News Column

BUSINESS LEADER: Something's got to give in Italy - better if it's Draghi with a nice big bundle of cheap credit

August 10, 2014

BUSINESS LEADER



European Central bank boss Mario Draghi came to London last month to criticise his fellow Italians. In an unusually candid speech to an audience that included Bank of England governor Mark Carney, he lambasted his fellow countrymen for wanting Brussels to become a "transfer union", in which debts were pooled. It was, he argued, a brazen attempt by Rome to offload its enormous public sector liabilities on its more solvent neighbours.

Draghi is one of many senior European policymakers who believe that southern European governments are lazy and corrupted by easy credit. It's a view he shares with Germany's finance minister Wolfgang Schauble - Brussels' paymaster. Without making a direct reference to Italian prime minister Matteo Renzi's administration, Draghi said austerity and reform forced nations to grow up and realise they must work for a living and stop relying on loans to pay the bills. He and Schauble want Renzi to stick to plan A.

Making a broader point, he said the stability of the eurozone depended "not on having more flexibility" but on enforcing the existing fiscal rules. "To unwind the consolidation that has been achieved, and in doing so, divest the rules of credibility, would be self-defeating for all countries," he said.

The speech came only a few months after Renzi's elevation to the premiership and his pitch to Brussels for greater flexibility. Renzi wants the commission to give him longer to institute reforms while he attempts to balance the books.

Then, last Thursday, Draghi told journalists at his monthly press conference that eurozone interest rates would be staying low for a long time to help the eurozone recover. Appearing doveish and conciliatory, he added that he was prepared to make credit cheaper still with a version of quantitative easing (QE) but, switching to a more hawkish tone, he added that the time for flooding the banking system with cash, Bank of England-style, had yet to arrive.

He is wrong. Italy, France and the Netherlands are already in trouble. They need cheap loans to ameliorate the worst effects of difficult reforms.

The Renzi administration is dealing with an economy in recession for a third time. The government's finances are getting weaker. One firm of analysts said last week that only with higher growth and higher inflation could Italy escape its death spiral. The magic of inflation, for debtors, is that it devalues the debt and makes it easier to service.

But it appears almost outlandish to forecast a return to the average 1.5% growth rate Italy saw in the 30 years running up to the crisis. And, according to Fathom Consulting, even if that could be achieved, "it would still require an inflation rate in excess of the 2% target just to stabilise Italian debt as a proportion of GDP".

Fathom added: "With no growth, no inflation, and of course no currency of its own, something needs to give, and soon, if Italy is to continue to finance its vast national debt."

Just as Draghi was holding his press conference in Frankfurt, Italy's parliament was giving its final approval to Renzi's second package of support measures for the ailing economy. These included a cut in energy costs for small companies and measures to spur lending to businesses. Unfortunately, many of the measures, weakened by numerous changes during a difficult passage through parliament, are likely to be ineffectual. A tax credit for firms that make new investments in machinery, and new rules allowing insurers and credit funds to lend directly to business, follow an income tax cut of up to euros 80 a month for low earners, effective from May.

Draghi won't be impressed. He wants broader labour market reforms and an end to restrictions on setting up businesses, changes to tax rules that tie businesses in knots and an end to wasteful subsidies.

Renzi has promised to tackle these in 2015. But without Draghi rolling out QE, he doesn't stand a chance.



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Source: Observer (UK)


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