GREEK PROBLEMS MASK THE RISING RISKS IN ITALY AND FRANCE / THE FINANCIAL TIMES MARKETS INSIGHT

Markets Insight

June 24, 2015 6:08 am

 

Greek problems mask the rising risks in Italy and France

 

Satyajit Das

 

Problems the countries face are structural, rather than attributable to the eurozone debt crisis

 

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Protest against the G7 summit on June 5 in Munich

 

 

According to John Maynard Keynes “the expected never happens; it is the unexpected always”.

 

Obsessed with the problems of Greece and the European periphery, financial markets are ignoring the rising risks of the core, especially Italy and France.

 

Italy and France face mounting problems of high debt, slow growth, unemployment, poor public finances, lack of competitiveness and an inability to undertake necessary adjustments.

Reductions in energy prices combined with low borrowing costs and a weaker euro, engineered by the European Central Bank, cannot hide deep-seated and unresolved problems forever.

Italian total real economy debt (government, household and business) is about 259 per cent of gross domestic product, up 55 per cent since 2007. France’s equivalent debt is about 280 per cent of GDP, up 66 per cent since 2007. This ignores unfunded pension and healthcare obligations as well as contingent commitments to eurozone bailouts.

Italy is running a budget deficit of 2.9 per cent. Government debt is around €2.1tn, or 132 per cent of GDP. French public debt is just above €2tn, or 95 per cent of GDP. The current budget deficit is 4.2 per cent of GDP. France’s budget has not been balanced in any single year since 1974.

 

Italy’s economy has shrunk about 10 per cent since 2007, as the country endured a triple-dip recession. Italy’s unemployment is more than 12 per cent, with youth unemployment about 44 per cent. French GDP growth is anaemic, with unemployment above 10 per cent and youth unemployment of more than 25 per cent.

Trade performance is lacklustre. Italy’s current account surplus of 1.9 per cent reflects deterioration of the domestic economy rather than export prowess. France’s current account deficit is about 0.9 per cent of GDP, reflecting a declining share of the global export market.

Italy and France’s problems are structural, rather than attributable to the eurozone debt crisis.

High wages, inflexible labour markets, generous welfare benefits, large public sectors and restrictive trade practices are major issues.

In the World Economic Forum’s competitiveness rankings, Italy and France ranked 49th and 23rd respectively, well behind Germany (fourth) and Britain (10th). In World Bank studies, Italy and France rank 56th and 31st in terms of ease of doing business. Transparency International ranks Italy 69 out of 175 countries in perceived levels of public corruption, comparable to Romania, Greece and Bulgaria.

 

The lack of competitiveness is exacerbated by the single currency. Italy and France faced a 15-25 per cent overvalued currency until the recent decline in the euro. Denied the historically preferred option of devaluation of the lira or franc to improve international competitiveness, both countries have relied increasingly in recent times on debt-funded public spending to maintain economic activity and living standards.

 

 

Progress on proposed structural changes is slow. Irrespective of whether the economy improves or deteriorates, reforms are frequently shelved as the time is not considered propitious. A deep antipathy towards markets and business impedes change.

France and Italy may not be able to avoid a financial crisis. Real GDP would need to increase at more than twice projected rates to stabilise and then reduce government debt-to-GDP ratios.

Alternatively, deep reductions in fiscal deficits would be required to start deleveraging. The necessary fiscal adjustment of about 2 per cent of GDP would be self-defeating, creating a familiar cycle of lower growth, rising budget deficits and higher borrowings.

A weak economy and low inflation will ultimately cause debt to increase beyond critical levels, triggering a climactic moment.

President François Mitterrand believed that “il faut donner du temps au temps” (time must be given time to do its work). But for the past 15-20 years, Italy and France have been promising essential reform. Unfortunately, time is running out, with serious consequences for the nations, the European project and investors in Italian and French debt and equity securities.


Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money