Essay on Italian Crisis of 2018

The Italian economy has been hit by a deep-seated political and economic stir which has led to an unprecedented financial crisis. Italy is the only eurozone country to enter recession in 2018 after two consecutive quarters of contraction in the business cycle. Alongside the 2010 debt crisis of Greece and 2018 currency crisis of Turkey, Italy stands alone to be the only eurozone nation to experience recession for the third time in the past decade.

The Italian Economy: A Background

Italy has been a ground for political and economic turmoil ever since the financial crisis in the United States sprung up. The effects of this breakdown could be observed in other real economies, especially in Europe. The markets and other indices began to slide officiating to a crash after March 2008. The euro area was able to withstand the pressure of the downfall for a little longer than the US. However, post-crash, production fell by 20 percent in the euro area between the first quarter of 2008 and the second quarter of 2009 and exports by 21 percent between the third quarter of 2008 and the second quarter of 2009. Furthermore, gross fixed capital formation declined by 11 percent.

In the context of Italy, both industrial production and exports fell more rapidly than in other European economies. The production declined by 24 percent and the total exports by 25 percent between the first quarter of 2008 and the second quarter of 2009. This was anticipated because of the significance of Italy's trade position in the eurozone and the effects of the devaluation of the dollar.

The unemployment rate has risen by approximately 1 percent. Despite the statement given by the 2009 World Economic Outlook of the International Monetary Fund (IMF) on the progressive decline of unemployment, the unemployment rate in Italy has increased by approximately 1 percent. Although the recovery can be felt, the course that these economies follow is uncertain and conditional to policy changes.

Contemporary Situation of the Modern Italian Economy

In the present times, Italy is trapped in a downward debt-growth cycle. The weak fundamentals of Italy evince the substandard condition of the economy. With a debt of 2.3 trillion euros, which accounts for roughly 131.2 percent of gross domestic product (GDP), it reckons a debt more than double the eurozone limit. Unlike other recessions faced by the members of the European Union since the Second World War, this situation has proved to be the most profound. Moreover, an unemployment rate of 10.7 percent in the year 2019 and a GDP of 1.93 lakh crores (in USD), less than that of 2005 inflicts the grave condition of the economy.

Genesis: Determinants of the Issue

The damage caused to the economy is due to self-inflicted reasons such as the formation of an erratic coalition government, weak banking system, intrinsic and adventitious factors.

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Political Stir-Polity

The growing instability due to political chaos has caused turmoil for the European Union. The inefficacy to form a stable government dates back from the March 2018 Italian general elections that resulted in a hung assembly and a need for snap elections. The two populist parties namely, the Five Star Movement and the Lega secured a majority (with 32.7% and 17.4% respectively) in the parliament, thus leading to the formation of a coalition government. Due to the sudden resignation of the proposed prime ministerial candidate, Giuseppe Conte, an opposition amongst the coalition stirred. They refused to offer another choice for finance minister, discarding the coalition. This steered President Mattarella to appoint Carlo Cottarelli, former International Monetary Fund official, as an interim Prime Minister until another round of elections were conducted. This decision taken by the President did not comply with the coalition. While one party favored tax cuts that were business-friendly, the other focused more on expensive welfare programs as a means to extricating the economy from the collapse. Nevertheless, the Keynesian approach does not fit in the situation due to the excessive amount of national debt. This disagreement of the alliances on fiscal priorities caused a conflict of interest.

Proposed Budget

The recent elections represented a blowback directing to the fall of the Italian economy. The coalition had promised the masses money that could not be retrieved unless it was to ask European Union officials, asserting a weak sense of governance and decision-making. The agenda of the government stated a deficit equal to 2.4 percent of the GDP, contrary to the previous government that had called for a 0.8 percent deficit. The statistics show the inadequate funds both the parties have in order to comply with their endorsed campaigns for schemes like the pension reform or the citizen's wage. The divide between the cost of fulfilling promises by implementing policy changes and the aim to minimize public debt was a major predicament that the coalition government had to face.

The Propaganda of an Anti-Brussel Idea

It is a well-noted fact that the populists at power have followed an anti-Brussel and anti-euro idea for the Italian economy despite the immense assistance that the European Union has provided it with to put Italy back on its feet. Regardless of the damage, it can do to do the market and the economy, their actions to join hands with Portugal and Spain manifest contradicting beliefs for the European Union and the euro. Brussels nearly accused the coalition of infringement of their agreement by excessive spending as highlighted in the 2019 Budget Law. Matteo Salvini, an influential politician released a statement emphasizing on the grave situation between Europe and Brussels and triggering anti-Brussel ideas.

Weak Banking System

The number of questionable loans is on a surge implying a frail banking system in Italy. The banks in Italy hold a huge amount of domestic government debt. European financial leading group, UniCredit, holds large volumes of debt. When production increases, the number of bonds and their value held by UniCredit reduces, deteriorating their capital. A huge collapse has been noticed when it comes to UniCredit shares from €18 to €12. There is an urge for the banks to become a bit more cautious with regards to lending. They raise interest rates or deny the consumers to borrow money. This would lead to a prolonged economic growth and a rise in unemployment. This worsens the situation of the economy and the financial situation of the government. This calls for a higher risk premium on Italian bonds from investors directing to an economy-wide doom loop.

Government Blame on Extrinsic Factors

The populist government of Italy put the blame on extrinsic factors such as global economic slowdown or the limiting amount of spending policy imposed by the EU. Prime Minister Giuseppe Conte has been criticizing the US-China trade war and slow global trade for the challenges faced by the Italian economy. The narrative of the populist government seems to be in conflict with data released as the net trade was found out to be positive. Cultural and historical factors limit an economy’s productivity growth. Corruption, inflexible labor market and shrinking labor force will only add up to the issues of the Italian economy. Given the weak access to capital and credit in Italy, the economy needs a two-fold measure to regulate the economy.

Consequences

It is anticipated that Italian consumer demand remains moderate and expects the investment to decline for the second consecutive quarter in the fourth quarter due to lower business confidence, greater uncertainty and lower credit supply. The stock market in Italy has been deeply affected by this recession. The benchmark stock market index of the Italian stock market, FTSE MIB dropped by 0.7% recently, worsening its condition as a European index. The currency of Italy and the other 18 members, the euro, dropped to an all-time low of $1.153 for 10 months. Global markets were shaken with a drop of industrial average by 1.58% while the investors shifted money into a safe haven of US bonds, resulting in pressure on bank shares. According to Nicola Nobile, an analyst at Oxford Economics, based in Milan, “The government will most likely miss the fiscal targets agreed with the European Commission at the end of last year (2% of GDP for 2019 and 1.8% for 2020)”. Moreover, it is extremely unlikely for Italy to default out of the Euro-One because of the repayment of the heavy sum of debt. The populist parties, the Five Star Movement and the League did not call an off for the euro membership, given the majority of Italians who do not want to leave the European Union or the euro currency. The two parties hope to win by an even more mandate in the snap elections. In April 2019, the league expected to win by 37%, however, the party support seems to have reduced. The European political leaders are likely to enforce sanctions by cutting off EU funds for the Italian economy. However, if the recession continues to exist even by the end of 2019, any measure of government spending will be unsustainable.

Conclusion

The autumn budget could prove to be the best opportunity to make rational decisions and keep the faith of investors intact. The country’s deficit could also be kept under the standard limits by introducing a raise in value added tax. An injunction of the pro-EU group will likely keep things stable and restrain Italy to become the epicenter of another financial crisis. In order to keep the euro from collapse and get the Italian economy out of the debt-trap, Mario Draghi, President of the European Central Bank, suggested bond-buying, hence, establishing credibility and a strong faithful relationship with its eurozone partners.