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A Cautionary Note on Italy

Dr. Hans Belcsák

While it is highly unlikely, as I pointed out in a recent article, that France will leave the eurozone and thus become a critical factor in bringing down the curtain on the single-currency project, the risks emanating from Italy are distinctly more troubling; although, at least in the near term, these are not overwhelming either.

The problem is that the Apennine Republic does not have a whole lot of benefits to show from belonging to the Club. It failed to make the necessary adjustments right after adopting the euro in 1999, and the economy has performed badly ever since, hobbled by too many small, unproductive businesses that are not growing. It is today barely above the level at which it was then.

How much of this is attributable to eurozone membership alone is hard to tell because the intervening period has seen many other important developments, from China’s entry into the World Trade Organization to the emergence of intricate global supply chains, dramatic technological changes, the replacement of many workers by machines and the growing habit of multinationals to outsource services. Italy has been much slower than, say, Germany to adapt, especially in loosening up its hamstrung labor market, and the country now has a serious competitiveness problem. Labor costs in Italy have increased by roughly 15 percentage points more than those in Germany. This has left the national unemployment rate stuck at more than 11%. Living standards today are one-tenth below what they were a decade ago. The public-sector debt has ballooned to the second-highest in the eurozone, at more than EUR 2.5 trillion or 133% of GDP. Italian banks have upward of EUR 360 billion in nonperforming loans on their books, depending on how one counts, which is tantamount to an eyebrow-raising 18% of their total portfolios. The banks also hold very large piles of government debt, totaling more than 10% of their overall assets. Following a now deeply ingrained pattern, gross domestic product inched up a mere 0.9% last year, on the heels of a gain by 0.8% in 2015. The government is forecasting growth of 1% for 2017, but this may well turn out to have been too optimistic an expectation.

Demographics are working against the country as well, as a vast tax-and-transfer welfare state is facing lengthening life spans and one of the lowest birthrates in the world. Such gimmicks as the government’s effort to promote “Fertility Day” on Sept. 22, seeking to encourage Italians to have more babies, will hardly remedy this problem. Added to these impediments is now a great deal of political confusion in the wake of Prime Minister Matteo Renzi’s failed effort to bring in constitutional reform and his resignation as PM as well as head of the Democratic Party (PD). The country is currently run by a caretaker government under former Foreign Minister Paolo Gentiloni, who is a competent manager, but in effect only a stand-in until new elections can be arranged. Not that political instability is anything new in Italy, which has had no fewer than 62 (sic!!) governments since World War II. But all of the leading parties are currently divided.

The front-running Five Star Movement of the comedian Peppe Grillo, which has been calling for a plebiscite to be held on ditching the euro and re-establishing a national currency, is torn between hardliners and moderates, troubled by tensions over the party’s mismanagement of the city of Rome. The radical anti-immigrant and anti-euro Northern League is trying hard, but not very successfully, to form an alliance with Forza Italia, headed by the former PM Silvio Berlusconi. In the PD, a leadership battle is under way in which Justice Minister Andrea Orlando is challenging Renzi’s attempt to reclaim power. As matters look now, no party is likely to win the 40% of votes in elections that are required for receiving bonus seats. Chances are, whenever the balloting is held, it will result in a minority government or a hung parliament in which small parties will be able to punch well above their weight, sparring in fragile coalitions that will be sorely tempted to blame all the country’s difficulties on the euro, instead of pushing ahead with the difficult and painful reforms needed to give the economy more momentum. Of the three large party groups, only the center-left PD is pro-euro. There is, therefore, a risk that at one stage or another, the anti-euro forces will gain the upper hand with the argument that most of the problems would go away if Italy just had, once again, a currency it can devalue. Some say that this is not a real danger since the Apennine Republic is notoriously adept at muddling through whatever difficulties it encounters. Others hold that peril slumbers in the possibility that Italexit becomes a self-fulfilling prophecy if there is a run on Italy’s banks and its government’s bonds. This latter argument is strengthened by the fact that the public debt is already more than double the EU ceiling of 60% of GDP, and still rising, and by the fragile state of the banking system. My own instincts lead me to support the “muddling-through” theory, at least for now. Clearly, leaving the eurozone would confront Italy with monumental problems. Creating a new currency and introducing it as functional legal tender could not be done in secret and would take months, during which foreign and local investors and private citizens would liquidate all assets they have so that they can take them out before devaluation happens.

Redenomination of debt would lead to a massive default and lock Italy out of the international capital and credit markets for a long time to come—while the country must borrow to cover its yawning budget deficit and refinance maturing IOUs. There would be countless bankruptcies among banks stemming from a rash of depositors withdrawing money. Insolvencies would also mushroom among private companies with foreign liabilities that are not matched by foreign assets. While Italexit would be extremely messy and damaging, however, this is not to say that it absolutely, positively cannot happen. In a worst-case scenario—some time down the road—a confluence of (1) an unsustainable deterioration in public finances, (2) severe tremors rattling the banking system, (3) a persistently weak economic performance, and (4) misguided political machinations could make the unthinkable possible. This is a long shot, to be sure, but until Italy begins in earnest to deal with its underlying problems, it will be an outside possibility of which one should not totally lose sight. After all, while the euro could survive a Greek exit, Italy is too large to be bailed out by the rest of the Zone members. Were it to slide into a full-blown economic and financial crisis and default on its mountainous public debt, the common currency could not continue to exist in its present form.

 

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Doing Business in Panama is Changing, Slowly

Antje Seiffert-Murphy, CFA.

Panama made the global headlines twice last year. For the opening of the long-awaited expanded Panama Canal and the so-called Panama Papers revealing large-scale offshore tax avoidance. Both events are a synonym for the strengths and challenges of this Latin American country, which ranked 75th largest by GDP and 128th by population in the world (World Bank 2015).

Panama is a small, open economy, which has been experiencing one of the highest regional growths in GDP. The canal provides for ample direct and indirect business opportunities and is a large source of USD to the country. Its expansive banking system is a regional financing hub with strong global connections. It ranks well for ease of starting a business (43rd Doing Business World Bank—DB rank 2017), credit access (20th DB rank 2017) and offering a politically stable, dollarized environment fueling foreign direct investments (FDI) and activities in the Colón Free Trade Zone. Those indicators make Panama among the best countries in the region for doing business according to the World Bank and not surprisingly are greatly valued by companies and individuals in less stable Latin American countries.

While being a relatively strong regional performer for doing business, the weaker rankings are in key areas that generally strengthen the attractiveness of an open economy and provide counterparties with comfort in business dealings. This includes paying taxes (170th DB rank 2017), enforcing contracts (145th DB rank 2017) and resolving insolvencies (133rd DB rank 2017). Its regional attractiveness and the Canal exposes also its vulnerability to external shocks that could negatively impact trade flows, its attractiveness for foreign investments and a place to start new business or impact the real estate activity. More trade protectionism by its largest export market (20% of exports), the US, would have significant impact. Finally, because of the dollarization of its economy, the government lost significant tools to help manage its monetary policy and therefore no formal lender of last resort to its financial system.

Panama is known as one of the global tax havens offering foreign companies and individuals attractive low tax rates, less regulation and more privacy than in their home countries. Although placing an immediate negative spotlight on Panama, the revelations of the Panama Papers were actually good news for addressing corruption—a target of the new government that came into power two years ago. Reported progress includes the expansion of financial and tax agreements with select countries, an improvement of the legal and business registration systems and also banks requiring broader identification requirements. But there is a long way to go for Panama, which scored a low 38 (score below 50 indicates a failure by government to tackle corruption) and ranked 87th by Transparency International in 2016.

Strengthening the rule of contracts and controlling corruption could impact negatively, if not at least temporarily, economic activity. But the cost of corruption is significant for a country—and includes inefficient use of public resources, increasing cost of doing business and undermining of law. But perhaps we saw two stars aligning—the opening of the canal and the Panama Papers being a catalyst for fundamental change as the first Canal opening had been for Panama in 1914.

Antje Seiffert-Murphy, CFA, is vice president of credit and political risk for New York-based trade credit insurer Equinox Global. FCIB members can see what credit professionals think of doing business in Panama by accessing the latest Credit & Collections Survey results, which were released last week.

 

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France and the Future of Europe

Chris Kuehl, Ph.D

The assessment of the upcoming French election has become as unsettled as it has ever been. There is a very clear path to power for the National Front and Marine Le Pen as the latest polls show she will pull more than 26% of the national vote in the first round and perhaps as much as 40% in the second.

If the losers in the first round rally around Emmanuel Macron, he would have 60% of the vote and would become the president. The problem is that many of those who support the left candidates (Benoît Hamon and Jean-Luc Mélanchon) are not prepared to support a former Rothschild’s banker–even though he was economy minister under the Socialist government of François Hollande. That connection to the Socialists makes him unacceptable to some of the supporters of the center-right candidate François Fillon. Le Pen only has to hold her base and snare a few from the camp of Fillon to win.

The National Front supporter is young, relatively uneducated and often from the rural areas. It is their sense that they have been dismissed and ignored by the urban elites on a variety of fronts. They have not seen job or wage growth, and their financial positions get more tenuous every day. The young can’t find work, and there is deep resentment of the immigrants that have arrived in France because they are accused of taking the jobs and of trying to change French culture. Evidence for this is nonexistent, but the perception lingers.

The support for Le Pen is as much a protest against the status quo as it is support for her policies. In almost every interview or poll, respondents can’t really identify most of Le Pen’s platform other than her desire to pull France out of the European Union and her desire to end immigration into the country. The plans for economic revival have not been developed, or at least they have not been communicated.


Election Calendar

March 15 – The Netherlands, Second Chamber

March 20 – Democratic Republic of Timor-Leste, President

April 2 – Ecuador, President

April 9 – Serbia, President

April 23 – France, President

May 19 – Iran, President



Global Roundup

President of South Korea impeached. Eight justices of the Constitutional Court unanimously upheld the impeachment of President Park Geun-hye on Friday in a historic ruling that will put an end to long-lasting political turmoil and social unrest triggered by a widespread corruption scandal involving Park and her longtime friend Choi Soon-sil. (Korea Times)

China’s trade and reserves data don’t add up. On March 7, came a surprise increase in foreign-exchange reserves. The next day, it was an unexpected trade deficit—China’s first in three years—which made the rise in Beijing’s currency hoard even harder to account for. Economists say the two don’t fit together easily. Chinese imports in February were up 45% from a year earlier in yuan terms, accelerating from January’s 25% pace, while exports increased just 4.2%. The result: a trade deficit. (HSN)

Odebrecht’s bribery scandal casts a shadow over Latin America. The shock waves are not only hitting Odebrecht and its partners, but also infrastructure and project finance markets across the region. In 2014, as the GSP natural gas pipeline concession wound through the bidding process, rumors circulated that Odebrecht was not competing fairly. The rumors intensified when, with just two bidding teams left in the hunt, the Peruvian government disqualified one on technical grounds, leaving the Brazilian builder to take the 34-year concession contract for the 1,000-kilometer pipeline. (LatinFinance)

More evidence of how badly austerity is strangling the Greek economy. Last month, the European Commission estimated that every country in the EU was growing in 2016. But Greece, as it so often does, sprang a nasty surprise. A shock revision to fourth-quarter GDP earlier this week suggested that the beleaguered economy may have shrank, again, in 2016. Annual GDP data published yesterday confirmed that Greece grew last year by just 0.01%. That won’t do much to dig the economy out of its hole; GDP has shrunk by a quarter since 2008, and the unemployment rate is stuck above 20%. (Quartz)

Cross one global economic problem off the list, for now. Remember deflation? That would be the worry that falling prices could spell big trouble for many of the world's biggest economies? You can forget about it—for now. Thanks to a pickup in global oil prices, the annual inflation rate in the developed world jumped to 2.3% in January 2017, the highest rate since April 2012, according to a Tuesday report from the Organisation for Economic Co-operation and Development. (CNBC)

Is a trade war between the U.S. and the EU on the horizon? America’s new governing party wants to reduce the price of U.S. exports, but are preparing a 20% “equalization tax” in return that would apply to goods imported into the United States. This would violate World Trade Organization rules. The European Union is threatening to bring an action before the WTO in response. But Trump has repeatedly floated the possibility that the United States might leave the organization. This would mean that the U.S. would avoid any possible sanctions. (EurActiv)

Sweden’s far-right party gaining ground as social problems mount. Sweden has accepted more refugees per capita than any other European country. At the height of the European refugee crisis in 2015, Sweden accepted 10,000 refugees per week. Sweden’s liberal immigration policy is honorable, but it does not come without problems. As social problems increase, Sweden’s far-right party, the Sweden Democrats (SD) are gaining territory and will likely be the major winner in the next election. (Global Risk Insights)

Chinese companies claim blockchain SCF first. Two Chinese companies have launched Chained Finance, which they claim is the first blockchain platform for supply chain finance. Chained Finance will provide upstream finance to companies in China and has been developed by Dianrong, an online marketplace lender, and, FnConn, a subsidiary of electronics manufacturer Foxconn. Few details have been released about the specifics of the blockchain technology at play or any details of the potential supplier companies that could be involved. (Global Trade Review)

The big reform India needs most. India’s Prime Minister Narendra Modi has reason to be wary of ambitious reforms to India’s economy, given the fraught rollout of his plan to ban 500- and 1,000-rupee notes overnight. For his country to reach its true economic potential, however, he will need to do something about India’s ailing state banks. (Bloomberg)

A new chapter in Thailand’s plagued politics? It has been almost three years since Thailand’s military seized power in a coup d’état, ending yet another period of political division and violent street protests. In May 2014, the coup leaders said they wanted to end corruption in government, stop violence and break political deadlock. Thailand is likely to see jockeying for power between political parties ahead of the elections, expected in February 2018. If, during this period, the military and the new sovereign can maintain a working relationship, it may usher in a period of stability. If they don’t, any dispute could quickly lead to divisions emerging across the country. (The Interpreter)

 

Week in Review Editorial Team:
Diana Mota, Associate Editor and David Anderson, Member Relations