One of the issues in the Euro area situation has been that a range of countries have come under pressure. The situation started with the smaller economies but then showed signs of spreading to the larger and hence more systemically important ones. This poses an obvious problem in itself but has been added to by the way that the so-called rescue systems of the Euro area depend on the stronger nations bailing out the weaker ones. As the list of weaker nations increases the number of stronger nations to support them reduces too in a system I have labelled an unstable lifeboat.
The European Stability Mechanism
This is an improvement on its predecessor as it has some capital behind it even if some of the capital is supposed to be provided by countries who plainly have no ability to do so. For example Greece will have to borrow the money to pay her share in an example of the type of financial engineering which got us into this mess rather than one which may help us out of it. The dangers of this are illustrated from an EFSF Newsletter.
The ESM will have a total subscribed capital of €700 billion comprising paid-in capital of €80 billion and committed callable capital of €620 billion.
If we feel extremely generous and allow that the weaker nations have capital to pay in which in some cases they do not ,how will they have “callable capital”? The only route for some will be to borrow it if they have to make the commitment described below.
against an appropriate amount of the authorised unpaid capital, which shall be called in accordance with Article 9(3).
The problem is that they will find themselves borrowing the money from the supposedly stronger nations which may tip them over the abyss too.
One of the nations in this situation is my subject of today which is Italy. Her capital share of the ESM is some 17.91% which as you can see is quite a potential exposure before were even allow for the fact that she may have to lend to others so that they can pay their share. On her own account this leads to a potential exposure of just over 125 billion Euros.
This matters for Italy because as she stands she is one of the most indebted Euro area nations if we look at her national debt to Gross Domestic Product (GDP) ratio.The latest numbers from Eurostat showed this ratio to be 126.1% and that it had risen by 4.4% over the previous year. So high and rising. However as well as her own problems Italy is finding that the “rescue” effort is adding to her public-sector debt just as she needs that least. Her share so far of the effort has been 1.9% of her GDP and we know that this will rise as we see today debate about yet another Greek bailout for example and one day the Euro area funds for Spanish banks will have to be paid.
How is the Italian economy doing?
Last week the Italian statistics office told us this.
In the third quarter of 2012 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.2 per cent with respect to the second quarter of 2012 and by 2.4 per cent in comparison with the third quarter of 2011.
This was perceived as good in the circumstances as it was an improvement on the second quarter. However it was a negative number and showed her economy to be firmly in decline compared to a year earlier. One of the reasons that her public-sector debt burden is rising is that what it is compared to -her economy- is shrinking.
Less well reported was this about her construction sector.
In September 2012 the seasonally adjusted index decreased by 8.0% compared with the previous month
So we can see that at the end of the third quarter it was still in decline and furthermore with an underlying seasonally adjusted index at 74.7 (2005=100) it is declining from a very weak starting point.
Italy’s industrial performance
This morning has give us an update on the state of play here and it is not a happy one.
In September 2012 the seasonally adjusted (industrial output) turnover index decreased by 4.2% with respect to the previous month (-3.7% in domestic market and -5.3% in non-domestic market).
If we look at this numbers one matter leaps out of the page at me and that is that the export performance is worse than the domestic one. As so many nations are claiming improved export numbers we see a potentially disturbing issue here. There is potential for the fact that this September had 20 working days as opposed to last years 22 to be an issue but if we check we see this.
With respect to the same month of the previous year the calendar adjusted industrial turnover index decreased by 5.4 %
If we look at the underlying calendar adjusted index we see a reading of 111.4 where 2005=100 however this will mislead the unwary. This is because turnover indices include price changes or inflation. In September for example Italian Consumer Price Inflation using Europe’s standardised measure was running at an annual rate of 3.4% so as a rough guide we need to subtract that from the September 2012 annual comparison if we are looking to look at an estimate of volume trends. When you do that we see that the numbers are genuinely poor.
What about future trends?
There is a gauge for this as we have industrial new orders numbers too.
In September 2012 the seasonally adjusted industrial new orders index decreased by 4.0% with respect to August 2012 (-1.4% in domestic market and -7.4% in non-domestic market).
Again we see a weak number that is compounded by the fact that overseas markets are leading the decline. We can also compare the situation with last year for some more perspective.
In September 2012 the unadjusted industrial new orders index decreased by 12.8% with respect to the same month of the previous year.
As you can see the future does not look too bright when considered in that context. Interestingly for those looking for a calendar adjustment the Italian statistics office does not consider it to be relevant or useful. However it does produce an underlying index for the series which is at 97 where 2005=100. As we mull Italy being back to pre 2005 levels overall we see that external orders (-8.1%) are now falling rapidly and that for 2012 as a whole they are some 4.1% below the levels of the same period in 2011.
Today’s economic figures for Italy show the weakness that was evident at the end of the last quarter and if we look at industrial new orders we see that matters look likely to deteriorate as we move towards the end of 2012. If we move to unofficial measures such as purchasing managers indices we see that her services sector was at 46 in October (here below 50 indicates contraction) and her manufacturing sector was at 45.5. So we see that official and unofficial measures are pointing in the same direction which is downwards.
If we bring this message to Italy’s public-sector debt problem we see the scale of the challenge which faces her. In fact the danger is for something of a “blowout” as further economic weakness leads to higher fiscal deficits which are divided by a lower GDP. This will be compounded as the latest austerity package of 30 billion Euros bites ever more. So far we have a clear map of where that leads from the countries that have tried it and ominously the one area where they have shown a gain which is trade is not working at the moment for Italy.
Added to this will be the fact that at best there will be a drip,drip,drip of funds from Italy to some of her Euro area colleagues. Almost everyday the numbers change (aka rise) for Greece and it will not be too long before Portugal needs another bailout too. This is before we get to the more systemically important Spain. If the unstable lifeboat I have described above starts to founder then the drips will become a flood and may be too much for Italy.
The main hope is that she can mobilise her black economy but that has been an apparently insoluble problem for many, many years.
I found it interesting that President Monti confirmed my views over the weekend. The hyperbole and what I call anti-truth reached new heights.
Perhaps today, without the austerity measures brought in by the government, the euro zone would be no more
And yes it was backed up by a claim that Italy will not need a bailout. We know what usually happens next after that!