Italy committed to multi-year adjustment programme despite unlimited ECB liquidity, SG warns

Even if the provision of unlimited liquidity to be provided by the European Central Bank lifted the worst of the supply side constraints on bank lending, Italy’s government remains committed to an extensive multi-year adjustment programme, warned today Société Générale (SG).

According to James Nixon, eurozone economist at the bank, as for Spain, the extent of the fiscal adjustment in Italy totally dominates any short-term cyclical considerations while the impairment of the monetary transmission mechanism means that there is very little scope for low interest rates to offset the fiscal consolidation measures.

“We continue to forecast a sharp decline in Italian GDP in both 2012 and 2013, -2.3% and -1.4% respectively, followed by a year of flat growth in 2014. The International Monetary Fund suggests that Italy’s long-term potential growth rate might be as low as 0.5% per annum, which underscores the importance of structural reform as a means of boosting Italy’s long-term growth rate and restoring Italian competitiveness,” he wrote in the note ‘Is Italian debt sustainable?’.

The Italian economy has already contracted for the last 12 months in a row and the dismal performance is in line with the bank’s previous forecast which anticipated that the combination of the credit crunch and fiscal austerity would significantly undermine growth.

At the moment, Spain is widely perceived as likely to request a formal bailout in the coming months in order to avail itself of the ECB’s offer to reopen its bond buying programme, subject to strict conditionality.

“Italy meanwhile continues to point to the low absolute level of deficit as an argument for a ‘conditionality lite’ bailout should it decide to ask for assistance too,” Nixon warned.

Aside from the high level of sovereign debt, the other structural weakness affecting the Italian economy has been a long history of low productivity growth.

“Indeed, this is a problem that has been significantly exacerbated by the earlier post-Lehman downturn which saw GDP fall by 6.7% peak to trough but employment only drop 2.6%. This resulted in a significant step-down in the level of productivity and the subsequent loss in Italian competitiveness,” said the economist.

Nixon also warned Italy looks perilously close to losing market access and finding itself on an unsustainable debt trajectory.

“Italy desperately needs to find a way to lower its debt servicing costs. Moreover, Italy’s economy looks painfully sclerotic, in desperate need of deep structural reforms to boost its long-term growth potential and restore its competitiveness,” he wrote.

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