Here are the real economic challenges for Italy
Although growth continues to show positive signs, the economic and financial situation, combined with the political crisis, brings with it a series of risks for our country. And the specter of recession continues to hover across Europe, as well as the worrying widening of spreads. The analysis by Michele Morra, Portfolio Manager of Moneyfarm
War in Ukraine, energy crisis, slowed growth, continuously rising inflation and the fall of the Draghi government are the main ingredients of this beginning of the second half of the year in Italy. On 25 September, a vote will be taken to elect a new government. To better understand the future, let's start with an analysis of the challenges that our country will have to face and with the map of its economic situation.
The challenges that Italy will have to face
The Italian GDP in 2022 will grow as well as in 2023. According to the latest Istat data on preliminary estimates, in the second quarter of the year the Italian economy recorded a growth of 1% in economic terms and of 4.6% in trend terms . Given that it marks an expansion phase of the GDP for the sixth consecutive quarter. The growth acquired for 2022 is equal to 3.4%, although it has been constantly revised downwards since March 2022, in line with that of other European countries. The economic and financial situation, combined with the political crisis, brings with it a series of risks for our country.
- The first element of concern is linked to the economic situation in Italy. The political crisis comes at an uncertain economic moment. At the moment the growth estimates are positive for both 2022 and 2023, but it should not be forgotten that the specter of recession hovers over the whole of the EU (and therefore also Italy).
- The second element is financial risk, measured by widening spreads. Whenever financial risk increases in the Eurozone, and globally, Italy pays more and more in terms of the yield differential with German Bunds.
Trade balance in balance
The geopolitical tensions, with the related problems related to energy supply, have also affected the increasing expenditure of energy imports which are causing a deterioration in the trade balance, expressed as a percentage of GDP, which would decrease in 2022. (+ 0.6%) to reach + 0.1% next year.
In 2021, a very positive year for trade, Italy's foreign trade showed a strong recovery after the collapse of the previous year (due to pandemics and forced closures). Exports of goods and services increased overall by 13.4%.
Imports also performed well, registering a rebound of + 14.3%. It should be emphasized that this recovery phase continued also in the quarter of the year. The sharp rise in the prices of energy raw materials, which began in the second half of last year, led to an increase in import flows. This, in turn, caused a deterioration in the Italian trade balance which, in the first quarter, marked a deficit of 7 billion.
Imports (relative to exports) are expected to increase this year. This imbalance results in the deterioration of the trade balance. Situation that should improve in 2023 when the two variables should rebalance.
Power
The problems of energy supply continue. According to a latest survey by the International Monetary Fund, European infrastructure and global supply have so far faced a 60% drop in Russian gas supplies since June 2021. Total gas consumption in the first quarter fell 9% compared to the previous year. previous year and alternative supplies are being used, in particular liquefied natural gas from global markets (US main exporters).
According to the IMF analysis, the EU could manage, without too many repercussions, a reduction of up to 70% of Russian gas. The situation would worsen in the event of a total stop of Russian gas. In this case, bottlenecks could reduce the ability to redirect gas within Europe.
The consequence? Shortages of 15% to 40% of annual consumption in some Central and Eastern European countries. The presence of obstacles that do not allow a flow within the EU represents a major problem that would affect some countries more than others. In a fragmented market, the economic impact deriving from the lack of gas would have significant effects, up to 6% for some countries of Central and Eastern Europe (in particular Hungary, the Slovak Republic and the Czech Republic).
And for Italy?
In the event of a drastic cut in Russian gas supplies, the situation will certainly not be rosy for our country. In fact, Italy will have to face significant consequences due to its high dependence on gas in electricity generation. Having access to alternative sources of supply and international markets for LNG is undoubtedly essential to try to make the impact less strong and destabilizing.
It should be emphasized that the Italian situation in the energy field relates both to national initiatives but also to EU decisions. If it were possible to maintain a situation without obstacles to the arrival of gas, within the EU (therefore a cohesive market), the energy problem could be managed with less tension within the individual countries.
Equity asset allocation
Although the valuations of Italian equities seem less expensive than those of the European and global indices, it is necessary to consider how the FTSE MIB is a generally pro-cyclical index and therefore more subject to phases of uncertainty such as the one we are experiencing. This cyclical nature derives from both country risk and sector exposure, which is highly concentrated in the energy, automotive and banking sectors.
Bank equities may also suffer from strains stemming from widening spreads caused by political uncertainty, monetary tightening and increased likelihood of default on corporate loans and bonds. Given the conditions of global uncertainty, it would be appropriate to diversify the equity component of the portfolio with a global exposure.
Bond asset allocation
From a bond perspective, political uncertainty may increase the short-term volatility of Italian bond spreads, although situations such as those seen in May 2018 (with spreads up 200 basis points) are less likely. It should also be remembered that the bonds of peripheral European countries, in particular Italian ones, generally have a higher systemic risk and contribute to portfolio risk in conditions of global tension.
The implementation of the TPI (Transmission Protection Instrument) by the ECB could mitigate the volatility of spreads, but there are still numerous unknowns to be cleared, uncertainty evaluated negatively by the markets.
The current rate of BTPs, around 2.9%, may contribute to the long-term return of the portfolio, but it does not seem sufficient to justify a significant over-exposure to Italian government bonds.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/ecco-le-vere-sfide-economiche-per-italia/ on Sun, 07 Aug 2022 06:13:10 +0000.