Why Italy Continues to be in Troubled Economic Situation

The markets may currently be giving Italy the benefit of the doubt, but recent data have supported a gloomy view of the economic outlook, according to Capital Economics.

Going by the report of Capital Economics it may only be a matter of time before Italy is dragged back into the region’s debt crisis.

Capital Economics says that on a larger perspective, 2012 has so far been a good year for Italy. Ten-year government bond yields have recently fallen more sharply than those of any other eurozone government and at 4.8 percent are now well below the supposedly critical 7 percent threshold. Also recently published data have shown that unlike other economies which slipped behind their budget deficit targets last year, Italy reduced its deficit to 3.9 percent of GDP in line with its goal.

However, Capital Economics gives three reasons for saying that Italy remains in a pretty precarious position. First of all, it is expected that the recession in Italy is deeper than is commonly presumed, prompting public debt to rise sharply over the next couple of years. Data published confirmed that Q4’s quarterly fall in the GDP of 0.7 percent was broad based. Household spending plunged by 0.7 percent, investment fell by 2.4 percent and exports stagnated. If it had not been for a sharp 2.5 percent drop in imports then GDP would have fallen more sharply.

Ben May, European Economist in Capital Economics, has pointed out that the consensus forecasts for a 1.4 percent drop in GDP this year and a 0.1 percent rise next year are too optimistic. The report expects falls of about 2 percent this year and 3.5 percent in 2013.

As second reason, Capital Economics says doubts about the new Government’s ability to pass much needed growth-boosting structural reforms may grow. Admittedly, the new administration is a marked improvement on its predecessor. But it has wilted in the face of pressure and altered reforms to liberalize the service sector and open up professions.

Thirdly, Capital Economics add that developments elsewhere in the region may damage market sentiment and have severe negative effects on Italy, particularly if eurozone policymakers fail to boost the size of the bailout funds.

Capital Economics concludes that Italy remains a major threat to the eurozone’s future. It adds that Italian bond yields could soon reverse at least some of their recent gains, bringing the new government’s honeymoon period to an end.