Italy – the eurozone’s black sheep

By Stewart Fleming

Date: 19/05/05

As Italy's finance minister Domenico Siniscalco and the Governor of the Banca d'Italia, the redoubtable Antonio Fazio, swept out of Luxembourg after last weekend's informal meeting of EU finance ministers, they can have been in no doubt that their country is now firmly established as the black sheep of the eurozone family.

Siniscalco tried to put the best possible gloss on the situation. The first quarter growth figures were bad, with a 0.5% fall, coming on top of the fourth quarter decline of 0.4%, confirming that Italy has dropped into recession. But we should wait and see how things develop over the next couple of quarters before rushing to judgement, was his view.

The reality, however, is different. His peers are less interested in the fact that Italy may, or may not, be in a severe cyclical recession. What is really troubling is the longer term evidence that Siniscalco's sun-drenched homeland has failed to measure up to the challenge of restructuring so as to make a success of its membership of the single currency. Is Italy now 'free riding' on the reform efforts of others?

Austria's finance minister, Heinz Grasser, rammed the point home. In the Italian case, he said, it is not just a problem of the world economic cycle and Italy's economy shrinking while others are growing. Italy used to compensate for high levels of wage inflation by devaluing the lira. This regime is no longer available to them. "The lesson for Italy is that you must adapt to the new euro system...reform, reform, reform," he said.

Joaquín Almunia, the EU's monetary affairs commissioner, did not pull his punches either. Italy, he made clear, is shaping up to be a test case under the new, more flexible, Stability and Growth Pact. The Commission is already projecting that Italy's budget deficit will surge through the 3% limit this year before soaring to 4.6% in 2006, even on what are beginning to look like quite optimistic growth assumptions.

Almunia intends to recommend action against Italy under the revised Stability and Growth Pact at the July meeting of EU finance ministers. So the peer pressure (emphasised in the new pact) is mounting on Prime Minister Silvio Berlusconi to get serious about structural and labour market reform. And while the Eurogroup president, Jean-Claude Juncker, did not mention Italy by name, his comment in Luxembourg that finance ministers are "seriously concerned" about the increasing divergences in economic performance in the Euro area, was widely taken as a veiled attack on Italy.

By chance, perhaps, the May Monthly Bulletin of the European Central Bank has a long analysis of the significance and causes of inflationary divergences in the EU. A telling graph on page 70 makes the point that while Germany in particular, but also Finland, France, and Belgium, have been battling since January 1999 to regain 'competitiveness', Italy has been falling further back.

Julian Callow, chief European economist at Barclays Capital, says that in part Italy's loss of competitiveness reflects a poor corporate structure, with too many small companies in the wrong sectors. "Not only does Italy continue to have a wage bargaining system that continues to deliver pay increases above the euro area average, but also the product mix of its exports seems to put it in direct competition with the emerging market producers in Central and Eastern Europe and China," said a recent Barclays country study. "Italy now faces the unenviable task of having to get out of a recession while being in a currency union that is without recourse to lower interest rates, or a lower currency and has little room to manoeuvre on fiscal policy."

When it comes to peer pressure, it may be more than just an accident that Internal Market Commissioner Charlie McCreevy and Competition Commissioner Neelie Kroes, have turned the screws on Italy's protectionist central bank governor Fazio, pressuring him to stop obstructing foreign takeovers of Italian banks.

For financial markets are now just one of the product markets being targeted by EU policymakers as in need of restructuring if the EU economy is firstly to stop its long-term trend rate of growth actually falling, and then get it up to levels which can deliver prosperity and sustain the European social model.

• Stewart Fleming is a Brussels-based freelance journalist and a former Washington bureau chief of the Financial Times.

Article takes a look at Italy's predicted breach of the Stability and Growth Pact and reports that the European Union was increasing pressure on the country to engage in economic reforms.

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