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Friday, April 11, 2008

Italy's Economy Going Into The Election

As Italians head to the polls this weekend in order to pick what will be their 62nd government in 65 years (in an election which is being held three years early to boot, due to the collapse of Romano Prodi's outgoing administration) one odd detail seems to stand out and sum up the multitude of political and economic woes which confront Italy at the present time: we still don't have economic growth figures for the last quarter of 2007. Now this situation may well be an entirely fortuitous one - Italy's national statistics office ISTAT are in the process of introducing a new methodology to bring their data into line with current EU standards as employed in other countries (Italy yet one more time is at the end of the line here, but let's not get bogged down on this detail) - but there does seem to be something deeply symbolic about all this, especially since Italy may well currently be in recession, and may well be the first eurozone country to have fallen into recession since the global financial turmoil of August 2007.

Perhaps the other salient detail on this election weekend is the news this (Saturday) morning that "national champion" airline Alitalia is near to collapse and may have its license to fly revoked, at least this is the view of Vito Riggio, president of Italy's civil aviation authority, as reported in Corriere della Sera.

"If something isn't done soon, everyone must realize that Alitalia is on its last legs.... The authority will have no choice but to revoke the airline's license ``in two, maximum three weeks if it can't show it can find cash to stay in business"
And as if to add insult to injury, only this week the IMF revised down yet one more their 2008 forecast for Italian GDP growth, on this occasion to a mere 0.3% - and (as we will see below) a steadily accumulating body of data now clearly suggest that Italy is probably already in recession, and may well have entered recession sometime during the last quarter of 2007. If confirmed this will mean that Italy will have been in and out of four recessions in last five years. So perhaps the real question we should be asking ourselves is not be whether Italy is in a recession, but when in fact she enter it, and even more to the point, when will she leave?

``Italy and its economy are like the Titanic hitting the iceberg,'' said Gianni De Michelis, deputy prime minister in 1988 and 1989. ``It's gotten to this stage after years of negligent governments on both sides. Berlusconi or Veltroni? It makes no difference.''

It should be plain from the above long term growth chart that the problems Italy is facing are not mere conjunctural (cyclical) ones. Deep structural processes are now obviously at work, and Italy is now in danger of spending more time in rcession than she actually spends out of one, a position which has some similarities with the Japanese lost decade - the so called Heisei recession - of the late 1990s and early 2000s. And this comparison may not be entirely accidental since, as we shall see below, Japan and Italy are two of the planets three (along with Germany) oldest societies.

But first let's take a look at some of the evidence that Italy may well now be in recession.

Retail Sales

Italian retail sales fell through the floor in March - at least according to the Bloomberg NTC Purchasing Managers Index - with sales being registered as falling at the fastest pace in four years. The seasonally adjusted index of retail sales declined to 36.4 from 43.8 in February, the lowest rating shown by any country since the survey began in January 2004. The reading on this particular index has now been below 50, the level that signals a contraction in sales, since February 2007.

In January (which is the latest month for which we have data) retail sales in Italy were up year on year by 1% according to data from the National Statistics Office (ISTAT). While the values on the two measures are a little different, with ISTAT figures being notably a little more volatile, the general downward trend in the rate of new activity since mid 2006 is still noteable in the chart.

A further indication about the current state of mind of the Italian consumer can be found in Italy's new car sales, which fell for a third straight month in March - down 18.76 percent - year on year. Sales of Fiat's three brands suffered an even harder fall of 20.6 percent. Registrations of new car sales totalled 212,326 in March against 261,370 for the same period last year. Those for cars of the three brands belonging to the Fiat group totalled 65,594 against 82,649 in March 2007. Fiat's share of registrations in what is its home market was 30.89 percent.

If we look at car sales across the first quarter taken as a whole then we find the total number of sales registered with the transport ministry was - at 663,532 - down 10.01 percent on the first quarter of 2007. This seems to suggest that the situation deteriorated dramatically between January and March, a finding which is entirely consistent with the shocking retail PMI reading for March.

Household spending, which makes up two-thirds of Italy's economy, was slowing throughout 2007, only growing very slightly (by 0.2 percent) between the second and third quarters, a rate which was down when compared with the 0.5 percent rise achieved in the second quarter over the fisrt, or the 0.7% one in the first quarter over the fourth quarter of 2006.

Indeed what we neem to note is that Italian domestic consumption, despite the considerable increase in the working population via immigration and the low levels of unemployment registered recently, is now congenitally weak, and only twice since the start of 2003 - during the rather exceptional Q1 and Q2 2007 - has the rate of increased broken through the 2% year on year threshold.

So Italian household consumption has remained unmovingly weak over a number of years now, and this weaknes rather took me by surprise, I must admit, when I first became aware of it, since it so closely mirrors what we have been seeing in Germany and Japan, where again, and despite extensive labour market reforms and extensive job creation domestic consumers have not been able to drive the economies. Due to the similarity in the structural components here between Germany, Japan and Italy (with Italy's weaker export performance being the only real distinguishing feature, indeed you might almost call Italy Germany and Japan without the export prowess) Claus Vistesen and I are arguing that the whole phenomenon is ageing related, since these three societies - with median population ages pushing the 43 mark - are now the oldest on the planet.

Industrial Output

If we now turn to Italian industrial output we find that this declined in February - the most recent month for which we have data from ISTAT - as the worsening economic outlook reduced demand for manufactured products. Production dropped 0.2 percent after rising a revised 1.2 percent in January. The seasonally and working day adjusted output index dropped back to 97.8 from 98.3 in January.

Year on year (and working day corrected) output was down 0.8% over February 2007. Production of Italian consumer goods fell 2.6 percent from January as the output of durable goods like refrigerators declined 0.6 percent with non-durable goods contracting 2.6 percent. The only gain came in energy related goods, which rose 0.5 percent.

Part of the decline in output may have been caused by the plunge in car production, which fell 24 percent from a year earlier on a non-adjusted basis. Istat did not give car output figures comparing February with January. Production of all vehicles - including trucks and busses - declined 3.2 percent from a year earlier on a non-adjusted basis.

If we look at the purchasing managers index and observe the chart (below) we can find the same general picture with the rate of expansion slowing from mid summer, and the index actually registering month on month contraction in March (49.4) for the first time in nearly three years, suggesting that output slowed to stagnation as exports decline.

"The slowdown largely reflected a fall in new orders from both domestic and foreign markets. Operating conditions were further worsened by the fastest rate of cost inflation for 20 months," NTC/ADACI said. NTC Research chief economist Chris Williamson said the figures were consistent with stagnation in the first quarter and added there could be a worsening in the second quarter given the fall in new orders.


Italy's service sector also seems to have contracted in March - for the fourth consecutive month - though the rate of contraction did drop back from February's record rate, as employment fell and input prices rose at their fastest pace on record, according to the latest NTC/ADACI survey. The NTC Research Purchasing Managers Index, which covers companies ranging from hotels to insurance brokers, rose to 48.8 from February's 47.2. Despite the recovery from February's all-time low, March's reading remained below the 50 divide between growth and contraction for the fourth consecutive month.

If we add all of this - retail sales, industrial output, services activity - together it is hard not to draw the conclusion that Italy is now in recession.

"These figures, coupled with the manufacturing PMI, suggest Italy's economy has started to contract," said Chris Williamson, chief economist at NTC Research which compiles the data. "It's hard to see any silver lining and it doesn't seem the worst is over by any means," he said, forecasting Italian gross domestic product fell 0.1 percent in the first quarter.

Sentiment Indexes

If we now turn to the sentiment indexes, a similar picture emerges. The European Commission recently reported its eurozone “economic sentiment” indicator for March, with the composite number for the whole region bouncing back a little from the February reading which its lowest level since December 2005.

The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, was back up to 102 after falling to 100.1 in February from 101.7 in January. However the picture is a mixed one (see chart below), with Germany for the time being holding reasonably stable (and climbing back to 104 from 103.7 in February), France also holding up fairly well at 105.6 (up from 105.2 in February), while Ireland continues to hover near the brink, Italy continues its steady downward path, and Spain heads straight off the map. (the March reading in Spain was 83.9 which was down from 87.5 in February). I suppose in the Spanish case it is now simply a question of how low can you go before you hit bottom.

Maybe for Italy at least there some consolation here, since bad as they are, they are far from being the worst case scenario at this point. This, however, is precious little in the way of consolation. And especially not when we start to think about all those government debt financing issues which are looming just round the next corner.

At the same time Italian business confidence declined to its lowest level in two and a half years in March as slowing economic growth and the euro's appreciation continued to weigh on orders and optimism. The Isae Institute's business confidence index fell to 89, the lowest since August 2005, from a revised 89.6 in February, according to the Rome-based research centre earlier in the month.

Worthy of note was also the fact that a sub-index measuring Italian manufacturers' total orders fell to minus 16 from minus 13. Exporters are currently pretty pessimistic about their short-term sales outlook, with the relevant sub-component falling to 5 from 9 last month, according to a recent quarterly survey of exporters.

``The fall in confidence is due above all to the contraction in orders,'' Isae
said. ``In the first quarter of 2008, both current exports and the outlook for
exports worsened.''

Italian consumer confidence falso fell in March - in this case to its lowest level in nearly four years, as rising prices and slowing economic growth increased pessimism among growing numbers of Italians. The Rome-based Isae Institute's index, based on a survey of 2,000 families, fell to 99 from a revised 102.8 in February. This reading is the lowest since May 2004.

Italians have been steadily cutting back on their spending, which makes up two-thirds of the economy, as the continuing rise in the cost of food and transportation reduces their disposable income. ISAE is currently predicting that the Italian economy will grow by as little as 0.5 percent this year, the slowest pace since 2003.

Again some of the details here are really quite striking, since the sub component concerning optimism about the current economic situation fell to a 14-year low of minus 132 from minus 118 in February, and the number of Italians who are "very concerned'' about rising prices is at a four-year high.

Obviously overhanging the whole economic climate is the current election campaign, which was triggered by the collapse of Prime Minister Romano Prodi's government in January after 20 months in power. Both leading candidates, two-time premier Silvio Berlusconi and former Rome Mayor Walter Veltroni, are promising tax cuts to help revive growth, although given the large fiscal constraints that this growth slowdown will present, it is far from clear where any of these will come from and more than likely most consumers interviewed were only too well aware of this when forming their assessment.

Italian Inflation

On the other hand the news on the inflation front is not good at all. According to the latest ISTAT data Italy's inflation rate rose in March to the highest level in more than 11 years, driven by gains in energy prices and a surge in the cost of food and housing. Consumer prices calculated by European Union's harmonised index rose 3.6 percent from March 2007, an increase on February's rate of l3.1 percent. The February reading had previously been the highest rate since the index was created in January 1997.

Consumer prices rose 1.6 percent in March from February, which is a very rapid rate indeed (annualised 18%). The rate of price increases has clearly accelerated and Italy - which given the very low (or even negative) rate of economic growth which exists at this point - could be said to be suffering from some variant of stagflation. This will not make it at all easy for the ECB to bring any kind of early reflief in the form of rate cuts (which could be just as important for their impact on the current high value of the euro which is crimping Italian exports, as for any easing of lending conditions) in the near future.

Employment and Unemployment

The one bright star in the Italian economic firmament in recent months has been employment. The Italian unemployment rate has been steadily falling since the last quarter of 2004, and in the last quarter of 2007 it stood at 6 percent, its lowest level since 1993.

However these record-low unemployment rates in Italy mask significant regional disparities in joblessness. The jobless rate in Italy's industrial north was 3.4 percent in the fourth quarter, compared with almost 11 percent in the mezzogiorno (south of the country).

Italian unemployment has in fact declined steadily since 1999 after the introduction of changes in labour market regulations which effectively made it easier for companies to hire part-time and temporary workers who don't enjoy the same benefits and job security as full-time staff and can be more easily fired when financial constraints force cuts. This flexibility in the ease of hiring and firing is also reflected in the data, since the number of full-time workers with temporary contracts fell year on year in the last quarter of 2007 for the first time in at least three years, indicating that as the Italian economy slowed these were the first workers to go.

Part time working has also grown steadily since the reform, and nearly 1 in 4 jobs in Italy are now either part time or temporary.

And growth in temporary and part time working has been especially pronounced among the over 35 age group. Unfortunately ISTAT don't provide detailed enough data here, but I think it would be reasonable enough to assume that a significant share of these workers are over 50, since stable employment participation rates in the 35 to 50 age group are traditionally high, so there is not a big pool of workers waiting around to be "sucked into" employment during times of economic expansion.

Moreover, after many years of very low fertility, fewer and fewer young Italians are now joining the workforce to replace the older Italians who are retiring, and their places are now being taken by a steady stream of newly arrived immigrants. In fact two-thirds of the annual increase of 308,000 new workers in the fourth quarter were immigrants, with the other third being effectively accounted for by an increase in employment rates in the 55 to 64 age group. So yet one more time we find a significant difference between what has been going on in Italy and comparable countires experiencing rapid population ageing - Japan and Germany - since while all three countries have leveraged labour reforms to increase job creation, and in all three economies unemployment has been falling steadily, in Germany and Japan this increased employment has been achieved by substantial icreases in the over 55 age group employment participation rates (for developments in Japan see this post here, and for Germany see this one), in Italy - given the ongoing failure to reach agreement on substantial increases in the retirement age and the inability to convince the general population that the problem is an urgent one - a very large share of the new employment has gone to immigrants, who are effectively working to pay a significant chunk of the pensions bill being run up by all of those who are still retiring at 58.

Last November Prodi finally managed to get the support of Italy's labour unions for the 2008 budget by accepting a much more gradual pace of increase in Italy's pension and retirement age as a trade off. The agreement he reached involved a staggered increase in the minimum retirement age, which at that point was set at 57. The change in fact involved supplanting (or going back on) a previously agreed reform law - one which would have boosted the retirement age to 60 from as early as January 2008 - and an effective slowing down of the reform process. The law which was put aside was agreed to in 2004, by one of Silvio Berlusconi's governments, and the decision taken then had been to raise the minimum retirement age— from 57 to 60 - as of January 2008. Under the new Prodi plan the retirement age was raised by one year, to 58, in 2008. In July 2009 the retirement age will again go up, this time to 60 for those with 35 years of contributions, or remain the same for those workers who can muster 36 years of pension payments. From 2011, the retirement age for everyone will rise to 60, and then to 61 by 2013.

This decision, apart from being an astonishing one for outside observers, raises a number of important issues, especially since the ageing population problem is one which affects Italy in a very important way. Male life expectancy in Italy is now fast approaching 80, and is among the highest in the EU. At the same time Italy currently has the third-lowest birth rate in the EU (TFR around 1.3). Without raising the retirement age, contributions simply won't keep pace with pension payments over the coming years, even assuming there is no ageing impact on the overall economic growth rate, which as we are seeing is far from clear.

Of course doing things like this is totally unsustainable. Italy undoubtedly needs migrant labour, but as a complement to, and not a replacement for, a very substantial and swift increase in the retirement age and in employment participation rates among the over 60s.

The regional disequilibrium in Italy also seems to be becoming quite important again (just like the East-West one in Germany, and Tokyo vs the rest one in Japan). While the national participation rate for the 55 to 64 age group went up from 28.9% in Q1 2004 to 33% in Q3 2007, in the mezzogiorno it has gone up from 31.8 to 35.3 over the samer period, so the South is keeping pace here, but if we look at the 65 plus group, while participation has gone from 3.4% to 4% nationally over the same period, in the mezzogiorno it has gone DOWN from 2.4 to 2.1%. The 15 to 64 participation rate also dropped from 54.1 to 52.5 over the period in the mezzogiorno while in the North it went up from 67.8 to 69.2 %. And this situation is reflected in the relative job creation performance between the North and the South.

Basically, given the very strong fiscal pressure which is about to come in Italy, and the danger of a possible sovereign default at some point, if nothing is done to correct the underlying weak national growth trajectory, Italy can be almost literally torn apart by this type of disequilibrium, especially given that it is reinforced by the unequal distribution of migrants (see chart below, the migrants are overwhelmingly concentrated in the North and North East of the country). We thus have an ongoing polarisation of wealth, employment and people, and we really aren't giving sufficient consideration to the longer term political implications of the underlying economo-demographic process.

If you look at the chart below (which is, I admit, a slightly illegitimate one - but only slightly so - since I have derived it by subtracting the number of foreign workers and the number of workers from 55 to 64 from total employment, and some - even if very few for their age profile - migrant workers are in the 55 to 64 age group) we can see that the number of under 55 year old Italians in the workforce has been virtually stationary during the last two years, years of comparatively strong economic growth (in Italian terms) and record low unemployment. I think it is very easy to see some sort of ageing population effect in all this.

So, where does that leave us? Well with a not especially strong underlying labour market dynamic I would say. Employment is being created, but not specifically in high value work. New employment is, as I say, increasingly of low skilled immigrant workers, and part time or temporary workers in the over 50 (and indeed over 60) age group. And all of this despite the evident progress that has been made in bringing down unemployment. Basically the Italian economy is creating employment, but it isn't creating productivity, and it isn't creation strong expansions in consumption. And again, if you take a long, hard and cold look at these numbers I think it isn't too hard to see some of the reasons which help to explain why Italy is suffering from the rather weak consumption and low productivity growth.

Italy's Trade Deficit

Given that Italian domestic consumption remains weak, exports - and with them the value of the euro - take on a special significance. As opposed to other ageing and export dependent economies like Germany and Japan, Italy runs both a trade and a current account deficit. In 2007 the trade deficit was running at a rate of 9.5 billion euros, although this was down substantially from the record deficit of 20.5 billion euros in 2006. The improvement in 2007 was largely due to an improvement in export performance, since Italian exports were up by 8% while imports were only up by 4.4% during the year. Italy has been running a current account deficit since 2000, and evidently a significant part of the instability in Italian economic growth since the turn of the century is attributable to this single detail (given that Italy is an export dependent economy). If we look at the chart below it is evident that as the current account situation has deteriorated economic growth has become more and more fragile. This is not simply because Italy has not reformed sufficiently and has become uncompetitive (the standard explanation, which is of course the case), but because in the context of a rapidly ageing population it is the lack of "gusto" in domestic consumption which makes the whole position so unstable (the part the standard explanation normally misses, and what separates Italy from other - younger - current account deficit running economies like Spain, which is surely hardly any more "competitive" at the export level, indeed arguably it is a lot less so, as we may be about to see as the housing boom steadily disintegrates).

In general Italy maintains a trade surplus with the other countries in the European Union (5.7 billion euros in 2007, up from 210 million in 2006), and the lions share of the trade deficit comes from commerce with the rest of the world, of which of course energy forms an important part. The deficit is important, since with the continuing very sub-par growth in domestic consumption, economic growth - and with it the sustainability of public finances - very much depends on export performance, and indeed Italy will only be able to achieve stable economic growth by running a sustained and sizeable trade suplus.

In fact Italy narrowed its trade deficit with non-European Union countries in February, boosted by exports of refined petrol and machinery and a slight improvement in exports to the U.S. according to the most recent data from Istat. Italy's trade deficit with non-E.U. countries was 1.33 billion euros in February, which compared with a 1.74 billion deficit in February 2007. Exports to countries outside the E.U. thus rose 17.7% year on year to 12.88 billion euros, while imports from non-E.U. countries increased 12% to 14.21 billion euros.

Istat said the improvement was driven in large part by exports of refined petrol products and machinery and mechanical appliances, which rose 67.8% and 27.8% respectively.

Exports to the U.S. rose 10%, while imports from the U.S. increased 2.4%. Imports from the OPEC countries, which account for 9.3% of Italy's total imports, rose 33% on the year. Imports from China, which alone now constitute nearly 6% of the import total, rose 8.4%, while exports to China were up 20.1%. The narrowing of Italy's trade deficit with non-E.U. countries in February offers some support to the view that exports may well rebound modestly in the first quarter of the 2008, offering a little support to what is otherwise bound to be a very weak GDP growth number.

In January, which is the last month for which we have total trade data, Italy had a trade deficit of 4.22 billion euros, compared with a deficit of 3.69 billion euros a year earlier. Exports rose 12% year on year and 4.9% month on month, while imports rose 12.3% year on year and 1.7% month on month.

Italy's trade surplus with other European Union countries slowed in January, to EUR125 million euros, which compared with a surplus of 619 million euros in January 2007, as exports slid 1.3% on the month, but rose 8% on the year. Imports rose 11.8% on the year and 0.8% on the month.

In general it is the persistent inability of Italy's export sector to compensate for the lack of strong internal demand growth which makes the path of Italian GDP so unstable.

Is Italy In Recession?

Italy's economy will expand in 2008 at the slowest pace in five years as "external shocks" such as record oil prices and the strong euro impact consumers and businesses, according to the most recent report from Italy's leading ISAE research institute.. The institute now predict that the Italian economy will grow by only 0.5 percent this year. That's down from their October forecast of 1.4 percent and if realised will be the weakest Italian growth rate since 2003.

Italy's Finance Ministry, on the other hand, still expect growth of 0.6 percent this year, the European Commission expect a rate of 0.7%, while Confindustria, Italy's largest employers' group, has cut its forecast to 0 percent.

The International Monetary Fund cut its Italian growth forecast to 0.3 percent for this year and the next, making Italy the worst-performing economy among the Group of Seven nations and the 15 countries sharing the euro.

Italy is thus topping lists worldwide as the developed economy in the worst shape. The country came last in terms of labor productivity - a key measure of economic growth and competitiveness - in a recent inter-country comparison carried out by the 30-member Organization for Economic Cooperation and Development. No other developed economy has been through three recessions in five years (now heading into its fourth) and the country is coming to look more and more like the Japan of the "lost decade" - even down to the huge increase in the government debt to GDP ratio. It is clear that Italy is now saddled with a whole plethora of economic problems that are holding it back, not the least of them its loss of overall competitiveness.

Watch Out, Here Come The Ratings Agencies

Whoever wins the election, Italy's new government's ability to stimulate the economy with tax cuts (or any sort of fiscal policy) is certainly going to be limited, since the Italian government has to finance and struggle to reduce what is currently the world's second-largest sovereign debt to GDP ratio. Italy's debt did fall back slightly in 2007 - to 104 percent of GDP from 106.5 percent in 2006 - but it is still huge, and of course 2007 was a remarkably good year, while we may now be about to have a remarkably bad one (or two, or more....). Again interest on the national debt currently runs at some 70 billion euros ($109 billion) a year, or about 1,200 euros for each Italian, and any serious slippage in fiscal "clean up" is going to be closely watch by the financial markets, where, it will be remembered, the difference in yield between Italian 10-year bonds and the benchmark German bunds increased to the most in almost a decade last month. The spread between German and Italian bonds widened to 52 basis points in mid March, the most since October 1998, when it was as by much as 61 basis points. Any repetitions of this incident will surely cost the Italian government dear, since spending programmes - like Italy's pension system that already eats up a full 15 percent of GDP - will almost certainly become more expensive to fund, leading to cuts in other - less protected and less structural - areas.

The deficit itself also fell back last year to 1.9 percent of gross domestic product, its lowest level since 2000. That is about half the 2006 deficit of 3.4 percent and - for the time being - within the EU ceiling of 3 percent. But what this deficit reduction process means is that Italian fiscal policy will also be restrictive, tightening the economy even as it falls back into yet another recession.

Nor will monetary policy be much help - at least in the short term - since Italy's prospects of obtaining cheaper interest rates to aid recovery are currently being frustrated by a European Central Bank anti-inflation policy that has kept borrowing costs at a six-year high of 4 percent even as several important eurozone economies have been slowing, and as the euro has surged - not coincidentally - to ever greater "highs" against the dollar. The single currency has risen by 11 percent over the past six months against the dollar and has hit a record 1.5913 dollars only this week, a development which lead European Union Economic Policy Commissioner Jaoquin Almunia to issue an explicit warning about currency valuations getting out of line with economic fundamentals.

Looking forward Italy's budget deficit is expected by ISAE to rise to 2.7 percent of gross domestic product this year. This is more than the 2.6 percent formerly predicted, (the Finance Ministry currently predict a deficit of 2.4 percent of GDP in 2008, again up from the 2.2 percent originally predicted) though all of this is still within the European Union ceiling of 3 percent. The difficulty is that this position may be subject to slippage, as revenue falls, and - if unemployment were to seriously rise - payments go up. So one of the most important consequences of the current weak growth is that it is likely to put increasing pressure on the budget deficit.

Italian tax receipts were higher than expected in the first quarter of 2008, the Italian Finance Ministry announced last week. Overall tax receipts increased 5.6% to 60.1 billion euro over the quarter, up from 56.9 billion euro in the first quarter of 2007. Overall receipts in March rose 10.1% to 29.9 billion euro from 27.1 billion euro in March 2007. Two-thirds of the increase in tax receipts in the first quarter are due to higher income taxes, according to the ministry's data. However, receipts from value-added tax rose only 0.9% on the year in March, reflecting the weaking climate in both consumer confidence and spending.
"These results are well above the trend projected by all the main macroeconomic variables," the ministry said.

The ministry noted that the 2008 budget forecast a net reduction in tax receipts of around 3 billion euro, so that the excess in the first quarter pointed to the possibility of "extra" income for the state over the course of the year.

Silvio Berlusconi and Walter Veltroni in fact have broadly similar economic programs, offering tax cuts and more public works spending as formulas to revive a stagnant economy. But both have failed to convince either economists or many Italian voters that they can afford to keep their promises.

Italy's ailing economy will limit room to maneuver on policy for its next government, as shown by similarities in the main political programs, a senior credit officer at Moody's Investors Service said on Friday. Alexander Kockerbeck said the targets set by the two main candidates in their programs pointed in the right direction, but the problem would be the next government's ability to achieve them.

Berlusconi pledges tax cuts on everything from income to property and plans to boost spending on costly infrastructure projects such as the world's longest bridge, linking Sicily to the mainland. Veltroni is offering similar tax cuts and wants to boost spending on roads and railways. Their plans are by no means cheap. Berlusconi would need some 63 billion euros to fund his manifesto promises, compared with the 58.3 billion euros for Veltroni, according to economists at Intesa Sanpaolo. To finance their plans, both would need to save money elsewhere and improve tax collection in a country where evasion is estimated to account for a minimum of 15 percent of gross domestic product.

Berlusconi has promised unspecified spending cuts and says he will sell state assets to pay down the debt which he himself accumulated. Veltroni calls for cutting spending by 0.5 percent of gross domestic product during his first year and by 1 percentage point a year after that, without specifying how he would do this.

Apart from the exceptional effort made in 2007, recent Italian governments have not done especially well in cutting state spending 8to put it mildly), which rose substantially during the last Berlusconi administration between 2000 and 2005, and now remains steady at around 40 percent of Italy's GDP. And the situation is a delicate one, since even if both candidates continue Prodi's clampdown on tax dodgers, fiscal revenue will inevitably slow as growth slackens.

Both candidates say they would like to fund special programs, such as increased minimum pension benefits, with the extra income the hope to obtain from clamping down on tax evasion, but they really may be jumping the gun somewhat here, and it will be interesting to see whether they are so imaginative and so enthusiastic when it actually comes to collecting the money in the first place. I would say downside risk for slippage on the fiscal deficit front is strong at this point, and especially if the Berlusconi coalition win the elections.

Silvio Berlusconi, tends to brush aside such concerns, and seems to see the issue as already a "done deal", since he is busy dreaming up ways to spend the extra income, without - it seems to me - taking due account of how the economic slowdown may impact both income and expenditure. "We will use that treasure to abolish this tax that has no reason to exist" he said on the "Matrix" television programende, refering to his "surprise" last minute, rabbit-out-of-the-hat proposal to eliminate a tax on car and motorcycle registration - at a cost of 4 billion euros - a cost which is, of course to be met by tapping the surplus - "that treasure" - always assuming that at the end of the day it exists.

``We hope they would reduce expenditure in public administration and, more importantly in the long term, cut pension spending before contemplating tax cuts,'' S&P's credit analyst Trevor Cullinan said in a telephone interview from London. ``That doesn't look likely.''

The pledge on the part of both candidates to cut Italy's public debt while at the same time easing tax pressure isn't cutting that much ice over at the credit rating agencies however. "I looked at the two programs and they seemed to confirm that margins for maneuver are limited," said Alexander Kockerbeck, senior credit officer at Moody's. Kockerbeck indicated that the stabilization in the level of the country's public debt warranted the retention of the stable outlook for the time being, but but he was quick to add that it was still too early to say whether the trend was under control in the medium term. "The latest positive data on debt and deficit are neutral in terms of their impact on the ratings because we saw them more as cyclical than structural."

To understand just why analysts like Trevor Cullinan and Alexander Kockerbeck may be worried one need look no further than to Silvio Berlusconi's proposed solution to the Alitalia crisis, which involves finding the money to float a rescue, rather than putting the squeeze on the Unions to come to terms with air France. Berlusconi has repeatedly denounced the Air France bid and said he personally would seek an Italian buyer. Veltroni has accused Berlusconi of "interfering" and called on unions and Air France to resume negotiations to save the airline and jobs.

``We cannot give up our flagship carrier,'' Berlusconi said in Rome during a campaign speech. ``I renew my appeal for Italian businessmen'' to join together to buy Alitalia, he said.

And while Alitalia was busy amassing more than 3 billion euros in losses over the past decade, Italy's overall competitiveness was slipping to 46th in the World Economic Forum's 2007-2008 ranking, putting it behind free enterprise stallwarts like Latvia, South Africa and Bahrain. In the 15 country eurozone Italy ranks only above Greece. And much of the slide in both state indebtedness and loss of competitiveness came precisely during Berlusconi's second period as prime minister between 2001 and 2006.

Unicredit economist Marco Valli is widely quoted as saying that he has not tried to do detailed costing on the two programmes because some measures will certainly not be implemented, while the final days of the campaign is seeing a 'crescendo' of promises. However, even without detailed calculations, he argues that it does seem 'possible' that Berlusconi's PDL's plans will breach the EU's 3 percent deficit limit, especially if they do not continue to be so vigourous in the fight against tax evasion (remember, Berlusconi described the methods being used by the outgoing Prodi government as "brutal").

Dresdner Kleinwort have also expressed the view that the new government will run into severe difficulties if it attempts to implement either of the groups' tax cuts. "Indeed, Italy agreed with the EU to reach a budget balance in 2011. With an estimated deficit of 2.4 percent in 2008 and 2.1 percent in 2009, the new government should pursue a tough fiscal policy" it said in a statement.

The prospect of rising debt fuels the risk to Italy's credit rating, ratings companies say. Standard & Poor's and Fitch Ratings slashed Italy's creditworthiness in October 2006, less than six months after the last election. S&P also cut the rating in July 2004, during Berlusconi's tenure. Fitch rates Italy's long-term debt AA-, while S&P gives it A+. Italy's debt is rated 'Aa2' with a stable outlook by Moody's.

And the issue with the ratings agencies is no mean one, as the ECB made clear back in November 2005, when they took the decision not to accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So, to end up where we began, rather than Gianni de Michaelis' analogy of the Titanic and the Iceberg, could this recession actually be the occasion that the Italian economy actually lets itself slide so far down the slippery slope that it proves well nigh impossible - in the conetxt of it's sovereign debt dynamics - to claw its way back up again. At this point it is hard to see, but this is not a danger, or a possibility, that any of us should be taking lightly.

Or perhaps Berlusconi has another plan up his sleeve to get Italy out of the mess:

"Ronaldinho only wants Milan", said Silvio Berlusconi. The President of AC Milan, in Savona for an election rally, said: "We are trying our best to bring him to Milan, Ronaldinho said he would not be in any team if not in that of the world champions, that is us. He would come here also because there are so many of his fellow Brazilians and he knows that at Milan we treat everybody very well."

Well I think it only remains for me to express the hope that his plan to keep the former world football champion afloat is not as doomed to failure as his plan to do the same with the national champion airline would seem to be. Or is Berlusconi simply destined to be a dedicated follower of lost causes? Of course, my status as an ardent supporter and enthusiast for Barça FC is in no way clouding my judgement here.

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