Flashnote

Economics
Italy

Italy: too much growth optimism

Hard to avoid tax rises in 2016
The Italian governments latest growth forecasts are fairly
realistic for 2015 but appear too high for the following years
Stagnating labour market, weak investment, low productivity
and poor demographics are limiting Italys growth potential
Missed forecasts and an inability to cut expenditure could
force the government to raise indirect taxes in 2016
The Italian government revised up its growth forecast yesterday. The upward revision to
2015 was small (from 0.6% in October to 0.7% now), broadly in line with consensus
(0.6%) and our own forecast (0.5%), and appears realistic in light of the latest soft data.
The government then expects growth of 1.4% in 2016, 1.5% in 2017 and 1.4% in 2018 as
it believes there is a large amount of slack in the economy as well and expects recent
structural reforms either implemented or in the pipeline to bear fruit. Italy, however,
has never achieved three consecutive years of growth above 1.2% since joining the euro.
Our estimates suggest that the output gap might only be around 1% of GDP, leaving only
a small room for a cyclical upturn. High long-term unemployment and skills mismatches
a shortage of skilled workers due to the deficiencies of the education system and retraining during unemployment mean structural unemployment could be as high as 10%.

14 April 2015
Fabio Balboni
European Economist
HSBC Bank plc
+44 (0) 20 79920374
fabio.balboni@hsbc.com

View HSBC Global Research at:

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Disclosures
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with the disclosures and
the analyst certifications in
the Disclosure appendix,
and with the Disclaimer,
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Before the financial crisis, the accumulation of cheap capital drove growth. This masked
the erosion in total factor productivity, to which low investment in R&D and the failure of
firms to move into more high-tech sectors contributed. But investment is set to remain
weak, also due to the government slashing public investment, eroding output potential.
All in all, we see growth of 0.8% in 2016 and potential GDP growing at 0.5-0.7% in the
medium term after taking into account the structural reforms. The downside risk to the
government's nominal GDP forecast is even greater due to widespread deflationary
pressures and likely wage moderation, making it hard to meet the EU debt reduction rule.
The 2015 budget law foresees a series of automatic tax rises to VAT and fuel duties from
2016 if Italy is not on track to attain a structural budget balance. Last week, prime
minister Matteo Renzi expressed confidence that the tax hikes would be avoided, also
thanks to a further EUR10bn (0.6% of GDP) of still unspecified expenditure cuts in 2015.
But lower growth and the failure to implement these cuts would make it hard for Italy to
avoid tax hikes, which worth 1% of GDP in 2016 could nip the Italian recovery in the
bud. Indeed, the European Commission is already banking on them in its latest forecast.
Extel Survey 2015 runs from March 23rd through to April 30th.
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Economics
Italy
14 April 2015

Optimistic medium-term outlook could open the way for tax hike
Government revises up growth forecast
In the latest update of the multiannual budgetary plan officially issued yesterday, the Italian government
revised up the growth forecast for 2015 and the upcoming years. The document will be the basis for the
European Commission to assess Italys compliance with EU fiscal rules, a process that will take place
between May and July. The upward revision to the growth forecast for 2015 is small (from 0.6% in
October to 0.7% now), despite the large fall in oil prices, which suggests that the previous forecast was
probably too optimistic. For the following years the government is forecasting GDP growth of 1.4% in
2016 and 1.5% in 2017 (table 1). The deficit forecast was revised down to 2.6% of GDP in 2015 (from
2.9% of GDP in October) largely thanks to the fall in interest payments, which we discussed in Italy: QE
and debt sustainability, 16 February 2015. The lack of revision to the deficit forecast in later years
suggests a small net expansion given lower interest rates.
1. Latest government projections for GDP and fiscal deficit

Growth (% Year)

Latest
Previous (October)
Latest
Previous (October)

Deficit (% GDP)

2015

2016

2017

2018

0.7
0.6
2.6
2.9

1.4
1.0
1.8
1.8

1.5
1.3
0.8
0.8

1.4
1.4
0.0
0.2

Source: Italy Ministry of Finance, European Commission

In six out of the last seven years growth turned out to be lower than forecast by the government (chart 2)
but the Italian finance minister Carlo Padoan stressed in a press conference last week that the updated
forecast that the government was being particularly cautious.
2. The Italian government has had a tendency to overestimate growth in recent years
3

% Year

% Year
3

-1

-1

-2

-2

-3

-3

-4

-4

-5

-5

Italian GDP: outturn vs. government projections

-6

-6
01

02

03
Outturn

04

05

06
07
08
09
10
11
12
Forecast (from budgetay plan in previous autumn)

13

14

15
16
17
Average (2001-14)

Source: Corriere della Sera, Italian Statistical Institute, Italy Ministry of Finance

Indeed, GDP growth in 2015 is only one notch higher than the March consensus forecast (at 0.6%) and
only marginally higher than our own (0.5%). As we argued in our latest European Economics Quarterly:
Beyond the bounce-back, there is increasing evidence of a marked improvement in the cyclical conditions
of the Italian economy, with consumer confidence at the highest levels since 2002 and PMIs firmly in
expansionary territory. So the growth outlook for 2015 appears broadly realistic.

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Italy
14 April 2015

and the medium-term outlook appears optimistic

The caution on the short-term outlook might be driven solely by a change of attitude compared to the
past: when it comes to the assessment by the European Commission of the fiscal adjustment undertaken,
which is measured in structural terms, it pays to be pessimistic on growth. Prime minister Matteo Renzi
confirmed this implicitly, when he said, in a press conference last week after the document had been
finalised and transmitted to parliament, that if the economic outlook turns out to be better than initially
expected and revenues pick up accordingly, there could be a small fiscal buffer to cut taxes in 2016 (and
once Brussels has given the final green-light on the 2015 budget).
The Italian government then sees growth picking up further to 1.4% in 2016, 1.5% in 2017 and then
slowing marginally to 1.4% in 2018 taking into account the structural reforms recently approved by the
government. Italy, however, has never had three consecutive years of growth above 1.2% since joining
the euro. In this note we focus on three main reasons why we are sceptical about its ability to do so now:
the situation of the labour market, investment and productivity.

High unemployment could become structural

The unemployment rate in Italy, whilst down from the all-time high of 13.3% at the end of 2015, has
started to rise again in February (12.7% from 12.6% in January), refuting initial claims made by the
government that the labour market reform approved last year is already starting to pay off in terms of job
creation. Indeed, there is a risk the reform might have come too late: the divergence in the trajectory of
the unemployment rate in Italy compared to more flexible labour markets such as the UK or Germany
since 2011 is striking (chart 3). The deterioration of the labour market in Italy has led to a sharp increase
in youth and long-term unemployment, now at 42% and close to 8%, respectively, and without any
significant improvement in the trend (chart 4).
3. The unemployment rate in Italy is now double pre-crisis
level
%
14

%
14

Unemployment rate

12

12

10

10

4
03

05
Italy

07

09

11

13

Germany

Source: Italian Statistical Institute, Thomson Reuters Datastream

15
UK

4.with youth and long-term unemployment increasing

dramatically
%
8

Youth and long-term unemployment

%
45

40

35

30

25

20

15
04

05

06

07

08

09

10

11

12

13

14

Long-term unemployment, 4mma (LHS)

Youth unemployment (RHS)
Source: Italian Statistical Institute

As we discussed in The Italian Job, 28 November 2014, the labour market reform (Jobs Act) which is
now being implemented is very comprehensive and addresses some of the key rigidities in the Italian
labour market, such as the inability of firms to sack employees when they are in economic difficulties.
However, the Jobs Act together with the important fiscal incentives introduced by the government
should initially lead to the conversion of part time contracts into permanent, while the net job creation
should be limited. In the second half of the year, we expect a more marked improvement in the labour

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Economics
Italy
14 April 2015

market, but it is unlikely we will see a return to the unemployment rates prevailing before the financial
crisis and the structural rate of unemployment could be as high as 10%.
The deterioration in the labour market since 2011 has not been accompanied by substantial downward
wage pressures (chart 5), which plays against the idea of the existence of large slack in the Italian labour
market. Furthermore, the Beveridge curve (the relationship between unemployment rate and vacancies
rate) has shifted out and flattened significantly in the last four years (chart 6) pointing to increasing skills
mismatches. According to a recent report by Manpower, the share of firms experiencing difficulties
filling jobs more than doubled between 2012 and 2014 (from 15% to 35%), despite unemployment rising
and according to the OECD, over 20% of Italian firms reported having underqualified workers. This also
points to the transition towards a new labour market equilibrium characterised by higher unemployment.
5. No significant downward pressure on wages in Italy
Wages
% Yr
5

Italy: real wage growth and unemployment*

6. and the Beveridge curve has flattened and shifted out

Wages
% Yr

0
5

8
9
10
11
12
Unemployment rate
2005-2010
2011-2015

13

14

Source: Italian Statistical Institute *CPI excluding energy was used to deflate wages

Italy: Beveridge curve

Vacancy rate

Vacancy rate

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
5

8
9
10
Unemployment rate
2005-2010

11

12

13

2011-2015

Source: Italian Statistical Institute

During the pre-crisis period, benign market conditions were masking the structural inefficiencies on the
Italian labour market and the failure of Italian firms to move into the next step of technological
specialisation1. Italy ranks poorly in terms of education attainment, with one of the lowest shares of the
population having attained higher education (16%, compared to 32% on average across OCED countries
in 2013, and 41% in the UK) and low and falling public investment in education (4.2% of GDP in
2012, compared to an average of 5% in the eurozone and 6.1% for example in France and the UK). Italy
appears to be particularly weak in scientific subjects, with only one of its universities in the top-100 world
rankings2.
The longer people remain in unemployment particularly given limited re-training on offer the more
their skills deteriorate which reduces their future employability. All these elements could limit the ability
of firms to achieve higher technological specialisation, which would be necessary to boost employment in
the future. At the same time, sectors that tend to hire low-skilled workers, such as the public sector and
construction, present limited potential for employment as the public sector has to shrink and house prices
continue to fall in Italy.

P.L. Iapadre, Trade and Employment in Italy, OECD Trade Policy Working Papers, n.126

2014-2015 Times Higher Education World University Rankings Top 100 universities for physical sciences 2014-2015

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14 April 2015

Investment to remain subdued

Another element which is likely to constrain future growth is the fall in investment. Investment in Italy
still hasnt recovered from the financial crisis, as happened for example in the US, and remains almost a
third below the level in 2007 in real terms (chart 7). A recent IMF paper shows the importance of the
accelerator effect in promoting investment, suggesting that it is unlikely we will see a significant pick-up
of private investment until GDP growth and demand picks-up substantially.
The fact that firms particularly SMEs continue to suffer from limited access to capital (see Is a Bad
Bank Good for Italy, 12 March 2015), house prices are still falling and firms capacity utilisation remains
well below historical averages (chart 8) also supports this view.
7. Investment has fallen by a third in real terms in Italy since
the peak
Index
110

Investment, real

8.and capacity utilisation remains below average which

discourages possible further investment

Index
110

%
90

100

100

85

85

90

90

80

80

75

75

80

80

70

70

70

70

65

65

60

60
07

08

Source: Eurostat

09
10
Eurozone

11

12
13
Italy

14

15
US

Capacity utilisation

%
90

60

60
03

05
07
Eurozone
Spain

09

11
France
Germany

13

15
Italy

Source: Eurostat

At the same time, public investment has fallen significantly during the consolidation period, falling by
over a third since 2009 and was about a third lower in 2014 as a share of GDP compared to pre-crisis
averages. The newly established European Fund for Strategic Investments (EFSI) should help promote
more investment, particularly after the Italian domestic promotion bank Cassa Depositi e Prestiti agreed a
further EUR8bn injection into the fund. However, given the need for the projects financed by the EFSI to
generate some returns to be able to attract private sector investors, it is unlikely it will be a substitute for
the much needed public investment, particularly in areas such as infrastructure, education and R&D.

Falling productivity further limits output potential

Low investment and also low quality of investment: Italy invested only 1.2% of GDP in research and
development in 2013, compared to a eurozone average of 2.1% of GDP and well below the EU target set
in the Lisbon agenda of 3% of GDP. This, together with a shortage of skills required by firms, has led to a
situation whereby, despite rising unemployment, labour productivity has been negative in Italy in the past
three years (chart 9).
But even before the crisis, looking at the productivity of labour alone can be misleading because the
increase in capital was masking the underlying decline in total factor productivity, where there is a clear
downward trend since 1980 (chart 10) for the reasons depicted above. Putting our analyses of the labour
market and investment together, our estimates suggests a modest output gap, in the region of 1% of GDP,
which limits the possible cyclical upturn.

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Economics
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14 April 2015

9. The productivity of labour has been negative recently

% Year

Italy: Employment and Productivity

10. but the total factor productivity has been on a

downward trend since joining the euro

% Year

-2

-2

-4

-4

-6

-6
98

00
02
04
Employment

06

08
10
Productivity

Source: Italian Statistical Institute, HSBC

12

14
GDP
Source: OECD, European Commission, HSBC calculations

The structural reforms implemented by the government recently including those that are still in the
pipeline should support potential growth (table 11), but their effects might not be evident until the
medium or even long term, particularly in the absence of a significant improvement in demand which is
unlikely given ongoing downward wage pressures (also as a result of the labour market reform).
And even then, given unfavourable demographics, our estimates suggest that the growth of output
potential in Italy should now exceed 0.5%-0.7% per year. The combination of a smaller output gap and
lower potential growth leads to significantly lower growth expectations in the medium-term than what the
government is expecting. For 2016, we are currently forecasting above-potential GDP growth of 0.8%.
11. OECD estimates of the impact of structural reforms (as percentage of GDP)
After 5 years

After 10 years

Product market
Labour market (Jobs Act)
Labour tax wedge
Tax structure reform
PA and judicial system

1.5
0.6
0.3
0.4
0.6

2.6
1.2
1.2
0.4
0.9

Total

3.4

6.3

Source: OECD Economic Survey of Italy, February 2015

Fiscal implications: possible VAT hike could hurt growth

All this has important implications from a fiscal perspective. In the governments plans, because of higher
growth real and also nominal, thanks to an expected pick-up in inflation (1% y-o-y in 2016 and 1.9% in
2017) the debt-to-GDP ratio should start to fall significantly from 2016 onwards. This is not only
important to ensure that the debt is sustainable, but is also a key requirement of the EU fiscal rules:
according to these rules the ratio has to fall each year by 1/20th of the difference between the current level
and the 60% debt-to-GDP EU threshold; this means debt should fall by about 3.5% of GDP a year. It is
therefore not too surprising that in 2017 (table 12) the ratio falls exactly by 3.5% of GDP in the
governments projections3.

In 2015 and 2016, Italy does not have to comply in full with the debt-reduction rule. EU rules allow additional flexibility to Italy
given that the output gap is very large, at least according to the European Commissions estimates (see European Commission,
Making the best use of the flexibility within the existing rules of the stability and growth pact, 13 January 2015).

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12. Debt-to-GDP projections

Debt-to-GDP ratio

Latest
Previous (October)
European Commission (February)
HSBC

2015

2016

2017

2018

132.5
133.4
133.0
134.3

130.9
131.9
131.9
134.8

127.4
128.6
n/a
n/a

123.4
124.6
n/a
n/a

Source: Italy Ministry of Finance, European Commission, HSBC

Lower yields as a result of the ECBs QE are providing relief to Italian public finances, but as we showed
in Italy: QE and debt sustainability, 16 February 2015 so long as nominal growth stays weak, the debt
dynamics remain highly problematic. In our forecast (table 13), we have debt-to-GDP still rising in 2016.
This could put its sustainability at risk, also increasing the risk of an increase in credit spreads which
could unwind the benefits of QE in terms of lower interest payments.
The 2015 budget law also foresees automatic increases in VAT and fuel duties from 2016 worth some
1% of GDP in 2016 alone and more in later years if Italy does not attain a structural budget balance by
20174. This clause was introduced initially by the Monti government at the peak of the crisis, to enable
Italy to meet the debt-reduction rule once the worst of the situation had stabilised. At the press conference
last week, Mr Renzi said with confidence that the governments intention is to eliminate completely and
forever the safeguard clauses. And to avoid triggering the increase in 2016, a further EUR10bn (0.6% of
GDP) of expenditure cuts were announced in 2015. However, the cuts have not been detailed yet, and the
Italian mayors have already been protesting against further cuts to the municipal budgets. It is therefore
unclear whether Mr Renzi will be able to convince the European Commission that those increases should
be avoided.
Indeed, in its latest forecast, the commission already banks on the VAT rise in 2016 which is why it
sees inflation rising to 1.5% in 2016 while we forecast inflation at 0.7% without the VAT rise (table 13)
and despite that, it still forecasts a structural deterioration in the budget balance by 0.2% of GDP between
2015 and 2016 taking Italy further away from achieving a structural balance5.
If these tax rises have to be introduced, it could nip the Italian recovery in the bud, bringing about a
significant downward revision of GDP growth as the recent consumption tax hike in Japan showed.
Therefore, the Italian government should focus on implementing swiftly and in full the EUR32bn of
targeted expenditure cuts identified by the Spending Review concluded in March 2014. As the same time,
EU fiscal rules appear to be increasingly out of touch with reality which is also undermining their
credibility as we argued in Reforming the EU fiscal rules, 19 November 2014 and therefore need urgent
reform.

4
According to existing legislation, these are the expected increases: for the VAT rate at 10% to 12% from 2016 and 13% in 2017;
for the 20% rate to 22% in 2016, 24% in 2017 and 25.5% in 2018.
5

See European Commission Winter Forecast, 5 February

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13. Summary of HSBC forecasts

% Year

2014

2015f

2016f

Q1 15f

Q2 15f

Q3 15f

Q4 15f

Q1 16f

Q2 16f

GDP
GDP (% quarter)
Consumer spending
Government consumption
Investment
Stockbuilding (% GDP)
Domestic demand
Exports
Imports
Unemployment (%)
Wage growth
Consumer prices
Budget balance (% GDP)
Gross government debt (% GDP)

-0.4
0.3
-0.9
-3.2
0.0
-0.6
2.4
1.6
12.7
1.2
0.2
-3.0
132.1

0.5
0.6
0.2
0.0
-0.1
0.4
3.9
2.6
12.5
0.7
0.2
-2.9
134.3

0.8
0.6
0.1
0.7
0.0
0.5
3.4
2.7
11.7
0.7
0.7
-2.3
134.8

-0.1
0.2
0.6
-0.1
-1.3
-0.8
0.1
4.0
2.7
12.7
1.0
-0.1
-

0.4
0.3
0.6
0.5
-0.3
-0.5
0.4
3.8
2.5
12.6
0.8
0.2
-

0.7
0.2
0.6
0.4
0.9
-0.5
0.6
4.3
2.5
12.4
0.6
0.4
-

0.9
0.2
0.6
0.0
0.8
0.1
0.5
3.5
2.8
12.2
0.4
0.4
-

0.9
0.2
0.5
0.3
0.7
0.1
0.5
3.6
2.8
12.0
0.6
0.8
-

0.8
0.2
0.5
0.2
0.6
0.0
0.5
3.3
2.6
11.8
0.6
0.7
-

Source: Thomson Reuters Datastream, HSBC estimates

Economics
Italy
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Fabio Balboni

Important Disclosures
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clients of HSBC and is not for publication to other persons, whether through the press or by other means.
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document is general and should not be construed as personal advice, given it has been prepared without taking account of the
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Additional disclosures
1
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3

This report is dated as at 14 April 2015.

All market data included in this report are dated as at close 14 April 2015, unless otherwise indicated in the report.
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