In these past weeks, the European Council, made by the prime ministers of the 27 European countries, has been discussing about the possible measures to take against the effects of the Coronavirus on the continent’s economy.
While the ECB has already decided to launch a €750 bn emergency purchase program, the EU has not yet clearly decided for a common fiscal policy. And after the last Council on April 23rd in Brussels, it seems now clear that the joint financial instrument also known as coronabond is not considered a feasible option anymore. In fact, in the document released after the meeting the words coronabond or eurobonds do not appear once. Instead, the Union seems to move towards a different approach that does not require the mutualization of debt, a topic at the centre of much discussion in the last weeks.
The first instrument to be deployed by the EU is the SURE, a €100 bn loan program for short time work schemes. The European Investment Bank will disburse loans for €200 bn (backed by a €25bn fund) for business in need of liquidity. Finally, the European Stability Mechanism should be available in the next two weeks. The ESM has been criticised harshly in Italy, as it has seen as a gateway to EU control of Italian economy, and eventually in the imposition of Troika-like measures. The proposed version of the ESM would only be conditioned to fund healthcare costs, but the underlying Treaty, if not modified, will still make the country “committed to strengthen economic and financial fundamentals” after the crisis period is over. The amount funded (up to 2% of GDP, around 35bn for Italy) would also not be game-changing: in Italy, as well as many other countries, the peak of contagions has been reached: infection cases have been reducing steadily in the last week, and hospital have already endured the hardest part. For Italy, the uncertainty regarding the future of the economy comes with negative expectations that the country won’t be able to successfully start again.
While the ECB has already decided to launch a €750 bn emergency purchase program, the EU has not yet clearly decided for a common fiscal policy. And after the last Council on April 23rd in Brussels, it seems now clear that the joint financial instrument also known as coronabond is not considered a feasible option anymore. In fact, in the document released after the meeting the words coronabond or eurobonds do not appear once. Instead, the Union seems to move towards a different approach that does not require the mutualization of debt, a topic at the centre of much discussion in the last weeks.
The first instrument to be deployed by the EU is the SURE, a €100 bn loan program for short time work schemes. The European Investment Bank will disburse loans for €200 bn (backed by a €25bn fund) for business in need of liquidity. Finally, the European Stability Mechanism should be available in the next two weeks. The ESM has been criticised harshly in Italy, as it has seen as a gateway to EU control of Italian economy, and eventually in the imposition of Troika-like measures. The proposed version of the ESM would only be conditioned to fund healthcare costs, but the underlying Treaty, if not modified, will still make the country “committed to strengthen economic and financial fundamentals” after the crisis period is over. The amount funded (up to 2% of GDP, around 35bn for Italy) would also not be game-changing: in Italy, as well as many other countries, the peak of contagions has been reached: infection cases have been reducing steadily in the last week, and hospital have already endured the hardest part. For Italy, the uncertainty regarding the future of the economy comes with negative expectations that the country won’t be able to successfully start again.
The market has penalised the uncertainty and the political turmoil in Italy. While the yield on sovereign bonds has been decreasing almost everywhere, as investors flew the equity market towards more secure government bonds, this has not been the case for Italy. The yield on 10-year sovereign bond (often considered a risk-free asset) has doubled and is now 1.82%, up from 1.051% on March 8th and is the second highest in Europe after Greece. Similarly, the spread between German and Italian 10-year bonds, a common measure of the perceived risk for the country, has risen well above 200 and is around 220 bps.
The price of Credit Default Swap (CDS) contracts on 5-year Italian bonds, used by investors to be protected against a possible default of the country, has also increased.
The price of Credit Default Swap (CDS) contracts on 5-year Italian bonds, used by investors to be protected against a possible default of the country, has also increased.
The fears are not only related to the severity of the pandemic in Italy and the political debates and anti-European talks, but also on the perceived difficulties that the already struggling Italian economy will have to start back again. Before the pandemic broke out, Italy’s forecasted GDP growth was 0.5%, well below Europe average 1.2%; but after the effect of the virus on the economy, which have been estimated between 8% and 11% for the first two quarters of 2020, the IMF estimates a real GDP drop of 9.1% this year.
Moreover, Italy is structurally weak against the effect of a recession like the one caused by Covid19. The high level of debt, which, as a fraction of GDP, has been around 135% for the last five years, is destined to increase dramatically over 145%, according to Scope Ratings. At the same time, the coalition in power since September 2019 faces strong opposition by anti-European parties and has had problems coping with the task of delivering subsidies to workers and business and using the necessary technology to ensure safety in the next phase of Coronavirus response. Moreover, the epicentre of the pandemic has been in the northern productive heart of Italy, which accounts for roughly 40% of GDP and more than 50% of exports.
Finally, the measures taken against Coronavirus will have long lasting effects on Italian economy. The tertiary sector is crucial for Italy and will struggle to start again in a world of social distancing. Hotels and resort in Italy have already lost up to 30% of their annual revenues so far and expect to make less than 50% their usual turnover in 2020. In general, small and medium business will be the hardest hit. They represent 57% of total production in the country, and in some regions up to 83%. Many do not have easy access to funding also due to the the difficulties the public administration has had delivering the necessary help and the delay in a European response.
Italy has been severely affected by the pandemic and has been the first epicentre of the virus outside China. Now that the infection cases start to reduce and lockdown measures start to be removed, comes the task of getting the economy back on its feet, and for Italy it will certainly be a difficult one.
Carlo Geat
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Moreover, Italy is structurally weak against the effect of a recession like the one caused by Covid19. The high level of debt, which, as a fraction of GDP, has been around 135% for the last five years, is destined to increase dramatically over 145%, according to Scope Ratings. At the same time, the coalition in power since September 2019 faces strong opposition by anti-European parties and has had problems coping with the task of delivering subsidies to workers and business and using the necessary technology to ensure safety in the next phase of Coronavirus response. Moreover, the epicentre of the pandemic has been in the northern productive heart of Italy, which accounts for roughly 40% of GDP and more than 50% of exports.
Finally, the measures taken against Coronavirus will have long lasting effects on Italian economy. The tertiary sector is crucial for Italy and will struggle to start again in a world of social distancing. Hotels and resort in Italy have already lost up to 30% of their annual revenues so far and expect to make less than 50% their usual turnover in 2020. In general, small and medium business will be the hardest hit. They represent 57% of total production in the country, and in some regions up to 83%. Many do not have easy access to funding also due to the the difficulties the public administration has had delivering the necessary help and the delay in a European response.
Italy has been severely affected by the pandemic and has been the first epicentre of the virus outside China. Now that the infection cases start to reduce and lockdown measures start to be removed, comes the task of getting the economy back on its feet, and for Italy it will certainly be a difficult one.
Carlo Geat
Want to keep up with our most recent articles? Subscribe to our weekly newsletter here.