February 8, 2012 6:00 pm

Investors debate Italy’s changing fortunes

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Prescient or foolhardy? Investors who took a punt on Italian government bonds late last year are already sitting on handsome profits, leaving those who missed out asking whether Italy under Mario Monti’s technocratic government has truly turned a corner.

Analysts are warning, however, that the strong market rally – primarily driven by cheap financing provided by the European Central Bank – flies in the face of expectations that Italy, the most critical element for the survival of the euro, will suffer the deepest recession among advanced economies this year.

At a debate moderated by the Financial Times, three professors of the European University Institute in Florence tackled this growing divergence of views, broadly agreeing that Mr Monti had made great strides in restoring Italy’s credibility – as demonstrated by his visit on Thursday to Washington – but lacking enough time to ensure his domestic reforms will go deep enough and last beyond him.

“Italy is heading towards recession, but not default,” commented Elena Carletti, professor of economics, noting that the spread between Italian and German 10-year bonds, which has already narrowed by some 200 basis points, has continued to shrink this month despite fears of a disorderly default by Greece.

“Italy is much more stable in the perception of investors. Greece will not bring Italy down now,” she added, pointing out that Italy’s debt to gross domestic product ratio had fallen by 1.6 percentage points to just under 120 per cent from the second to third quarter last year – the biggest decline in the eurozone.

While agreeing that Mr Monti’s euro package of tax increases and spending cuts risks deepening the recession, Stefano Bartolini, professor of political science, sees Italians putting up with austerity thanks to a vast hidden economy and family transfers.

“This is a country of rich families and rotten governments,” he said. Trade unions, whose members account for less than 30 per cent of the workforce, are “in retreat”, while Silvio Berlusconi, hounded out of office last November, is too weakened to bring the new government down before elections expected in early 2013.

The unelected Mr Monti has done a clever job of painting minor policy changes as major achievements, with only pension reforms passed in December of real significance, commented Giovanni Federico, professor of economic history.

“We turned the first corner in terms of international reputation but still there are lots of corners to turn,” he said.

Mr Monti’s stature in Europe has also been enhanced by the declining fortunes of France’s Nicolas Sarkozy – although the professor warns that a victory for François Hollande, the opposition Socialist candidate, in April’s presidential elections could badly damage Italy in terms of market fears over the unravelling of eurozone fiscal rigour.

While the view in Italy may be characterised as mildly optimistic for the year ahead, perceptions abroad diverge enormously.

International Monetary Fund forecasts of a 2.2 per cent contraction in Italy’s economy in 2012 and continued recession in 2013 are spooking foreign investors who have only cautiously returned to Italy’s bond market. Major US fund managers in Rome this month were doubtful that Italy would meet its target of eliminating the budget deficit by 2013.

Erik Nielsen, London-based chief economist for UniCredit, a major Italian bank, sees these fears as overblown. He also admits he is the most “bullish” among analysts in forecasting a fall in GDP of just 0.3 to 0.5 per cent this year, with growth returning in the second half.

“The probability of default in Italy is very, very low,” he said in Rome, calling yields of nearly 6 per cent on its 10-year bonds a “massive opportunity”. Asked if Italy has turned a corner, he replied: “Chances are they have.”

Mr Nielsen admits that Italy is trying to climb out of a deep hole. After growing just 4 per cent in real terms in the decade to 2010 – a period in which productivity fell – GDP is now only back at levels reached in 2004.

Nicholas Spiro, a London-based sovereign debt analyst, stressed that it is ECB financing of banks that is fuelling the rally.

“After being paranoid about Italy late last year, the markets are now becoming somewhat complacent,” he warned. “Italy has turned a corner in [bond] pricing terms. The question is how real and sustainable this is.

“It strains credulity to suggest that Italy has turned a corner when the economy, instead of growing, is expected to contract by 2.2 per cent.”

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