Five years ago we doubted that Italy would stay in the Euro for a decade. Now half that decade is up and so far Italy is still in the Euro. But the referendum yesterday, which resulted in a 59-41% majority against a programme of constitutional reforms to make the country more governable and the resignation of the widely admired Prime Minister Matteo Renzi increased the chances that Italy’s euro membership is on borrowed time.

Since 2000 Italy’s competitive position has deteriorated by 14% on OECD unit labour cost data. But the position is at least improving – by 3.2% in the past 5 years. But this progress is glacial compared with the scale of the problem. In the current century, Italy’s share of world trade has dropped from 3.7% to 2.4%. Despite the weakness of exports, Italy’s current account is now in surplus but this is because of very weak economic growth and depressed consumers expenditure (the flip side of the attempt to improve competitiveness by squeezing real wages). The weakness of consumers expenditure in the last 6 years is shown in the chart.

Even Renzi’s labour market reforms have their down side. For new employees the traditional employee protections are greatly weakened. In time this will help free up the labour market. But its initial beneficial effects are offset by the incentive these reforms give for the less capable employees to hang on to their old jobs.

For the time being, these real economy issues which will determine what happens to Italy in the long run take second place to the crisis of refinancing the banking system, especially the world’s oldest bank, the Banco Monte dei Paschi di Siena which had hoped to complete a €5 bn recapitalisation today. Bank shares were hit this morning but have recovered. If the markets will not refinance, then the Italian government is likely to face a bill that could reach €40 bn for all the weak banks. With a debt GDP ratio already about 130% this is a headache the government could do without.

We expect ECB chairman Mario Draghi to provide sufficient liquidity to prevent a short term crisis that could pull Italy out of the euro.

Longer term, the problems remain. There is no doubt that Italy could stay in the euro if it were prepared to pay the price of virtually zero growth and depressed consumer spending for another 5 years or so. But that is asking a lot of an increasingly impatient electorate. We think the chances of their sustaining this policy are below 30%.

Quarterly Italian Consumers Expenditure (€ mil 2010 prices)

Douglas McWilliams
President

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