Italy is going from bad to worse

Matteo Salvini © Rex Features
Salvini is dismantling pension reforms and spending too much

“They are going in exactly the wrong direction,” Lorenzo Codogno, former chief economist of the Italian treasury, told The Daily Telegraph. Italy’s anti-immigration, populist government, led by Matteo Salvini of the Northern League and Luigi Di Maio of the Five Star Movement, is dismantling recent pension reforms and introducing a basic income for all.

About one in ten Italians live with serious deprivation, says Ferdinando Giugliano on Bloomberg. But the Five Star’s “citizens’ income” risks getting “bogged down by its own complexity and the country’s famously inefficient bureaucracy.”

In addition to spending more money it doesn’t have, Italy’s anti-establishment government has been attacking France on various fronts in recent weeks, exacerbating political tensions in the eurozone. According to Politico, 51% of Italian voters under 45 would vote to leave the European Union in a potential referendum.

Italy’s leaders have criticised everything from France’s role in Libya to its stance during the migrant crisis, says the Financial Times. “Using France as a whipping boy is a helpful alternative to bashing Brussels, which risks rattling investors.”

Back in recession

Investors, however, are pretty rattled anyway. Consider the economic backdrop. Italy’s GDP has shrunk for two quarters in a row, so it is officially in recession– for the third time in a decade. Industrial production was down by 2.6% year-on-year in November. Youth unemployment in Italy stood at 32% last year, according to Trading Economics. Rome’s interim deal with Brussels over the Italian budget “may have averted a dangerous political showdown for now but nothing is resolved”, says Ambrose Evans-Pritchard in The Daily Telegraph. Given all this, concern over the country’s debt pile will intensify. Government debt comprises 132% of GDP; without growth there isn’t a hope of whittling it down.

Italy’s poor GDP has only been a phenomenon for the last decade, says Societe Generale. Until 2006, Italy’s GDP growth was broadly in line with that of Germany. Before it adopted the euro, Italy tended to let the lira fall, cut interest rates and increase government spending every time it faced a downturn. Under the single currency and Brussels’ fiscal regime, these escape routes have been closed off.

ECB firepower

Another problem is that the European Central Bank has halted its quantitative easing (QE) programme, whereby it buys government bonds with printed money. That leaves Italy without a “buyer-of-last-resort standing behind its sovereign bonds”, notes Evans-Pritchard. This means there is no longer a cap on how high the yields of Italian bonds, and thus implied long-term interest-rates, can go. Dearer money is the last thing a country in debt up to its eyeballs needs. If investors panic and sell off their Italian bonds, the country could fall back into a debt crisis.