immediately puts its firepower into the engine of the economy. When Italy gets up it runs.
The next context is that this is way beyond the ability of the ESM to deal with alone.
The ESM, with its unused financial firepower of €410 billion, could provide credit lines at low interest rates. ( Klaus Regling)
Actually that is more than we have been told in the past but as you can see the numbers are so large here even 10 billion is not especially material. As there would be calls from countries other than Italy the ESM presently needs more ammo.
If we look at the public debt of Italy it was 2.44 trillion Euros at the end of the third quarter of last year. So if the spending plans above come to fruition we will see it rise to more like 3.2 trillion. With the economy shrinking we could see a debt to GDP figure of the order of 200% for a time. The real issue is for how long a time?
As to the bond vigilantes then they have mostly been anaesthetised by the QE buying of the ECB which is likely to be around 15 billion Euros or so per month. Whilst the Eurogroup indecison has raised the benchmark ten-year yield by 0.08% today ( and I am assuming the ECB is buying more today to resist this) it is at 1.67% under control. But as you can see even the powered up Pac-Man of the ECB is in danger of being swamped by the size of the bond issuance.
Oh and as to Eurobonds well actually they do exist.
When both the EIB and the ESM increase their actions, they need to issue bonds to finance their lending. The EIB – and to a smaller extent the European Commission – issue such debt for all 27 EU Member States, and the ESM for the 19 euro area countries. These three institutions have issued mutualised debt, i.e. European debt, for many years already. Today, these institutions have around €800 billion in outstanding European debt. ( Klaus Regling)
Let me finish with something more optimistic Italy has a large grey economy estimated at over 200 billion Euros and it is a nation of savers.
The saving rate of consumer households was 8.2%, 0.1 percentage points lower than in the previous quarter. ( Istat)
Let us cross our fingers and hope that it can mobilise both.