Back Italy: The sick man of Europe 05 August 2016 Italy’s banks are laden with bad debts; its economy is stagnant and consumers are reining in their spending – all this points to the grim fact that the country is the sick man of Europe. Banks Italian banks came out of recent EBA stress tests looking pretty risky – not that we didn’t know this already. Monte dei Paschi di Siena (MPS) is struggling more than most, although the steep sell-off in UniCredit following the report is a clear sign that the entire sector is mired in bad debt. MPS has managed to agree a €5bn capital-raising and is now looking to offload €10bn in non-performing loans. Many are rightly sceptical about this – MPS has already gone cap in hand to investors to plug capital shortfalls and the share price has collapsed by 84%. The world’s oldest bank has frittered away €8bn that it’s raised over the last two years. Why would this €5bn be any different? The problem is that stronger banks are being asked to support the weaker ones. Italian banks cannot keep lending to each other as the healthiest are not strong enough to pull the weakest along. One third of Italy’s banks’ bonds are owned by other Italian banks, so if one domino falls others could easily follow. Italy’s banks are weighed down by €360bn in non-performing loans – around a fifth of annual economic activity and a third of all the eurozone’s toxic debt. There are many reasons for Italy’s troubles. Unlike Spain, the country failed to use the financial crisis to clear out the cobwebs in the banking sector and is now paying the price for its complacency. All the bad eggs are not in one basket – they’re spread around and threaten the entire system. Assets are mispriced – currently these NPLs are priced at around 40 cents in the euro but the market is only prepared to offer 20 cents. Much of the bad debt for MPS can be traced to its ill-thought out €9bn all-cash acquisition of Antonveneta. Italy’s NPLs are also a feature of a moribund economy – one that has failed to grow and inflate its way out of trouble. Italy’s GDP has barely recovered to where it was before the global financial crisis – little wonder businesses and consumers are not able to service their debts. IMF Italy’s economy is stagnant and there is not much hope on the horizon. GDP expanded by 0.8% in 2015 but this comes after a triple-dip recession in the wake of the financial crisis. According to the International Monetary Fund (IMF), Italy won’t see pre-crisis growth until the mid-2020s. It notes that it is recovering from “a deep and protracted recession” only “gradually”, despite being “buoyed by exceptionally accommodative monetary policy, favourable commodity prices, supportive fiscal policy, and improved confidence on the back of the authorities’ wide-ranging reform efforts”. “Structural challenges remain significant,” said the IMF, adding: “Productivity and investment growth are low; the unemployment rate remains above 11 percent, with considerably higher levels in some regions and among the youth; bank balance sheets are strained by very high NPLs and lengthy judicial processes; and public debt has edged up to close to 133 percent of GDP, a level that limits the fiscal space to respond to shocks.” PMI The IMF notes that there is improve confidence, but this doesn’t seem to be feeding through to consumers, at least at the moment. Markit’s latest PMI reading shows another steep fall in retail sales in Italy in July. It was the seventh decrease in spending in as many months. The July reading of 40.3 was barely from June’s 40.2 reading. Anything below 50 signals contraction. Industrial production data has been poor too, with output contracting in June by 0.4%, worse than expected. Even the good news – and there is some – comes with caveats. According to Markit’s latest PMI, the nation’s services economy remained in expansion territory at the start of the third quarter, with job creation accelerating at the fastest pace since August 2007. “However, firms’ optimism towards the year-ahead outlook for business activity eased to the lowest for 32 months,” the research group said. Can prime minister Matteo Renzi turn things around? There are signs of improvement, notably in services, but the weight of banks and NPLs weighs heavily. A referendum on constitutional reform this autumn will prove vital.