Country Intelligence Report 1

Country Intelligence: Report
Italy
REPORT PRINTED ON 03 DECEMBER 2012
Created on 03 Dec 2012
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This information was last updated on 03 DEC 2012, 8:55 AM EST (13:55 GMT)
Outlook and Assumptions: Outlook

Italian borrowing costs have fallen back, but bond markets remain concerned that the sharp focus on Spain is resulting in a more relaxed approach in Italy to fiscal consolidation and the need to implement effective structural reforms. Specifically, Italy's benchmark 10-year bond yield on the secondary market stood at 4.73% on 23 November, with the spread to the German equivalent at 322.7 basis points. Italy has been one of the better-performing sovereign debt markets during 2012, with the 10-year bond yield falling back sharply from a 2011 high of 7.2% in late November 2011. Still uncomfortably high Italian sovereign debt yields reflect some contagion from the financial crisis enveloping Spain and the ongoing volatility surrounding Greeces ability to meet the terms that accompanied the EU/IMF bailout. Domestic issues, however, are also contributing, namely gloomy economic and fiscal data, fears of a stalling of the critical structural reform drive, and political gridlock following the March/April 2013 general election. Nevertheless, Italy remains confident that it will not need financial support from the Eurozone rescue funds to unlock the revamped ECB bond-buying program, and continues to believe it still has domestic policy options to help lower its borrowing costs. Indeed, Bank of Italy governor Ignazio Visco hopes Italy can convince markets that the country has reached the turning point with regards to greater fiscal discipline and "steps up its efforts to promote growth, then there will be no need for a rescue fund intervention. The ECB president Mario Draghi has spelled out that the ECB will buy bonds on the secondary market, but this will be dependent on the stressed countries going to the EFSF/ESM first, with the conditionality that this involves. The recession continues to deepen at a disconcerting pace. Economic activity shrank for a fifth successive quarter in the third quarter of 2012 but at a slower pace than the first half of the year. Furthermore, recent indicatorsnamely the purchasing managers' surveyssignal another contraction in real GDP in the fourth quarter. With domestic spending appearing to shrink aggressively in the first half of 2012, the near-term recovery prospects remain very bleak, with a further fall in activity expected in the first half of 2013. To make matters worse, our new baseline assumption of Greece exiting the Eurozone no later than the third quarter of 2013 is expected to delay any significant recovery of the Italian economy until early 2014. Despite IHS Global Insight's assumption of a strong policy response to a Greek exit, we expect some contagion to fall on Italy. This could lead to a period of deep uncertainty engulfing Italy just prior to and during the exit event, resulting in a further spike in bond yields, some financial-market disruption, and a hit on business and consumer sentiment. We have assumed the impact on economic activity will be at its most acute in the second and third quarters of 2013, with Italy not exiting the current recession until early 2014. Overall, real GDP is expected to contract by 2.2% in 2012 and 1.0% in 2013 before stabilizing in 2014, according to the November 2012 forecast. The markets blame Italys poor growth prospects on its dismal productivity performance and declining competitiveness since the adoption of the euro, and the resulting erosion in Italy's export share in world markets. Apart from weak labor-productivity performance, Italy's ability to compete both at home and abroad has also been hampered by a lack of competition in several key services sectors. These include the banking and legal sectors as well as others, which are able to transfer their low productivity onto their selling prices, representing a burden for the whole economy, particularly the traded goods sector. The new technocratic government has pledged to tackle the long-standing structural impediments, namely a segmented and rigid labor market, excessively regulated business climate, and high levels of inefficient public spending funded by one of the largest tax wedges in the Eurozone. The first batch of reforms passed in mid-January is an encouraging first step, and over time will help to improve the business climate in Italy, which will help to produce a modest boost to the country's growth potential. Nevertheless, deeper labor reforms will be needed to reverse Italy's woeful productivity performance.
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Outlook and Assumptions: Domestic Assumptions

Greece is expected to leave the Eurozone in mid-2013. We assume that a Greek exit is the trigger for the rest of the Eurozone to move more quickly and clearly towards a full financial and fiscal union, to safeguard the remaining members. This will limit the collateral damage from the Greek exit. Fiscal policy in Italy will remain tight, as the government strives to improve the poor state of country's public finances. Strong pressure from international investors and European Central Bank (ECB)/EU policymakers will force Italy to maintain the recent pace of structural reforms in the next few years. The ECB will cut interest rates to 0.50% in the fourth quarter. It will take them down to 0.25% around mid-2013 as part of the measures to combat the Greek crisis. The euro will trade largely below USD1.30 over the rest of 2012 and will then trend down to USD1.20 by mid-2013 and a low of USD1.15 in the third quarter of 2013 as expectations mount anew during 2013 of a Greek exit and it then occurs.
Outlook and Assumptions: Alternative Scenarios

Policymakers fail to build a strong enough policy framework in place in the Eurozone to deal with the expected Greek exit around mid-2013. Contagion would be much deeper and longer, and there is an increased danger that more countries would end up leaving the Eurozone. Greece stays in the Eurozone and European policymakers make well-received progress in moving towards a full financial and fiscal union. Consequently, Eurozone and global economic activity recovers more quickly from the current problems than we currently forecast Italy fails to kick starting its growth-boosting reform agenda after the next general election in early 2013, encouraging sovereign debt markets to take a more negative outlook on Italys debt sustainability. The situation is made more urgent, with Italy needing to tap heavily into the sovereign debt markets against a backdrop of an uncertain investor sentiment, not helped by a likely Greek euro exit and the increasing risk that Spain will need a full sovereign bailout. A renewed firming in oil prices means that consumer price inflation is stickier than forecast in Italy, keeping a significant squeeze on consumers purchasing power. Renewed high oil prices would also squeeze companies margins. This could weigh markedly on Italian growth prospects over the second half of 2012.
Economic Growth: Outlook

The outlook for the fourth quarter is far from upbeat, with the economy expected to lose further ground, with real GDP likely to fall another 0.2% quarter-on-quarter (q/q). The purchasing managers' reports for both manufacturing and service sector activity in October alongside still-gloomy business and consumer surveys signal real GDP remains under pressure in the fourth quarter. The latest survey data remain well short of the levels required to herald an upturn in the business cycle, pointing to further declines in real GDP in the final quarter of 2012 and the first quarter of 2013. The economy continues to flounder in the face of a profound collapse of consumer and business confidence, not surprising given the tougher tax regime, tighter credit conditions, and rising unemployment.
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To make matters worse, our new baseline assumption of Greece exiting the Eurozone by the third quarter of 2013 is expected to delay any significant recovery of the Italian economy until early 2014. Despite IHS Global Insight's assumption of a strong policy response from the EU/European Central Bank (ECB) policymakers to a Greek exit, we expect some contagion to fall on Italy. This could lead to a period of deep uncertainty engulfing Italy around the exit event, resulting in higher bond yields, financial market disruption, and a hit on sentiment. With the recent positive contribution from exports diminishing, the other sectors of the economy, damaged by a tough austerity plan, remain too weak to pick up the baton of the recovery. With consumer confidence bouncing around record lows in the first 10 months of 2012, cautious household spending will serve as a major obstacle to any recovery in economic activity during 201213. Despite the smaller value-added tax (VAT) hike now planned for July 2013 and proposed labor tax cuts from January 2013, IHS Global Insight remains downbeat about the near-term consumer spending outlook. The main drags are likely to be household disposable income retreating for a sixth successive year in 2013 as well as a steadily rising unemployment rate. Clearly, household demand conditions are expected to remain fragile in Italy, not helped by the government having to maintain aggressive fiscal tightening to keep the intensifying sovereign debt crisis at bay. The latest consumer confidence survey provides compelling evidence that households continue to refrain from non-essential spending. Overall, real GDP is expected to contract 2.2% in 2012 and 1.0% in 2013, according to the released November 2012 forecast.
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Economic Growth Indicators 2009 Real GDP (% change) Real Consumer Spending (% change) Real Government Consumption (% change) Real Fixed Capital Formation (% change) Real Exports of Goods and Services (% change) Real Imports of Goods and Services (% change) Nominal GDP (US$ bil.) Nominal GDP Per Capita (US$) -5.5 -1.6 0.8 -11.7 -17.7 -13.6 2010 1.8 1.2 -0.6 2.0 11.2 12.3 2011 0.6 0.1 -0.8 -1.3 6.7 1.2 2012 -2.2 -3.2 -1.2 -8.4 0.8 -7.5 2013 -1.0 -1.2 -2.6 -3.3 -0.2 -0.9 2014 0.0 -0.2 -0.4 -0.8 0.8 0.3 2015 1.4 1.0 0.8 1.7 3.3 3.0 2016 1.4 1.4 1.0 1.8 3.5 3.6
2,111.2 2,055.3 2,197.4 2,011.5 1,886.3 2,004.5 2,187.4 2,363.1 35,042 33,944 36,149 32,995 30,879 32,766 35,718 38,558
Source: Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the 15th of each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release of the GIIF bank. Download this table in Microsoft Excel format
Economic Growth: Recent Developments

Italy's economy remained in recession after contracting for a fifth successive quarter during the third quarter of 2012, according to a flash estimate from the Statistics Bureau. Specifically, seasonally and calendar-adjusted real GDP contracted 0.2% quarter-on-quarter (q/q), compared with drops of 0.7% q/q in the second quarter and 0.8%
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year-on-year (y/y) in the first. The annual comparison remained weak, with real GDP tumbling 2.4% y/y, the fourth successive fall on a y/y basis. ISTAT did not reveal any details about third-quarter GDP in terms of expenditure. Nevertheless, IHS Global Insight suspects that a stronger-than-expected boost from net exports helped to stem the rate of decline in economic activity while domestic spending conditions appeared to remain sluggish in line with the profound collapse in confidence as an austerity-hit Italy continues to pay a heavy price to pull clear from the Eurozone sovereign-debt storm. The real GDP performance in the third quarter was slightly better than anticipated, but failed to shake off our view that Italy is being engulfed by deep recessionary conditions. More recent survey data suggest that confidence-sapping conditions are likely to prevail, helping the downturn to continue throughout the remainder of 2012. We only have the breakdown of second-quarter GDP by expenditure component, which reveals that a strong growth impulse from net exports was offset by a notable slump in domestic demand. The main components of domestic spending (excluding a change in stocks and government consumption) retreated during the quarter, curtailing the q/q change in real GDP by 1.0 percentage points. In addition, a fall in the level of stocks (plus statistical discrepancy) represented a sharp drag on activity, knocking off 0.5 percentage point from the q/q change in real GDP during the second quarter, compared with a negative contribution of 0.2 percentage point in the first quarter. It is likely that companies paid even greater attention to their level of stocks given the gloomier economic outlook both in Italy and abroad. This, coupled with deteriorating domestic demand conditions, appeared to be an important factor behind a further drop in imports during the second quarter, alongside a modest rise in exports during the quarter, allowing net exports to contribute 1.0 percentage points to the q/q change in real GDP. Private consumption retreated by 1.0% q/q in the second quarter of 2012, compared with a 1.1% drop in the first quarter, the sharpest fall since the first quarter of 1993. The annual comparison was disappointing, with overall spending plummeting by 3.6% y/y, compared with a 2.8% y/y fall in the first quarter and a 0.2% rise in 2011 as a whole. Other spending indicators also provided a muted picture of consumer spending in the second quarter. First, the number of new car registrations was down by 18.9% y/y, compared with a 21.1% y/y drop in the first quarter of 2012. Meanwhile, the average nominal value of retail sales decreased by 2.8% y/y in the second quarter, after a 0.5% y/y drop in the first quarter. The slump in investment activity deepened in the second quarter. Gross fixed capital formation dropped back by 2.3% q/q during the second quarter of 2012, implying that it has fallen in six of the last seven quarters. Therefore, the y/y percentage change accelerated to -9.5% in the second quarter, after drops of 7.4% in the first quarter and 1.2% drop in 2011 as a whole. The slump in machinery and equipment spending deepened during the second quarter, when it contracted 3.1% q/q and 10.4% y/y. Furthermore, IHS Global Insight believes the investment climate is markedly tougher, with companies enduring uneven profitability and an uncertain economic outlook, still difficult access to credit markets, and lower than normal capacity utilization. Disappointingly, investment in transport equipment plunged by 3.8% q/q and 22.4% y/y in the second quarter. Finally, construction investment took a battering, falling by 1.5% q/q and 6.3% y/y. Clearly, the sector is under a cloud, with restricted channels to credit while construction activity has been curtailed by falling state infrastructure spending alongside weak demand for new housing. Meanwhile, government spending edged up 0.2% between the first and second quarters, but was still 0.9% lower than in the second quarter of 2011. This was stronger than expected, given that the government is under considerable pressure to contain expenditure and improve underlying public finances. Exports surprised on the upside but remain moderate in the second quarter. Exports of goods and services grew 0.2% q/q in the second quarter, after retreating moderately in the previous two quarters. However, the annual rate of growth slowed to 1.4% from 1.7% in the first quarter. Meanwhile, imports of goods and services fell for the sixth successive quarter, contracting 0.4% q/q in the second quarter. In addition, the y/y percentage change stood at -8.2% and -9.2% in the second and first quarters, respectively.
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Economic Growth: Consumer Demand - Outlook

The fallout from the Eurozone sovereign debt crisis will continue to constrain both consumer confidence and spending in the latter stages of 2012 and 2013. Household confidence continues to bounce around record lows, while overall private spending fell by 2.8% year-on-year (y/y) and 3.6% y/y in the first and second quarters of 2012, respectively. In addition, consumer confidence surveys continue to signal the near-term outlook will remain challenging with households expressing continuing reluctance to undertake major purchases as they struggle to cope with significant headwinds. First, consumers are enduring shrinking real household disposable income, partly resulting from slower nominal wage growth alongside higher-than-expected consumer price inflation when placed alongside dismal domestic demand conditions. Second, the unemployment rate has risen notably, and is just shy of 11.0%. Third, painful revenue-raising measures passed during December 2011 have contributed to a rising tax burden on struggling households. To make matters worse, our baseline assumption that Greece will leave the euro no later than the third quarter of 2013 will cause some financial market disruption, impacting on Italian household confidence and spending intentions. The outlook for consumer spending remains bleak, with households likely to remain cautious about non-essential spending. Indeed, overall household spending is projected to contract by 3.2% in 2012 and 1.2% in 2013, according to the November 2012 forecast. To make matters worse, the government has retreated from its initial promise to provide immediate support to struggling low-income households by cutting income tax rates from early 2013, and will now plan to take action from 2014, which could entail higher tax deductions for young workers. Therefore, the outlook for consumer spending is even darker in 2013, not helped by the planned VAT increase from 21% to 22% going ahead in July 2013. This could encourage a temporary spurt in private consumption in the second quarter of 2013 as consumers bring forward major purchases to avoid the tax rise. Nevertheless, this will be a drag on spending intentions in the second half of 2013 and early 2014. The cut in payroll taxes planned for 2014 is a rare piece of good news for households, but they could be tempted to save a significant slice of the additional disposable income when faced with still-volatile employment prospects and tight personal finances. Overall, consumer spending is set for a bumpy ride in the latter stages of 2012 and the whole of 2013, providing a major obstacle to Italy pulling clear of the current recession.
Economic Growth: Consumer Demand - Recent Developments
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More recent indicators suggest consumer spending remained weak in the third quarter of 2012, with new car sales falling at an accelerated pace while spending on other consumer durables appeared to be sluggish. The average number of new car registrations contracted 22.8% year-on-year (y/y) in the third quarter after an 18.9% drop in the previous quarter. The nominal value of seasonally adjusted retail sales edged up 0.1% between August and September, which had been preceded by zero growth in the previous month and a 0.2% m/m drop in July, according to the National Statistical Office. On an unadjusted basis, retail spending in September fell 1.7% y/y, compared with a 1.1% y/y retreat in August. Furthermore, retail sales were considerably weaker during September when adjusted for consumer price inflation, which averaged 3.2% during the month. A breakdown by type of goods reveals spending on food items was up by 0.2% over the month but was 0.6% y/y lower in September in nominal terms. Spending on nonfood items was unchanged between August and September, and was 2.4% lower y/y. The latest national-accounts data revealed that private consumption retreated 1.0% q/q in the second quarter of 2012, compared with a 1.1% drop in the first quarter, the sharpest fall since the first quarter of 1993. The annual comparison was disappointing, with overall spending plummeting by 3.6% y/y, compared with a 2.8% y/y fall in the first quarter and a 0.2% rise in 2011 as a whole. Other spending indicators also provided a muted picture of consumer spending in the second quarter. First, the number of new car registrations was down by 18.9% y/y, compared with a 21.1% y/y drop in the first quarter of 2012. Meanwhile, the average nominal value of retail sales decreased by 2.8% y/y in the second quarter, after a 0.5% y/y drop in the first quarter. According to the National Statistical Office, Italy's seasonally adjusted consumer confidence index improved for a second successive month in October. The overall index stood at 86.4, compared with 86.2 in September, 86.1 in August, 86.5 in July, and 85.4 in June, the lowest level since the monthly series began in 2009. Consumers remain very anxious about the current economic climate, with the sub-index for this at a disappointing 71.7 in October, moving up from 71.1 in September, 69.6 in August, and a survey low of 60.3 in June. Households stayed downbeat regarding their personal situation in October, with the sub-index standing at 91.0, a new survey low that is unsurprising given higher-than-normal unemployment, squeezed real incomes, and a tougher tax regime. Finally, households expressed deep pessimism about their outlook, with the sub-index measuring an aggregate view on the future economic situation and personal finances at 76.0 in October, against 76.9 in September, and 76.7 in August.
Economic Growth: Capital Investment - Outlook

Overall fixed investment is likely to remain modest in 201213. Total fixed gross investment is projected to fall 8.4% in 2012 and 3.3% in 2013 after a 1.2% drop in 2011, according to the November 2012 forecast. The recovery in business fixed investment weakened steadily during 2011, and capital spending is now projected to fall at an aggressive pace in the second half of 2012 and 2013. Specifically, according to our fourth-quarter 2012 detailed forecast round, we estimate industrial capital expenditure (excluding general government investment) will fall 10.5% in 2012 and 5.7% in 2013, with the balance of risks on the downside with Italy stuck in a deepening recession. The slump in business investment appeared to bottom out in late 2009 and was lifted by the introduction of tax breaks to encourage firms to replace obsolete machinery for one year from July 2009. Indeed, machinery and equipment investment had dropped to its lowest level relative to GDP since 1999. Nevertheless, the recovery has stalled, with firms continuing to face substantial excess capacity, tight financials, and heightening fears of a prolonged recession. Specifically, increasingly uncertain assessments of both the domestic and global economies remain obstacles to a sustained and strong recovery in business confidence. Consequently, IHS Global Insight believes business confidence is likely to remain uneven during the latter stages of 2012 and 2013 as these factors persist, not boding well for investment during the period. The outlook from
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2013 is uncertain, with the prospect of still-fragile demand and tough credit conditions helping to limit the upside in business investment. Furthermore, the risks remain on the downside because of the lagged effect of the robust austerity measures planned from 2012 to 2014, and the potential impact of our baseline assumption that Greece will exit the Eurozone no later than the third quarter of 2013. The near-term outlook for construction activity is set to deteriorate in 2012, but will improve in 2013. Restraining factors, including still-disrupted access to mortgage loans, a recovering but still-fragile property market, and the prospect of muted growth in real household incomes are expected to remain acute throughout 2012. Consequently, we expect residential investment to fall for the sixth successive year in 2012, probably down by 5.3% in 2012 after a 2.3% drop in 2011. Residential construction is projected to recover in 2013 and 2014, up 1.0% and 1.8%, respectively, on the back of the reconstruction of the earthquake-damaged Emilia-Romagna region. The government has put aside EUR1 billion in both 2013 and 2014 to assist the reconstruction efforts, with the rest being obtained from EU.
Economic Growth: Capital Investment - Recent Developments

The slump in investment activity deepened in the second quarter. Gross fixed capital formation dropped back 2.3% quarter-on-quarter (q/q) during the second quarter of 2012, implying that it has fallen in six of the last seven quarters. Therefore, the year-on-year (y/y) percentage change accelerated to a 9.5% drop in the second quarter, after drops of 7.4% in the first quarter and 1.2% drop in 2011 as a whole. The slump in machinery and equipment spending deepened during the second quarter, when it contracted 3.1% q/q and 10.4% y/y. Furthermore, IHS Global Insight believes the investment climate is markedly tougher, with companies enduring uneven profitability and an uncertain economic outlook, still difficult access to credit markets, and lower than normal capacity utilization. Disappointingly, investment in transport equipment plunged by 3.8% q/q and 22.4% y/y in the second quarter. Finally, construction investment took a battering, falling by 1.5% q/q and 6.3% y/y. Clearly, the sector is under a cloud, with restricted channels to credit while construction activity has been curtailed by falling state infrastructure spending alongside weak demand for new housing. Meanwhile, government spending edged up 0.2% between the first and second quarters, but was still 0.9% lower than in the second quarter of 2011. This was stronger than expected, given that the government is under considerable pressure to contain expenditure and improve underlying public finances. Italian business (manufacturing) confidence deteriorated in October and is low when compared with historical norms, according to the latest survey conducted by the National Institute for Statistics. The overall confidence indicator edged down to 87.6 in October, compared with 88.3 in September and 87.3 in August and July. The overall confidence index is a composite of the sub-indices for current inventory levels, orders, and the production outlook for the next three to four months. The new orders sub-index remained at -42 in October, compared with -40 in September, and a 29-month low of -43 in May. With the poor new order situation prevailing, firms' near-term production expectations remained weak in September, standing at -6 in October, compared with -7 in September. ISTAT's newly launched composite index, which combines surveys of the manufacturing, retail, construction, and services sectors, revealed a slight improvement due in confidence in October, resulting from increased optimism in the services and retail sectors.
Labor Markets: Outlook

The demand for labor remains very sluggish and is expected to remain weak throughout 2012 and 2013, with the economy likely to be entrenched in a more painful and protracted recession than previously anticipated. We believe the private services sector will struggle to generate any new employment opportunities, while public-sector
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employment at both the central and local government level is likely to fall as a result of the need to curtail public spending. Meanwhile, we expect further notable industrial employment losses, as companies continue to tightly control their workforces amid falling profits and lower-than-normal output. In addition, the government will be under increasing financial pressure to rein back the use of the state-assisted "cassa integrazione scheme" in the next few quarters. The scheme allows firms to send workers home temporarily on reduced pay, which has helped to restrict the employment losses during the recession. Italy's seasonally adjusted unemployment rate rose to a new survey high in September, in line with soft labor demand conditions. According to the National Statistical Office (ISTAT), total employment contracted for a second successive month by 0.2% between August and September, to stand at 22.937 million, after an identical drop in the previous month. IHS Global Insight continues to argue that employment intentions have weakened progressively since mid-2011, with firms increasingly shaking out labor amid the deepening recession and very competitive trading conditions. Meanwhile, the labor force was unchanged between August and September, to stand at 25.712 million. This, accompanied by contracting employment, raised the seasonally adjusted unemployment rate to 10.8%, the highest level since the series began in 2004 Diminishing employment prospects are expected to result in higher unemployment in 2012/13. The unemployment rate is expected to develop more aggressively in the next few quarters given the deteriorating economic climate. Unemployment is projected to climb from 8.3% in 2011 to 10.7% in 2012, 11.4% in 2013, and 11.3% in 2014, according to the November 2012 forecast. Furthermore, it stands notably higher than the recent low of 6.1% in 2007, which was the lowest rate since 1975.
Labor Markets: Recent Developments

Demand for labor edged up in the second quarter of 2011, despite firms facing ever tougher trading conditions. According to the National Statistical Office (ISTAT), total employment edged up by 0.1% quarter-on-quarter (q/q) to 23.000 million, after a 0.2% q/q gain in the first quarter and being flat in the final quarter of 2011. In unadjusted terms, overall employment contracted 0.2% year-on-year (y/y) to 23.046 million in the second quarter, compared with a 0.4% y/y drop in the first quarter. The demand for labor has been propped by the "cassa integrazione" scheme, with the scheme making up the pay of permanent employees affected by temporary layoffs (who are not considered unemployed) or under shorter working hours for a maximum of two years. During the last recession, the number of authorized hours subsidized by the " cassa integrazione" scheme increased more than 600%, and the Organisation for Economic Co-operation and Development estimates that the share of total employees (full-time equivalent) in short-time work schemes in Italy rose from 0.6 percentage point in mid-2008 to just under 4.0 percentage points by early 2010. Job losses were recorded in industry, falling 2.2% y/y in the second quarter of 2012, while service employment edged up 0.6% y/y. Finally, employment in construction continued to shrink aggressively, plummeting by 5.1% y/y in the same quarter. Unemployment rose during the second quarter of 2012. An expanding labor force rose offset the moderate rise in employment to push up the seasonally adjusted unemployment rate to 10.6%, the highest rate since end-1999, and up from 10.1% in early 2012. More labor-market reforms needed to boost employment ratio. Italy continues to endure one of the lowest employment ratios in the Eurozone, particularly among women. The overall employment rate in Italy was unchanged at 57% in the second quarter of 2012, compared with 56.8% at end-2011. It peaked recently at 59.2% in mid-2008.
Inflation: Outlook
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Consumers are struggling to cope with a steady stream of adverse developments, particularly with stubbornly high inflation contributing to a squeeze on real wage income. Inflation is expected to drift down in the next few quarters, however, in line with Italian retailers and service providers struggling to attract new customers and lower global crude oil prices when compared with a year earlier. Inflationary pressures will also be limited by our baseline view that Greece will exit the euro no later than the third quarter of 2013. Despite our assumption of a strong policy response, some contagion will fall on Italy, with the impact on economic activity likely to be at its most acute in the second and third quarters of 2013, and Italy mired in recession until early 2014. This will heighten pressure on Italian retailers and service providers to price competitively to generate new business, while ongoing intense competition on the high street in the face of reluctant consumers will continue to contain the price of some services and durable goods, especially with regard to clothing, footwear, and electronics. Finally, wage pressures are projected to remain moderate during latter stages of 2012 and 2013. The industrial and service sectors are under pressure to control wage costs due to tight profit margins as companies are resorting to aggressive pricing to drum up new business against a backdrop of still-high non-wage input prices. Conversely, the consumer price inflation rate will be elevated (and distorted) by the planned 1.0-percentage-point rise in the VAT rates from 21% to 22% from the third quarter of 2013. Overall, consumer price inflation is expected to average 3.1% in 2012 and 1.6% in 2013, according to the November forecast. Wage inflation is projected to remain moderate during late 2012/13. The industrial sector is under pressure to control wage costs due to tight profit margins as companies are resorting to aggressive pricing to drum up new business against a backdrop of rising input prices. Labor costs must be contained in order to protect competitiveness. The Italian export sector has lost much of its dynamism thanks to a marked fall in price competitiveness with the euro and even slowed more acutely against non-euro countries after the euro recovered. This increase has created problems for Italian exporters, given the price-elastic products in which Italy specializes, notably clothing, footwear, and capital equipment.
Inflation Indicators 2009 Consumer Price Index (% change) Wholesale-Producer Price Index (% change) 0.8 -5.4 2010 1.5 3.1 2011 2.8 5.0 2012 3.1 2.7 2013 1.6 1.3 2014 2.2 1.6 2015 2.2 1.8 2016 2.1 1.8
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Inflation: Recent Developments

According to the final release, Italian consumer price inflation fell to a 19-month low of 2.6% (national definition) in October from 3.2% in September, with the value-added tax (VAT) increase in September 2011 falling out of the index. Nevertheless, a breakdown of October's consumer price index (CPI) data by goods and services still reveals an acute inflationary impulse from essential goodsnamely domestic energy and to a lesser extent food prices. This puts an additional burden on gloomy households, eroding their ability to spend on non-essential consumer durables. October's data confirm a sharper rise in energy-related prices, with transport and housing, electricity, and fuel prices rising 6.1% year-on-year (y/y) and 6.8% y/y, respectively. On the flip side, other goods and services reported more moderate price pressures across the economy. Communication costs fell 2.4% y/y, while healthcare and recreation and culture sectors reported muted price developments in October in a y/y comparison. Finally, underlying price pressures eased in October. Core inflation (excluding fresh food and energy prices) stood at 1.5% in October from 1.9% in September. Wage inflation remained moderate in September. Hourly wages edged up 0.1% between August and September, with the annual rate of wage inflation at 1.4% in September, compared with 1.6% in August and 1.5% in both July and June. It has slowed from 1.8% in 2011, 2.2% in 2010, and 3.0% in 2009. Despite the rise in nominal hourly wages, real wages fell when compared with September 2011, given that the annual rate of consumer price inflation was 3.2% during September 2012. A breakdown by sector reveals that nominal hourly wage growth in September was strongest in industry, recorded at 2.4% y/y. Meanwhile, private services and public administration revealed weaker growth in hourly wages, at 1.5% y/y and 0.0% y/y, respectively.
Exchange Rates: Outlook

The euro is expected to remain pressurized overall by Eurozone sovereign debt tensions, although it could stage limited periodic rallies on any action from policymakers and the European Central Bank that are seen as easing
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the pressure on Spain and Italy, and reducing the possibility of a Greek exit from the Eurozone (as was the case in late November). Furthermore, ongoing very weak Eurozone economic activity and lower interest rates (the European Central Bank cut interest rates from 1.00% to a record low 0.75% in early July and we suspect a further reduction to 0.50% will occur in December), are also likely to weigh down on the euro. While the dollar should continue to benefit as a safe haven from all the problems in the Eurozone, its upside is likely to be limited by modest US growth and ongoing stimulative action by the Federal Reserve. Consequently, we expect the euro to soften from its September highs to largely trade under USD1.30 over the final weeks of 2012. We expect the euro to come under mounting pressure as 2013 progresses as Greece continues to struggle hugely and market expectations mount anew that it will leave the Eurozone sometime during the second half of the year. Eurozone economic activity already is expected to increasingly suffer because of the uncertainties and the hit to confidence coming from the Greek situation. Consequently, the euro is seen falling to USD1.20 by mid-2013. Greeces exit from the Eurozone, the initial turmoil following it, GDP contraction, and a further reduction in Eurozone interest rates to 0.25% by the ECB is seen sending the euro down to a low around USD1.15 during the third quarter. The euro is seen stabilizing and then starting to recover in the final months of 2013 on the assumption that European policymakers and the ECB make strong policy responses to the Greek exit, most notably including major progress on fiscal and banking union. Such developments would increase markets confidence in the longer-term future of the Eurozone. It would also provide a more settled and stable environment, which would hopefully significantly boost business and consumer confidence, and lift their willingness to invest and spend. On this basis, the euro is seen rising modestly to USD1.20 at the end of 2013 and then improving appreciably to USD1.31 at the end of 2014. Should Greece leave the Eurozone, its new currency is expected to devaluate sharply. IHS Global Insights forecasts now assume that there is a 75% chance of Greece exiting the common currency area over the next five years. Although the timing of this event is difficult to predictas it will largely depend on political decisionswe currently assume it will happen during the third quarter of 2013. We believe that it is likely that the new currency will be left to float at an initial state. Past experiences suggest that the devaluation is likely to overshoot initially, given the high uncertainly likely to prevail, but the government will surely have to introduce measures aimed to stabilize foreign-exchange markets (for example, it could oblige all export revenues above a certain amount to be sold to the central bank). We estimate that Greeces new currency will weaken by around 70% against the euro and remain at that level over the medium term. Exchange Rate Indicators 2009 Exchange Rate (LCU/US$, end of period) Exchange Rate (LCU/US$, period avg) Exchange Rate (LCU/Euro, end of period) Exchange Rate (LCU/Euro, period avg) 0.69 0.72 1.00 1.00 2010 0.75 0.76 1.00 1.00 2011 0.77 0.72 1.00 1.00 2012 0.78 0.78 1.00 1.00 2013 0.83 0.83 1.00 1.00 2014 0.76 0.79 1.00 1.00 2015 0.73 0.75 1.00 1.00 2016 0.70 0.71 1.00 1.00
Exchange Rates: Recent Developments
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Having largely traded in a USD1.301.35 range during the first four months of 2012, the euro sank to a 23-month low of USD1.2288 at the start of June. The euro moved below USD1.30 in early May as an election stalemate in Greece and the replacement of elections in France and Greece raised market concerns and uncertainty as to how measures dealing with the Eurozones sovereign debt crisis would proceed. The euro gained no relief from data in mid-May showing that Eurozone GDP had stagnated rather than contracted in the first quarter of 2012. It continued to soften as speculation mounted that Greece could leave the Eurozone and concerns increased over the state of the Spanish banking system. The euro managed to rally modestly as June progressed, but it remained fragile. The euro gained only limited support from the second Greek general election in mid-June that resulted in a narrow win for the pro-reform, pro-bailout New Democracy party. This election result was seen easing the risk of a Greek Eurozone exit in the near term, at least. Nevertheless, Greeces problems remain very serious. The euro was also supported to a limited extent by a relatively successful EU summit at the end of June, which came up with some concrete steps to reduce the borrowing costs of Spain and Italy, as well as an important first step towards greater banking integration in the Eurozone. Consequently, the euro traded as high as USD1.26 in early July, but it then fell back sharply after the European Central Bank (ECB) cut interest rates from 1.00% to a record low of 0.75% on 5 July and concerns over Spain mounted. Indeed, the euro sank to a 25-month low of USD1.2040 in late July before stabilizing and edging up from its lows after ECB president Mario Draghi said that the bank would do whatever is necessary to preserve the euro. The ECB followed this up by announcing plans at its 2 August policy meeting to make future Eurozone bond purchases (under certain conditions) in order to reduce the risk premia on the yields of pressurized countries. In addition, German Chancellor Angela Merkel and French President Francois Hollande issued a joint statement saying that they are determined to do everything to protect the Eurozone. The euros rise from its late-July low gained momentum in September as it was helped by the ECB fleshing out its bond-buying plans and by the German constitutional court giving the go-ahead for the European Stability Mechanism. Meanwhile, the dollar was pressurized by the Federal Reserve announcing further aggressive quantitative easing to support the US economy and indicating that it was unlikely to raise interest rates before mid-2015. Consequently, the euro reached a four-month high of USD1.3173 in mid-September. The euro has since moved back below USD1.30 on occasion, influenced significantly by uncertainty over Spains situation and intentions. The euro was further hit in November by increased concerns over Greeces adoption of austerity measures and the disbursement of further aid; this caused it to trade as low as USD1.27. On the other hand, the euro was only modestly pressurized by the expected news that Eurozone GDP fell 0.1% quarter-on-quarter in the third quarter, thereby putting the single currency area officially into recession. Agreement in late November among Eurozone policymakers and the IMF on measures to cut Greeces debt over the long term and to release loans needed to stop Greece defaulting in the near term saw the euro trade back up around USD1.30 in early December.
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Economic Policy: Monetary Policy and Outlook

We expect the European Central Bank (ECB) to take interest rates down from 0.75% to 0.50% in December, given persistent weak Eurozone economic activity and muted underlying inflationary pressures. Nevertheless, the ECB could well delay trimming interest rates until early 2013 because of concerns that the impact of a near-term cut could be diluted by the problems in monetary policy transmission channels. The ECB also wants attention to focus on its Outright Monetary Transactions (OMT) program. Eurozone GDP contracted for the third time in four quarters in the third quarter of 2012, and another decline looks probable in the fourth quarter. Furthermore, the prospects for 2013 hardly look bright at the moment. The Eurozone is being buffeted by major headwinds, notably including increased fiscal tightening in many countries, markedly rising unemployment and tight credit conditions. Consumers are under additional pressure from muted wage growth and in some countries, a need to deleverage. On top of this, relatively muted global growth is limiting export orders. Meanwhile, the Eurozone sovereign debt crisis is still highly problematic, despite some recent positive developments. Importantly for the ECB, the Eurozone inflation situation and outlook are far from alarming. A flash estimate from Eurostat indicates Eurozone consumer price inflation retreated to a 23-month low of 2.2% in November after rising to 2.6% in September from 2.4% in August. Furthermore, latest data show core Eurozone consumer price inflation dipped to 1.6% in October and September from 1.7% in August and 1.9% in July, which took it down to its lowest level since August 2011. Although consumer price inflation may be prevented from dipping further in the near term because of higher food prices, the chances remain high that it will fall below 2.0% on a sustainable basis during 2013 because of the constraining effect of extended weakened economic activity and high and rising unemployment. Admittedly, the European Commission's business and consumer confidence survey showed that consumers' inflation expectations across the Eurozone rebounded fairly markedly in JulySeptember, following a moderating tendency during the first half of 2012, but this likely largely reflected the highly visible fuel price spike. Significantly, inflation expectations softened in both October and November. Furthermore, recent higher inflation expectations are highly unlikely to feed through to lift current muted wage growth in most Eurozone countries anytime soon, given appreciable job insecurity and persistently high and rising unemployment across the single-currency area. Significantly, companies pricing power appears limited. The composite output prices index of the manufacturing and services purchasing managers surveys indicated that prices fell for an eighth month running in November, and at increased rate compared with October. Meanwhile, the European Commission survey showed that pricing expectations among most business sectors softened in November and were well below long-term norms. Further supporting the view that underlying price pressures will be limited, the adjusted three-month moving-average growth rate for annual Eurozone M3 money supply was limited to 3.1% in October, which is well below the ECBs targeted rate of 4.5%. Consequently, the chances seem high that core Eurozone inflation will be relatively modest over the medium term, and it remains probable that Eurozone consumer price inflation will fall back in line with the ECB's target rate during 2013. Further out, we believe the ECB will have a crucial role to play in Eurozone policymakers efforts to contain the fall-out from an expected Greek exit from the Eurozone around mid-2013. ECB action could well include: (1) providing substantial liquidity to banks; (2) stepping up its own bond-buying activity, effectively setting a cap on bond yields of Spain, Italy, and other vulnerable countries; and (3) providing assistance in recapitalizing Eurozone banks. We also expect the ECB to trim interest rates further, taking them down to 0.25%. In addition, the EU summit in late June agreed that the ECB will be given a supervisory role for Eurozone banks in 2013.
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Monetary Policy Indicators 2009 Policy Interest Rate (%, end of period) Short-term Interest Rate (%, end of period) Long-term Interest Rate (%, end of period) 1.00 1.23 4.27 2010 1.00 0.81 3.99 2011 1.00 1.39 5.29 2012 0.50 0.62 5.38 2013 0.25 0.18 5.20 2014 1.00 0.80 4.87 2015 2.25 1.84 4.59 2016 3.50 3.09 5.27
Economic Policy: Monetary Policy - Recent Developments

The European Central Bank (ECB) kept its key interest rate unchanged at a record low of 0.75% at its 8 November policy meeting. The ECB had previously trimmed interest rates by 25 basis points from 1.00% to 0.75% at its June meeting. Prior to this, the ECB had cut interest rates by 25 basis points in both December (from 1.25% to 1.00%) and November 2011 (from 1.50% to 1.25%). These interest-rate cuts at the end of 2011 had marked a quick, full turnaround in the Eurozone interest-rate cycle amid a markedly weakening economic environment, as the ECB had previously raised interest rates to 1.50% from 1.25% in July 2011 and to 1.25% from 1.00% in April 2011. The ECB also cut its deposit rate to 0.00% from 0.25% at its July meeting. This acts as the floor for money market rates and by cutting it to 0.00%, the ECB is likely hoping that it will encourage banks to lend more to each other, and to the private sector, rather than just park the money with the ECB.
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The ECBs cutting of its key interest rate to 0.75% in July could be seen as a significant change of tack as the bank notably did not take interest rates below 1.0% even at the height of the 2008/09 recession. Indeed, the previous lack of a cut had implied that there was a significant core of ECB Governing Council members who had a strong aversion to taking interest rates below 1.00%. The ECB has appeared more flexible and pragmatic in its policy since Mario Draghi replaced Jean-Claude Trichet as ECB President in November 2011, although many of the Governing Council members are the same as in 2008/09. Significantly, after the November ECB meeting, the banks president Mario Draghi appeared to ease open the door to a cut in the key interest rate from 0.75% to 0.50% over the coming months and potentially as soon as December. In particular, when asked at the press conference whether the ECB had discussed an interest-rate cut at their November meeting, Draghi commented that we always discuss all instruments. This contrasted to his comments after both the September and October meetings, when Draghi said that the bank had not discussed cutting interest rates. Draghi also commented that the ECB stands ready to act on standard monetary policy as well as on non-standard policy. Interestingly, though Draghi indicated that the ECB had not discussed negative deposit rates. Furthermore, Draghi acknowledged that the Eurozone growth situation and outlook had weakened recently, and hinted that the ECBs GDP growth staff projections would be revised down in their December forecasts. The ECBs statement observed that most recent survey evidence for the economy as a whole, extending into the fourth quarter, does not signal improvements towards the end of the year. Furthermore, the ECB considered that growth momentum is expected to remain weak in 2013, largely because of the need for balance-sheet adjustments in both the financial and non-financial sectors, combined with an uneven global recovery and high uncertainty. Draghi has also expressed concern recently over very high and rising Eurozone unemployment. Reinforcing this downbeat assessment of Eurozone growth prospects, the ECB statement observed that the risks surrounding the economic outlook for the euro area remain on the downside. Meanwhile, the ECBs view on inflation does not appear to preclude an interest-rate cut in the near term. While the ECB expects Eurozone consumer price inflation to remain above 2.0% and at elevated levels for the remainder of 2012, the bank sees inflation declining to below 2.0% again in the course of next year. In fact, data released since the November MPC meeting show that Eurozone consumer price inflation dipped markedly to a 23-month low of 2.2% in November from 2.5% in October and 2.6% in September. The ECB regards long-term inflation expectations as well-anchored and believes that underlying price pressures should remain moderate, with the result that current levels of inflation should be transitory. Meanwhile, the ECB made no further announcements at either its October or November meetings on its bond purchase (Outright Monetary Transactions) program, although the bank indicated that it is ready to buy the bonds of pressurized countries once all the prerequisites are in place. The ECB had previously fleshed out its bond-buying plans at its September policy meeting after announcing the introduction of such a program in August. This followed Mario Draghis statement in late July that the ECB will do whatever it takes to preserve the euro. And believe me, it will be enough. It is very clear that it will be the success of governments in problem countries in undertaking structural reforms and other measures that lift their competitiveness and improve their underlying fiscal positions and in Eurozone policymakers ultimately taking major steps towards greater fiscal and banking integration that will be key to the Eurozones survival in its current form. Having said that, the risk premia in bond markets that have periodically sent the yields of Spanish, especially, and Italian bonds to dangerously high levels is a major threat to the stability of the Eurozone that needs to be tackled urgently. So the ECB is treading a fine line by trying to put in place a strong enough bond-buying program that impresses the markets and will potentially lead to a sustained, marked reduction in problem countries risk premia while at the same time keeping major pressure on the problem countries to commit to structural reforms and see them through.
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In many respects, the Outright Monetary Transactions (OMT) program seems to satisfy these conditions. The markets should be impressed by the fact that there are no ex ante size limits to the ECBs buying of a countrys bonds and that the ECB will accept the same (pari passu) treatment as private creditors in the case of a default. While there had been some speculation that the ECB could indicate a targeted ceiling for a countrys bond yields or a maximum spread differential, the unlimited size of the bond buying should be a powerful measure. The bond buying will be focused on sovereign bonds with a maturity between one and three years. It will be fully sterilized. To keep pressure on countries to commit to, and see through, major structural reforms and corrective measures, the ECB is imposing strict conditionality on its bond-buying program. The ECB will not buy a countrys bonds until its government has requested assistance from the European Financial Stability Facility (EFSF)/European Stability Mechanism (ESM) and then signed up to either a full macroeconomic adjustment program or a precautionary program. Critically, the ECB will only consider bond purchase if a country fully respects its program. If non-compliance occurs, the ECB may terminate or suspend its bond buying. The ECB will also ask the IMF to help countries monitor compliance with the programs. The ECB has undeniably gone a long way towards providing an effective backstop. Ultimately, the success of its actions will depend critically on whether or not problem countries are prepared to first of all approach the EFSF/ESM for assistance, agree to specific corrective actions, and then see them through over a sustained period. Attention will now be focused on the Spanish government in particular, and also on the Italian administration.
Economic Policy: Fiscal Policy and Outlook

The Italian Stability Law for 201315, was passed by parliament on 22 November, which pulled the previous pledge to lower the tax burden on struggling low-income households. After a prolonged cabinet discussion, the government has retreated from its initial promise to provide immediate support to struggling low-income households by cutting income tax rates from early 2013, and will now plan to take more significant action from 2014. This will entail a cut in payroll taxes, while tax deductions for workers under 35 will rise from EUR10,600 to EUR13,500 from 2014. In addition, the government has confirmed the planned value-added tax (VAT) hike in July 2013 from 21% to 22%, but the reduced rate of 10% will remain unchanged. This was preceded by a VAT hike from 20% to 21% on 17 September 2011. Finally,
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the new stability law paved the way for a new Tobin Tax of 0.5% on the purchase and sale of equities and derivatives. Later administrations are required to consider broadening the base on this taxable income. The government made no announcement about new spending cuts, which had been expected to fall mainly on the health budget. Disappointing recent fiscal data are a warning that the government faces significant challenges to deliver its fiscal goals. Indeed, the government has admitted that the recession is likely to be steeper than previously anticipated, and will result in missed fiscal targets, according to the latest update of the state's Economic and Financial document for 201215 (DEF). The economy is now projected to contract by 2.4% in 2012, a marked downward revision from the previous official projection of 1.2%. In addition, the government now expects a further contraction in 2013, with real GDP projected to shrink by 0.2%, a notable shift from the earlier forecast of a 0.5% gain. The growth forecasts for both 2014 and 2015 have been slightly raised to 1.1% and 1.3%, respectively. The gloomier economic outlook has been reflected in softer public-sector budget deficit targets, which are now expected at 2.6% of GDP (up from 1.7%) in 2012, 1.8% (up from 0.5%) in 2013, and will not balance in 2014 and 2015 as previously thought. This will result in greater upward pressure in Italy's public debt ratio, now projected to climb to 126.4% in 2012, compared with the previous forecast of 123.4%, but will trend down to 119.4% by 2015 (up from 114.4%). The government's new growth and fiscal projections are better aligned with our latest thinking. With regard to fiscal developments, IHS Global Insight predicts the public-sector budget deficit will narrow from 3.9% in 2011 to 3.3% of GDP in 2012, 2.3% in 2013, and 1.9% in 2014 and not balance until well into the medium term. Finally, we have produced more downbeat public-debt projections in the current forecast update, given a sharper squeeze on nominal GDP than previously anticipated. According to our fourth quarter detailed forecast, the public-debt ratio is projected at 126.1% of GDP in 2012 and 128.7% in 2013.
Economic Policy: Fiscal Situation - Recent Developments

Italy faces mounting fiscal pressures in line with a stumbling economy, while the latest indicators suggest that it remains short of the "turning point" with regard to restoring fiscal discipline. Specifically, public debt increased by EUR72.4 billion year-on-year (y/y) to stand at a record high of EUR1972 billion, or an estimated 123.0% of nominal GDP at the end of June 2012, according to the Bank of Italy. Indeed, according to our third-quarter 2012 detailed forecast, we now expect Italy's public debt ratio to climb by more than 3.0 percentage points to 123.6% of GDP in 2012, due to falling nominal GDP, a significant general government budget shortfall, and Italy's contribution (standing at EUR17 billion in the first half of 2012) to the Eurozone bailout funds. Meanwhile, the general government budget deficit, not seasonally adjusted, stood at 8.0% of nominal GDP in the first quarter of 2012, the widest level since early 2009, and up from 7.0% in the first quarter of 2011. Poor fiscal developments were partly reflected in weaker economic activity shrinking overall revenues, which fell by a 1.0% y/y. Meanwhile, government spending increased by 1.3% y/y, elevated by higher social benefit payments (2.5% y/y) and debt servicing costs (16.0% y/y). Nevertheless, there were some positive fiscal developments, namely the recent austerity measures prompting lower compensation of employees. Italy's parliament passed an additional EUR4.5-billion (USD5.59-billion) worth of spending cuts for 2012 in early August 2012, with the savings expected to accumulate to EUR10.9 billion in 2013 and EUR11.7 billion in 2014. The new measures will allow the government to postpone and limit the planned increase in value-added tax (VAT) to just the general rate from 21% to 22% from July 2013. In addition, the government needs to raise funds to finance the welfare costs of 55,000 individuals who were left without benefits or pensions after legislation in December 2011 raised the retirement age, and help in the reconstruction of the earthquake-damaged Emilia-Romagna region. The cost of the earthquake aid is estimated at EUR1 billion in both 2013 and 2014. Overall, these new fiscal measures are estimated to have a neutral impact on net borrowing, lowering it by around EUR600 million in 2012, 16 million in 2013, and 27 million in 2014, according to the Bank of Italy.
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The fiscal savings will be generated from the following measures: The government plans to reduce the number of public officials gradually, with the bill proposing a 20% and 10% cut in senior servants and standard-level employees, respectively. Ministerial budgets will be cut by EUR1.5 billion in both 2013 and 2014, followed by a further EUR1.6 billion in 2016, with the Ministry of Finance taking the largest hit. The central government intends to cut the cost of regional, local, and provincial government. First, it plans to halve the current number of 110 provincial governments. Second, transfers to regional and local governments will be reduced by EUR2.3 billion in 2012, EUR5.2 billion in 2013, and EUR5.5 billion in 2014. The bill also includes cumulative cuts to the national health fund, estimated at EUR0.9 billion in 2012, EUR1.8 billion in 2013, and EUR2.4 billion. Meanwhile, eight regions that have a shortfall on their health budgets can raise the local income tax to finance the imbalance. The government had passed its third fiscal-correction package since mid-2011 in early December 2011 to bolster its fiscal consolidation plan. According to the Ministry of Economy and Bank of Italy, the December 2012 austerity package will raise EUR32.1 billion in 2012, EUR34.8 billion in 2013, and EUR36.7 billion in 2014. Around EUR20 billion, or 1.3% of GDP, per year will be allocated to reinforce the multi-year budget-deficit reduction plan. The austerity plan announced at end-2011 was weighted towards tax hikes to bolster the budget-deficit plan. This anticipates net revenues to increase by EUR19.4 in 2012, EUR17.0 in 2013, and EUR14.9 in 2014, which will contribute more than two-thirds of the reduction in the deficit. The most important new revenue measure will be property tax reform, which is expected to raise an additional EUR11 billion per year. The other significant measure was the postponement of the planned VAT hike from October 2012 until July 2013. The austerity plan in early December also contained proposed expenditure cuts totaling EUR0.9 billion in 2012, EUR4.4 billion in 2013, and EUR6.5 billion in 2014, and will be sourced mainly from pension changes (EUR0.9 billion in 2012, EUR4.4 billion in 2013, and EUR6.5 billion in 2014). Overall, Italy has adopted a punishing austerity plan. According to official estimates, the fiscal measures passed in July and December 2011 will extract fiscal savings worth EUR28.6 billion in 2012, EUR54.4 billion in 2013, and EUR9.9 billion in 2014. The cumulative impact of all the measures taken since July 2011 should cut the deficit by 3.0% of GDP in 2012 and 4.7% in each of the following two years.
External Sector: Outlook
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Italian exports are projected to grow very modestly in the latter stages of 2012 in line with softer domestic spending across the Eurozone. Latest industrial-related indicators provide compelling evidence that Italy's export recovery is stuttering, highlighted by the Markit/ADACI manufacturing purchasing managers' index survey. A sub-index from the October survey reveals the inflow of overall new export orders stabilized, but this was preceded by a fall in 12 of the last 13 months. Italian exporters are struggling to sustain their recent impressive performance, which had helped to lift Italy out of recession. Italian exporters are struggling to sustain their recent impressive performance, which had helped to lift Italy out of recession. The main factor is likely to be a difficult second half of 2012 for the Eurozone as a whole, with domestic demand conditions expected to be soft. The recent financial turmoilresulting from the regions sovereign debt crisishas hurt consumer and business confidence across Italys key export markets. Furthermore, economic activity across the Eurozone and the United Kingdom will be curbed by increasingly restrictive fiscal policy, with several countries having to work hard to keep the sovereign debt crisis at bay. This, coupled with cautious French and German consumers, poses a significant threat to the Italian export outlook. The export outlook for 2013 is likely to be more challenging, with Eurozone trade flows disrupted around the middle of the year by our assumption that Greece will leave the euro no later than the third quarter of 2013. The Eurozone economy (with Greece) is projected to contract by 0.4% in both 2012 and 2013, according to the released November 2012 forecast. More encouragingly, Italian exports will receive a lagged boost in 201415 from the euro slipping to a low of USD1.15 in the third quarter of 2013 as expectations mount of a Greek exit, and it then occurs. Consequently, we expect exports of goods and services to expand 0.7% in 2012 and to contract by 0.2% in 2013 from a 6.3% gain in 2011, according to the November 2012 forecast.
Trade and External Accounts Indicators 2009 Exports of Goods (US$ bil.) Imports of Goods (US$ bil.) Trade Balance (US$ bil.) Trade Balance (% of GDP) Current Account Balance (US$ bil.) Current Account Balance (% of GDP) 406.2 405.1 1.1 0.1 -42.2 -2.0 2010 447.5 475.2 -27.7 -1.3 -72.7 -3.5 2011 523.5 546.6 -23.1 -1.1 -67.5 -3.1 2012 500.4 479.6 20.8 1.0 -11.5 -0.6 2013 475.2 441.9 33.3 1.8 -3.0 -0.2 2014 506.7 469.0 37.7 1.9 -1.3 -0.1 2015 564.6 517.9 46.7 2.1 -0.6 0.0 2016 619.9 568.2 51.6 2.2 -1.7 -0.1
Source: Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the 15th of each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release of the GIIF bank.
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Download this table in Microsoft Excel format
External Sector: Recent Developments

According to the latest custom-basis data, Italy enjoyed trade surpluses with both the European Union and the rest of the world in September as a result of a steep fall in the value of merchandise imports. With the European Union, Italy registered a trade surplus of EUR1.002 billion in September 2012, compared with a deficit of EUR47 million in the same month a year earlier. A breakdown reveals a 7.6% year-on-year (y/y) fall in merchandise exports, which was offset by a 13.0% y/y drop in imports. Italy also enjoyed a better trade position with rest of the world in September 2012, reporting a surplus of EUR0.408 million, compared with a deficit of EUR1.890 billion in the same month in 2011. Again, merchandise exports to the rest of the world fell way, posting a 4.2% y/y, the sharpest drop since December 2009. Soft domestic spending across Italy delivered a pronounced drop in imports, which fell back by 10.6% y/y. Exports have lost significant momentum, according to the latest national accounts. Exports of goods and services grew 0.2% q/q in the second quarter, after retreating moderately in the previous two quarters. However, the annual rate of growth remained moderate, at 1.4% down from 1.7% in the first quarter, and more recent trade data suggest soft Italian export sales at the start of the third quarter. Specifically, the average level of merchandise export sales in nominal terms edged up by a seasonally adjusted 0.3% month-on-month (m/m) in July, and was unadjusted 4.3% higher when compared with a year earlier. Meanwhile, a breakdown of exports by destination reveals weaker demand from key export markets across the Eurozone in the first half of 2012. The average level of merchandise export sales in nominal terms to the Eurozone contracted 4.2% y/y in the second quarter, compared with gains of 1.4% y/y in the first quarter and 1.5% y/y at end-2011. This spells the end of a steady export recovery after they plunged 19.1% in volume terms in 2009, when all sectors of manufacturing took large hits, particularly mechanical machinery and equipment, the traditional Italian export goods industries, and the transport equipment sector. Import demand shrunk again due to poor domestic demand conditions. Specifically, imports of goods and services fell for the sixth successive quarter, contracting 0.4% q/q in the second quarter. In addition, the y/y percentage changes were declines of 8.2% and 9.2% in the second and first quarters, respectively. Net exports lifted activity in the second quarter, boosting real GDP quarterly growth by 1.0 percentage point. This was up from a positive contribution of 0.7 percentage point in the first quarter. The current-account improved in 14 of the last 15 months in September 2012 when compared with a year earlier. The current-account recorded a deficit of EUR2.581 billion (USD3.318 billion) in September 2012, an improvement from a EUR4.175-billion deficit in the same month a year earlier. This was due to an improved trade balance when compared with a year earlier, which increased by EUR1.85 billion to record a modest surplus of EUR0.61 billion in September. The nominal value of merchandise exports dropped 2.2% y/y to EUR32.12 billion, while merchandise imports dropped 8.1% y/y to EUR31.5 billion. Meanwhile, the services balance posted a surplus of EUR86 million, compared with a deficit of EUR34 million in September 2011. Finally, the net factor income account deteriorated by EUR0.379 billion y/y to post a deficit of EUR1.738 billion in September In the first nine months of 2012, the current-account deficit stood at EUR15.64 billion, compared with EUR43.176 billion in the corresponding period in 2011.
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Higher global crude oil prices led to another substantial current-account deficit in 2011. The current-account deficit stood at EUR50.554 billion, or an estimated 3.2% of GDP, compared with EUR54.072 billion in 2010.
Economic Structure and Context: Development and Strategy

The performance of the economy since the early 1990s suggests that, in an absence of significant structural reforms, it will be trapped in a cycle of progressive decline. A key problem remains the high fragmentation of the Italian enterprise system, with a high incidence of very small enterprises struggling to compete in the face of a strong euro and increased competition from abroad. Second, there are excessive regulations in several markets and a lack of competition in many key services sectors. This includes the banking sector as well as others, which are able to pass on their low productivity onto their selling prices. Consequently, the competitiveness of the traded goods sector suffers as it is obliged to use inputs from the service sector, where unit labor costs have tended to increase faster than in the traded goods sector. Relatively high service prices, including among the highest for energy in the European Union (EU), have reduced profit margins in the traded goods sector. In more general terms, Italy needs to adjust more fully from the competitive devaluation model which existed prior to joining the euro to a model based on productivity gains and on higher value-added production and services. The export sector has struggled to regain much of its dynamism. Italy's past strengths are now responsible for heralding a period of very weak growth. The economy has developed strong specialization in the production of textiles, clothing and footwear, leather goods, furniture, and machine tools. This specialization, however, coupled with the high concentration of small enterprises in the traditional textiles and footwear sectors has made Italy vulnerable to strong price competition from low-cost producers in China, India, and Eastern Europe. In addition, Italy has endured a marked fall in price competitiveness within the euro, and even more acutely against non-euro countries after the euro recovered. Its real exchange rate has increased because of higher inflation than in the rest of the euro area, rising relative unit labor costs and the recovery of the euro from 2003. This has created serious problems for Italian exporters, given that the type of products in which they specialize tend to be highly price elastic. Consequently, Italy's export market performance has deteriorated rapidly, with its share of the nominal value of world exports falling to 3.0% in 2010 from 3.6% in 2007. In a pre-euro world, the short-term solution would have been a competitive devaluation.
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Italys largest problem remains its dismal public finances, with its public debt now estimated at 123.6% of GDP in 2012. Several items contribute to high levels of government spending, particularly the excessive cost related to the pension system. Future budgets will need to curtail more aggressively the large transfers to both local government and the health system, while reducing the high cost of the public sector employment. The government also needs to introduce more structural measures to bolster its receipts. Tax evasion is falling, but is still widespread, and entrepreneurial activity in some regions, particularly the south, is still conditioned by organized crime and corruption.
Economic Structure and Context: Demographics and Labor Markets

Job growth began to pickup after the start of the labor-market reforms in 1998, and had been strong from 2001 until stalling with the onset of the Great Recession during 2009. The recent labor-market reforms have improved flexibility of work contracts, and have reduced hiring and firing costs for marginal and new workers. The Treu and Salvi Laws, passed in 1997 and 2000 respectively, relaxed the regulations on part-time employment. In 2001, Italy implemented the 1999 European Union (EU) Directive on temporary work. For the first time, the law made it possible to hire workers on a temporary basis (provided the reasons for term employment are clearly stated in the contract). Italy features another form of employment contract, which is legally framed as a self employment, but very often has the attribute of dependent employment. Indeed, "CO.CO.CO." (Collaborazione Coordinata e Continuativa) workers include a variety of professional figures, from qualified professionals to de-facto dependent workers. The Biagi law transformed the CO.CO.CO contracts in project contracts, primarily contracts related to the existence and duration of a pre-specified project. CO.CO.CO workers were not required to pay social security contributions, and are still not eligible for maternity leave, unemployment insurance and paid vacation. The Biagi law now requires that social security is paid and grants eligibility for maternity leave, unemployment insurance, and paid vacation. There are no official statistics on the number of these contracts, but administrative sources estimated more than 2 million contracts in 2000. Despite a spate of labor-market reforms in the late 1990s and early 2000s, specific inefficiencies continue to prevail in the Italy. They include: Italy has a substantially lower employment ratio when compared with most of the countries in the European Union (EU), particularly among women, older workers, and the young. Despite employment rates of prime-aged males being above 70%, the overall employment rate in Italy stood at a lowly 57.0% in the third quarter of 2011. This is accompanied by painfully high youth unemployment, with 30% of 18- to 24-year-olds currently unemployed. A dual labor market has been encouraged by past reforms. Italy has adopted asymmetric reforms to increase labor-market flexibility, which entailed adopting less restrictive regulations on temporary contracts alongside strong employment protection for permanent workers. Consequently, firms have shown a very strong bias towards recruiting workers on temporary contracts, especially with first-time contracts, which tend to be less productive. With recent labor-market reforms failing to address the high cost and the legal obstacles of dismissing workers on permanent contracts, firms remain reluctant to hire workers permanently because they struggle to dismiss non-productive workers. This is encapsulated by the symbolic Article 18 of the labor statute implemented in 1970, which requires firms with more than 15 employees to reinstate workers who have been wrongly dismissed, with full payment of lost salary, and this covers around two-thirds of all workers. Furthermore, firms are reluctant to invest and train workers on temporary contracts, adding to the productivity malaise. Italian labor-market laws are too wide-ranging and inflexible, with the process of dismissing workers a laborious and costly one for employers. Therefore, the response to tougher economic conditions at both the firm and national level, as well as technology shocks, has been too slow. Indeed, firms can only dismiss workers for business reasons as part of a company restructuring, while it is difficult to remove unproductive individual workers. The wage-bargaining framework in Italy is too centralized, which prevents wages adapting to specific productivity and demand conditions at the firm level. About 60% of Italian workers are covered by collective wage bargaining
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agreements (IMF, 2009), which is high when compared with the rest of the EU. The lack of flexibility in Italy's centralized wage-bargaining system was illustrated by the Italian carmaker Fiat having to create new companies to manage its factories in Italy to circumvent national labor contracts in 2010.Furthermore, the current wage formation system is even more punishing for small enterprises, with the nationally negotiated wages having greater weight than those negotiated at the firm level. Italy's unemployment insurance system is too wide-ranging and also has "dual characteristics. Unemployment benefits are initially high, with a net replacement ratio of 60% before dropping to zero after eight months (12 months for workers aged over 50). In addition, tough eligibility rules restrict the number of individuals who qualify for unemployment benefits. On the other hand, the wage supplementation fund scheme (cassa inegrazione) is substantially more generous, both in terms of level and duration. The scheme makes up the pay of permanent employees affected by temporary layoffs (who are not considered unemployed) or under shorter working hours for a maximum of two years. It is limited to workers on certain contracts, with the participating firms mostly large and located in the north. Italy has a relatively high tax and social security wedge on labor income. According to IMF calculations, a single taxpayer at average earnings takes home less than 55% of what he or she costs the employer. This drops to 50% for workers on higher earnings. Overall, the average tax wedge in Italy is at least 10 percentage points higher than the OECD average, which remains a major reason for low labor utilization, and weighs down on both employment and growth potential. The technocratic government led by Mario Monti passed a new labor reform bill in 2012. The main goal of the new reform bill is to remove some of the dismissal restrictions currently specified in Article 18, which require firms with more than 15 employees to reinstate workers who have been wrongly dismissed, with full payment of lost salary. The reform bill does not scrap Article 18, but amend its scope by allowing firms to dismiss workers for business reasons on payment of compensation. In cases of wrongful dismissal for misconduct, it will be left up to a judge to decide if the worker should be reinstated or just receive compensation. The compensation for wrongful dismissal could range from 15 to 27 months' salary, based on the number of years worked. Automatic reinstatement would only remain for cases of proven discrimination. Finally, the planned changes to Article 18 would only apply to new hires. The reform also wants to introduce a special legal procedure for dismissal disputes in order to speed up decisions and overcome the current system, which allows workers to be reinstated after years of dispute. The reform also makes short-term contracts more costly for employers by raising the tax and welfare contributions they have to pay by 1.4 percentage points. Firms will be reimbursed the extra tax if the temporary contract is made permanent.
Economic Structure and Context: Monetary System

Since the euro was born in 1999, monetary targets in the Eurozone have been set by the European Central Bank (ECB). There are currently 17 member states that compose the Eurozone, each of whom surrendered monetary sovereignty upon joining the union. Oversight of the Economic and Monetary Union (EMU) is vested with the European Commission, although control of monetary policy and the European Monetary System is administered by the independent ECB. The euro is the sole legal tender of Austria, Belgium, Cyprus (excepting Northern Cyprus), Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. As one of the world's major convertible currencies, the euro operates on a free float, although the ECB reserves the right to intervene in the foreign-exchange market to smooth over fluctuations in the euro exchange rate. It has done this in practice, but eschews active exchange-rate management. Rather, its main objective is to preserve price stabilitythat is, to preserve the value of the euro. Although it sits atop the European System of Central Banks (ESCB), the ECB also delegates this objective of maintaining price stability to all member states' national banks, with the proviso that the ESCB will generally support the economic policies and objectives of the European Union (EU).
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Price stability is defined as a year-on-year (y/y) increase in the EU's preferred measure of inflation, defined by the Harmonized Index of Consumer Prices (HICP) for the euro area of below but close to 2%. Thus, the governing council of the bank has determined that medium-term price stability involves keeping inflation at approximately 2%. The HICP is used for measuring inflation in the context of international, mostly inner-European comparisons. Its calculation relies on harmonized concepts, methods, and procedures and is designed to reflect the development of prices in the individual states based on national consumption patterns. The HICP serves, among other things, to measure the convergence criterion of "price stability" as a basis for judging whether a member state can participate in the European EMU. The HICP is calculated for each EU member state, as well as Norway and Iceland. It is used to form aggregates for the Eurozone (Monetary Union Index of Consumer PricesMUICP), for the EU (European Index of Consumer PricesEICP), and for the European Economic Area (European Economic Area Index of Consumer PricesEEAICP). The ECB makes use of the MUICP in the context of its monetary policy to judge price stability within the Eurozone. The governing council effectively consists of the 6 members of the executive board and the 17 governors of the national central banks of the euro area. The key task of the governing council involves formulating the monetary policy for the euro area. The ECB has frequently come under political pressure over interest rates and, increasingly during the Eurozone sovereign debt crisis, other elements of monetary policy (such as liquidity provision and bond buying). Nevertheless, it has jealously guarded its independence and has refused to bow to outside pressures, despite the best efforts of member states. Indeed, it is to its credit that it has been able to steer a relatively influence-free trajectory for monetary policy given the Eurozone's peculiar makeup (i.e., an amalgam of several countries whose economies are, despite significant convergence, still relatively disparate). Until the Eurozone sovereign debt crisis, the bank tended to err on the side of inaction, earning itself a reputation for being unresponsive to conditions in the Eurozone. Nevertheless, the bank insists that its mandate is to keep the price level stable, and as such has remained immune to political demands. The ECB has certainly been highly active during the Eurozone sovereign debt crisis. While it has remained unwilling to take its key Eurozone interest rate below 1.00%in marked contrast, for example, to both the US Federal Reserve and the Bank of Englandthe ECB has undertaken a number of non-standard measures to counter the problems. Most notably, this has included making massive liquidity available to banks and, to a lesser extent, buying sovereign bonds of the pressurized countries on secondary markets.
Economic Structure and Context: Financial System

The Italian banking sector has become more consolidated, and has gone from being one of the most fragmented and inefficient in Europe to having a concentration ratio similar to that of France, and above that of Germany. By 2000, around 50% of the banking sector was located among the five largest banks in the country, following hundreds of mergers during the 1990s. Key to the consolidation was the sale by government and charitable foundations of large quotas of their holdings in the banking sector. The spate of mergers has allowed banks to specialize in more profitable business areas than traditional deposit-and-loan products. It has also allowed them to protect themselves more effectively against foreign intrusion and to expand overseas. The ambitious UniCredito, one of Italy's biggest banks, has interests in Central Europe, for instance. Despite a potentially risky large exposure to Italian government bonds, the banking sector remains relatively secure. Indeed, the Italian banking system appears to be sounder than most of the Eurozone, partly due to the traditional character of many domestic banks, which are based on a higher dependence on retail deposits for funding than many other European banks. Importantly, the Italian banking system did not oversee a property bubble or even a credit explosion during the past decade. Rather like the banking sector, the country's financial capital, Milan, has historically lagged some way behind its European counterparts, particularly those of Frankfurt and London. Despite some growth in the 1980s, the capitalization of La Borsa
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by 1992 had shrunk to just 12.2% of GDP, at a time when there were 229 companies registered on the exchange. The Borsa nevertheless came to life dramatically in the late 1990s amid the banks' merger mania. Between 1995 and 2000 the Borsa's capitalization expanded by 378%growing to 70.2% of GDP. The creation of the Nuovo Mercato (equivalent to the German Neue Markt) helped fuel the financial sector, listing 42 new technology and hi-tech stocks by 2001. Subsequently, the Borsa has suffered from the international market downturn, dropping sharply. Combined with a banking sector seeking to make profits outside of its traditional savings and loans business, the capital markets look set to become increasingly important to the economy. If combined with structural reforms, particularly regarding labor taxation, the increasing medium-term importance of La Borsa could encourage greater corporate consolidation within the country.
Economic Structure and Context: Key Sectors

Shoes, Textiles, Luxuries: A large number of Italy's small producers specialize in the production of shoes, leather goods, and textiles, as well as domestic furniture. The area of manufacturing is concentrated in the Central Italian regions of Tuscany and Marche. After manufactured engineering, this is the biggest foreign currency earner in the country. The industry, however, is constantly under pressure from cheaper cost producers and represents income-elastic goods, which suffer sharply in the wake of any drop in external demand. Automotive: The Fiat group's domination of the Italian automotive industry is almost total, but the company is in serious financial trouble and is currently undergoing painful restructuring. More than 90% of all vehicles produced in the country are made by one of the group's core brands, such as Fiat, Alfa Romeo, Lancia, or truck-making division Iveco, and much of the remainder is made either by Fiat-owned companies or manufacturers in alliance with the Italian giant. The reorganization of suppliers during the 1990s has hit component manufacturers however, and the slump in domestic demand has struck the car-making division of Fiat, Fiat Auto, very badly in recent years. The government collects around USD70 billion in automotive taxation every yeararound 20% of Italy's total taxation income. Industrial Machinery: The largest sector of industrial output is within machinery and metals production. Heavy industry is mainly concentrated in Emilia-Romagna, Lombardy, Piedmont, and Liguria. But there are serious concerns about the country losing out in the hi-tech sector as lower-priced foreign competitors in the industrial machinery sector undercut Italian producers. Tourism: A key earner of foreign currency, tourism is not as large or as developed as in France or Spain. The number of foreign visitors to Italy stood at 46.1 million in 2011, up from 43.6 million in 2010. This compares with 79.5 million and 56.7 million visitors to France and Spain in 2011, respectively. Telecoms: Liberalization of the industry occurred in the 1990s, but Italy has been slow to inject greater competition, with the former state monopoly Telecom Italia particularly reluctant to embrace change, as evidenced by continuing investigations into its potential abuse of a dominant position by the country's Competition Authority. This has led to slower industry revenue growth than was expected. There has been a cellular boom in Italy second only to those in Nordic countries. The penetration rate for mobile phones is above 90%, although the country lags in terms of broadband penetration, fixed-line revenues, data networks transmission, cable TV penetration, and other telecoms sectors. Italy: Top-10 sectors ranked by value added 2011 Level (Bil. USD) 1. Real estate 2. Business services 3. Public admin. and defense 277.6 137.0 135.3 2012 Percent change (Real terms) -2.3 -1.8 -1.5 Percent share of GDP (Nominal terms) 13.7 6.8 6.7
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4. Health and social services 5. Retail trade - total 6. Construction 7. Education 8. Wholesale trade 9. Banking and related financial 10. Hotels and restaurants Top-10 total
123.2 120.4 116.8 98.4 96.1 82.9 81.4 1,269.1
-1.0 -2.5 -2.3 0.9 -1.6 -1.5 -2.2
6.1 6.0 5.8 4.9 4.8 4.1 4.0 62.8
Source: World Industry Service, IHS Global Insight, Inc. Updated: 18 Oct 2012
Economic Structure and Context: Natural Resources

The forestry industry has traditionally been limited and significant amount of wood is still imported. Most of the old growth forests have already been harvested, and the resulting soil erosion has hampered the industry. There have been some advances in recent years, however, and the timber harvest in 2002 was 7.8 million cubic meters. Italy has very low indigenous oil reserves. It is estimated at only 622 million barrels, and therefore has to import more than 90% of its demand from the Middle East, particularly Algeria and Libya. Domestic gas production has also been falling for over a decade but reserves are still estimated at 230 billion cubic meters. Natural-gas imports account for around 75% of total consumption. Gas is primarily imported from the Netherlands and Russia. Even though mining as a whole contributes only a small portion to the country's economy, production in some minerals is considerable. Mineral resources include barites, lignite, pyrites, fluorspar, sulfur, and mercury. Italy is the world's largest producer of pumice and related materials, based on the isolated island of Lipari, and is also the largest producer of feldspar, which is used in the production of ceramics. Italy's coastal waters are rich in fish, despite the continuing depletion of Mediterranean stocks. The total catch in 2003 was 314,807 tons, with a value of about EUR1.4 billion. Anchovies, sardines, hake, mullets, and swordfish together accounted for 44% of the volume in 2003.
Economic Structure and Context: Trade Profile

Italy specializes in highly price elastic goods, notably clothing and footwear, as well as capital equipment. Mechanical machinery and equipment accounts for the largest share of Italian commodity exports, recorded at a 17.8% of total commodity exports in 2010. Basic metal products and fabricated metal products and transport equipment account for the next largest export shares, at 11.7% and 10.2%, respectively. The share of clothing (including in leather and fur) and footwear exports stood at 6.6% in 2010, which has fallen from over 10% in the early 1990s in line with increasing competition from low-cost producers in Far East, particularly those from China.
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During the 1970s and 1980s, Italy's trade with other European Union (EU) countries expanded dramatically. This has fallen back since the early 1990s, with Italy's still largest export markets Germany and France accounting for a smaller share of Italian commodity exports in 2010, at 13.2% (down from 19.2% in 1990) and 11.8% (down from 16.3%), respectively. The country's dependence on imported coal, oil, electricity, and other essential goods continues to weigh on the balance of trade. The imbalance is also partly offset by the tourism industry, remittances from Italian nationals abroad, and shipping revenues. Italy: Major trading partners, 2011 EXPORTS Country Germany France United States Spain Switzerland United Kingdom China Belgium Poland Turkey
Source: IMF, Direction of Trade
IMPORTS Billions of USD 68.7 60.8 30.4 27.7 27.7 24.4 13.8 13.6 13.1 12.9 Percent share 13.3 11.8 5.9 5.4 5.4 4.7 2.7 2.6 2.5 2.5 Country Germany France China Netherlands Spain Belgium United States United Kingdom Switzerland Russia Billions of USD 86.9 46.5 40.6 29.0 24.9 20.3 16.1 15.0 13.9 13.4 Percent share 16.5 8.9 7.7 5.5 4.7 3.9 3.1 2.9 2.7 2.6
Italy: Major trading partners, 2000 EXPORTS Country Germany France United States United Kingdom Spain Switzerland Belgium Netherlands Austria Greece
Source: IMF, Direction of Trade
IMPORTS Billions of USD 35.7 29.7 24.5 16.3 14.8 8.0 6.5 6.3 5.2 4.8 Percent share 15.1 12.6 10.4 6.9 6.3 3.4 2.7 2.7 2.2 2.0 Country Germany France Netherlands United Kingdom United States Spain Belgium Switzerland Russia China Billions of USD 41.2 26.8 14.0 12.8 12.5 9.7 9.5 7.8 7.6 6.5 Percent share 17.5 11.4 5.9 5.4 5.3 4.1 4.0 3.3 3.2 2.7
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Medium- and Long-Term: Outlook

The Italian parliament has passed legislation to inject greater competition into several key professional and service sectors. The reform bill abolishes the use of minimum professional tariffs for all sectors, with the notable exception of the legal profession. The bill also increases the number of pharmacy licenses nationwide. Nevertheless, having accepted a number of amendments applied by the Senate (upper house of parliament), ministers have been accused of watering down proposals. Pressure from transport workers led to a rapid climb-down on the proposed liberalization of taxi licenses. Nevertheless, this is an important first step to dismantling the excessive regulation in key sheltered service sectors. This first layer of economic liberalization reforms will bring about some incremental benefits, but more profound measures will be required to realign Italy's growth potential with the leading performers in the Eurozone. The main battleground remains the labor market, with the economy needing far-reaching labor reforms to reverse Italy's poor productivity performance. First, the wage-bargaining framework in Italy remains too centralized, which prevents wages adapting to specific productivity and demand conditions at the firm level. A truly decentralized wage formation system in Italy would provide wider scope to alter working conditions, break the link with projected inflation, and allow the greater use of performance-related pay. Second, Italy's labor laws are too wide-ranging and inflexible, with the process of dismissing workers a laborious and costly one for employers. Despite recent reforms, the high cost of dismissing workers and the legal obstacles prevail, and continue to discourage the recruitment of permanent employees. More importantly, it makes it difficult to lay off non-productive workers on permanent contracts, resulting in a bias towards less-productive employment. The technocratic government has responded by presenting a new labor market reform bill, which is currently passing through parliament. The main goal of the reform bill is to remove some of the dismissal restrictions currently specified in Article 18, which require firms with more than 15 employees to reinstate workers who have been wrongly dismissed, with full payment of lost salary. The reform proposals do not plan to scrap Article 18 but amend its scope by allowing firms to dismiss workers for business reasons on payment of compensation. In cases of wrongful dismissal for misconduct, it will be left up to a judge to decide if the worker should be reinstated or just receive compensation. The compensation for wrongful dismissal could range from 15 to 27 months' salary, based on the number of years worked. Automatic reinstatement would only remain for cases of proven discrimination. Finally, the planned changes to Article 18 would only apply to new hires. The reform also wants to introduce a special legal procedure for dismissal disputes in order to speed up decisions and overcome the current system, which allows workers to be reinstated after years of dispute. The draft reform also intends to make short-term contracts more costly for employers by raising the tax and welfare contributions they have to pay by 1.4 percentage points. Firms will be reimbursed the extra tax if the temporary contract is made permanent. Business lobby groups were opposed to more profound proposals to significantly reduce the use of temporary hires. Assuming the introduction of far-reaching structural reforms in Italy and short-term adjustment pains, real GDP growth could stabilize in the 1.21.5% range in the outer years of the forecast period. Currently, we estimate long-term growth at around 1.0%, which assumes a less aggressive reform agenda, while the economy is weighed down by poor demographics. Clearly, an underlying improvement in competiveness in the upbeat scenario would help Italy to better exploit any growth in the trade-weighted index of world demand for Italian products beyond the short term, and provide more ammunition to protect its under pressure export market shares in the face of the anticipated steady appreciation of the euro and intense competition from low-cost producers in the Far East and Eastern Europe. In addition, further labor market reforms would be required to encourage higher labor-force participation in order to offset the projected decline in working population, and help to lift the employment ratio, which remains the lowest in the euro area. Without a significant package of economic-liberalization reforms, Italy's long-term outlook remains challenging. The population is aging fast, which will lower Italy's potential output growth for many years to come. Without significant reform, IHS Global Insight expects potential growth to fall from around 1.7% in 2005 to 1.2% by 2030 as the population ages. The birth rate has fallen from 18.4 per 1,000 inhabitants in 1960 to an estimated 8.89 in 2005. With steadily longer life expectancy, the ratio of elderly persons to children under 6 years old has increased from 1 in 1961, to 1.8 in 1981 and
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2.6 in 1991. Consequently, the median age in Italy has climbed from 33 years in 1975 to 41.77 years in 2005, and is projected to rise to 51 years by 2024. Further labor-market reforms are required to encourage higher labor-force participation in order to offset the decline in working population. Major labor-market reforms have produced encouraging results, but the employment ratio remains the lowest in the euro area. Increasing wage flexibility and reducing the tax wedge over time will be required to raise employment. Prime Minister Mario Monti also wants to address the inequality of pension entitlements across Italy, noting that the system "awards high pensions to some and low ones to others." High state pension expenditure remains a huge drain on government finances, accounting for most of the social protection budget, and is expected to remain at around 15% of GDP between now and 2040, according to the latest calculations from the Ministry of Economy and Finance. A heavy burden on the state's pension obligations is the high incidence of male workers who qualify for early retirement known as "seniority pensions" after satisfying the retirement eligibility of 35 years of social security contributions and a minimum age requirement of 61 years from 2010. An option for Monti could be to ratchet up the minimum age of requirement, or lengthen the "exit window," which is a postponed entitlement to early retirement. Another area of potential reform is to accelerate the transition from a defined-benefit system (based on final earnings to a less burdensome notional defined-contribution system, which will only be fully effective after 2030). According to government estimates, the stock of pensions calculated (fully or partially) according to the old defined-benefits rules will still be over 45% in 2050. Despite a flurry of reforms since the 1990s, Italy's pension-earnings ratio was the second largest in the Eurozone in 2007, behind only Greece, which in conjunction with a low effective retirement age does make considerable demands on Italy's welfare spending. Further reform will be needed, given that the pension system is facing a sizeable demographic shock. Given the low birth rate, Italy's population is set to age rapidly over the next 50 years. Assuming no sharp acceleration in net immigration, the working-age population is set to shrink markedly over the next 50 years. Currently, there are four working people available to support each pension, but this is expected to narrow to 1.63 workers by 2050, according to Eurostat estimates.
Analyst Contact Details:
Raj Badiani, Howard Archer
Italy: Country Reports - Recent Analysis

Economic
1. Italian consumer price inflation edges down to 2.5% in November

03 DEC 2012
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Economic
2. PMI reports Italian manufacturers continuing to struggle in November

03 DEC 2012
Economic
3. Italian business confidence posts surprise improvement in November, but outlook still tough
30 NOV 2012
Economic
4. Italian unemployment hits 11.0% in October

30 NOV 2012
Economic
5. Italian consumers reveal record-low pessimism in November

26 NOV 2012
Economic
6. Italian retail spending remains subdued in September

23 NOV 2012
Regulatory - Country - Economic
7. Italy's Stability Law clears parliamentary vote, productivity agreement reached

23 NOV 2012
Economic
8. Italian new orders fall back sharply in September

19 NOV 2012
Economic
9. Italian merchandise exports slip back in September, according to latest custom trade data
16 NOV 2012
Country - Economic
10. Italian economy contracts at slower pace in Q3 but outlook remains challenging
15 NOV 2012
Created on 03 Dec 2012 Reproduction in whole or in part prohibited except by permission. All Rights Reserved Information has been obtained by sources believed to be reliable. However, because of the possibility of human or mechanical errors by our sources, IHS Global Insight Inc. does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. http://www.ihsglobalinsight.com/
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123.2 120.4 116.8 98.4 96.1 82.9 81.4 1,269.1

-1.0 -2.5 -2.3 0.9 -1.6 -1.5 -2.2

6.1 6.0 5.8 4.9 4.8 4.1 4.0 62.8

Economic Structure and Context: Natural Resources

Economic Structure and Context: Trade Profile

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Medium- and Long-Term: Outlook