Italy will struggle to return to economic growth in 2013 despite a rise in manufacturer’s confidence this month, a lesser rate of economic decline in the 3rd quarter and shrinking bond yields since July.
People are optimistic creatures and do not wish to be bombarded with an endless stream of negative facts. Bad news decreases ratings and page views, so the mainstream media attempts to spin data in a positive light. Reading the headline above, you may believe that Italy has turned a corner with increasing business confidence and an easing recession. Those cherry-picked facts are not indicative of Italy’s true economic condition.
The article hangs its hat on improved confidence in November, a smaller decrease in GDP in the third quarter and recent low bond yields. These figures are not what they seem.
While the confidence index improved to 88.9, this score still represents a poor performance. Any number less than 100 means that pessimists outnumber optimists; what the rise from October to November tells us is that the number is still bad, just not as bad.
The article is correct in pointing out that Italy’s rate of economic decline decreased to a level of only 0.2%, but look at the year-over-year performance:
The longer-term trend smooths out the temporary ups and downs of a data series, like a an outlier quarter of -0.2% that might excite permabulls, to show that Italy’s GDP still shrunk 2.4% in the last year even with a better third quarter. Economic performance is still poor, just not as poor.
Bond yields have dropped from over 6.5% to just over 4.25% since July:
This decline is not indicative of an impending Italian boom. Recall that Mario Draghi promised to print money to support bond prices in late July and then released the plan in early September. This implicit guarantee to support periphery bond prices by the ECB has more to do with the decline in yields rather than the fundamentals.
Italy’s economic fundamentals all point towards continue recession in 2013. Let’s review the components of GDP and determine whether each will be higher or lower next year to predict the direction of Italy’s GDP.
GDP is simple to calculate, Consumption + Government Spending + Investment + Trade Balance. The components are in order of their importance to the economy. Consumption is easily the largest piece with the trade balance the smallest. We will review the components in the order above.
Consumption will increase if consumers have more discretionary income at their disposal. Unfortunately, rising unemployment and taxes will curtail spending in 2013, which keeps in line with the trend:
During the last year and a half, retail sales have decreased in 16 months against two increases. This type of performance is to be expected as unemployment has increased steadily in the same time period:
Less workers means less disposal income for consumption, not to mention that the workers fortunate to have jobs will pay higher taxes. The largest component of GDP will decrease in 2013.
Government spending is the second largest component of Italian GDP. Italy is in an austerity program, which has reduced the deficit substantially since 2010. Believe it or not, Italy will have a smaller deficit than AAA-rated France this year and probably next year, too. A smaller deficit is good, but the consequence is that decreased government spending will subtract from GDP. Government spending will remain roughly constant at 2012 levels in 2013.
The next portion of the GDP calculation is Investment. The long-term average for investment as a portion of GDP is 22.7%, but this number dropped to about 19.5% in 2010 where it remains today. Economists expect investment to remain the same, at best. Italy will receive no boost in growth from increased investment.
The last piece we consider is the trade balance. The decrease in the price of the euro has led to increased Italian exports, and the recession has reduced imports. Since these factors are unlikely to change in the short-term, Italy should benefit from a continued rise in its trade balance adding to GDP.
With the foregoing information, let’s update the formula C + I + G + BoT to C↓ + I- + G- + BoT↑. While I and G remain flat, the trade balance should improve in Italy’s favor, but consumption will continue decreasing. Since consumption accounts for 61% of Italy’s GDP, the tapped out Italian consumer virtually guarantees a continuing recession in 2013. At least Italy is not one of the other PIIGS, all of whom are in much worse shape.
While Italy will not be getting out of trouble in 2013, it shouldn’t fall further into the debt spiral either. Italy should be able to continue to fund its debt. If you’re looking for a country that will precipitate the breakup of the euro, look elsewhere but with one caveat. If the country revisits bunga-bunga time in February, then all bets are off.