There is unlikely to be any reprieve from the current political instability until the next government is elected on April 14.

Lorenzo Piccardi and Luca Dal Cerro, partners at Italian law firm Tremonti Vitali Romagnoli Piccardi e Associati say: “Only a strong government with a clear parliamentary majority, with the capacity to pull through radical reforms can achieve a stronger business confidence. These days, maintaining confidence is probably the toughest challenge ever for a state and its institutions”.

They add: “The current phase should be regarded as transitional. In our view, though Italy is left without a government for a handful of weeks, a clear election result would definitely benefit our economy, stalled under the previous government due to its very narrow parliamentary majority.”

Even a newly-elected government will not be in the position to work out miracles: the world’s economy is experiencing a slowdown.

External factors such as the rising cost of materials, energy and petrol and the US sub-prime mortgage crisis and the volatility in the European stock markets have made liquidity more of a problem when financing investments. The rising costs of materials, energy and petrol have all meant higher labour and transport costs, reduced profits and a fall in buying power.

Data showed Italy’s growth last year below expectations at 1.5 percent, little more than half the eurozone average of 2.7 percent and maintaining a trend which has seen Italy grow less than other eurozone countries for at least a decade.

Italy’s government in fact cut its economic growth forecast for this year and hiked its target for the budget deficit which is going to make it very tough for whoever wins next month’s general election – centre right leader Silvio Berlusconi or Walter Veltroni for the centre left.

Previous forecast
A document issued by Italy’s economy ministry said the Euro zone’s third largest economy would grow by only 0.6 percent in 2008, down from 1.5 percent it had forecast last autumn.

In addition to this, the present government has raised the 2008 budget target deficit to 2.4 percent of the GDP from 2.2 percent blaming the deteriorating economic outlook.

“The Italian economy will be hit this year by the significant worsening of the international macro-economic situation and the high degree of uncertainty surrounding the global scenario,” the economy ministry said.

The European Union’s Monetary Affairs Commissioner, Joaquin Almunia, commenting on the efforts by the outgoing Italian government, has already pointed out that “There is still lots of work to be done.”

Italy’s employers’ confederation Confindustria also said in a statement that the economy “is heading towards zero growth in 2008,” weighed down by high oil prices and the strong Euro.

With consumer and business confidence both close to 2-year lows and industrial output slumped in the last quarter of 2007, what can Italy do?

The country’s below average productivity is greatly affected by oversized public debt which is more than 100 percent of annual GDP (in 2007 debt-to-GDP stood at 104.0 percent down from 106.5 percent the year before). The reason for this fall was because of stricter fiscal policies, a further decrease of 0.1 percent is expected this year.

Other factors contributing to Italy’s low productivity are stagnant salaries, high tax burdens and rising inflation which in the fourth-quarter of last year ended at 2.6 percent. In January of this year inflation continued to rise to 2.9 percent, the highest since 2001.

While other Euro zone countries like Germany have adapted a new economic environment, Italy’s small to medium-sized countries are struggling to keep up with global trends.

Germany, for instance has switched to high-value areas like renewable energy and other capital goods that are in high demand in China, in contrast Italy seems to be still focussed in low-added value areas like textiles.

Intensive economy
Piccardi notes: “Italy has no capital-intensive economy – like Germany – nor a technology-intensive one – like Finland. Though there are some major exceptions, our economy’s strength is usually attached to specialised manufacturing clusters (distretti industriali). The major threat to such businesses comes from countries with very low labour costs (typically, South East Asian players), and only an increased level of specialisation may prevent serious damage.”

A reduction of public spending and debt could also help Italy’s economic woes. Dal Cerro adds: “Tax slashes – backed by cuts in public current expenditure – have been insistently called upon not only by Italian taxpayers, but also by respected institutions like the Bank of Italy and the International Monetary Fund.”

What is promising is that both electoral candidates Berlusconi and Veltroni have made the reduction of public spending a key issue in their campaigning ahead of the April election. If these measures are enforced then the Italian economy would greatly benefit.

The issue of tax evasion and Italy’s “black economy” are an ongoing problem for the current caretaker government and future governments. Italy has the highest rate of tax evasion in Europe, nearly double the rate in France, Germany, UK and nearly four times that of Austria, the Netherlands and Ireland, with the cost at 7 percent of GDP or $137bn (Euros100bn) a year. This problem would again have to be solved if Italy’s economy were to improve in the future.

Dal Cerro recalls: “Tax evasion has [also] been a political issue from time to time, with one side calling for major crackdowns on evaders and the other spearheading a moderate taxation level (and thus, lower incentives to evade). Also, according to general knowledge, tax evasion is driven by small-size companies and individual investors. Nonetheless, corporations are in any case oppressed by a huge number of legal restrictions and administrative undertakings, and may face tax avoidance accusations rather than outright evasion charges. Indeed, the constantly changing tax framework, as well as the approach by tax authorities make it sometimes very burdensome to comply with the law.”

Downward spiral
On the upside there is a positive side to the Italian economy. Italy boasts one of the lowest unemployment rates in the eurozone at six percent with the downward expected to continue in 2008.

Italy’s construction industry has experienced a boom for the ninth consecutive year, finishing 2007 with a record Euros150bn of investment. The construction market has played a central role in the economy since 1999, having grown twice as fast at GDP.

Additional jobs have been created, the construction industry as a whole employs nine million Italians. Although the construction of new homes remained steady in 2007, it is expected to fall one percent this year and residential prices should only grow moderately at 2.5 percent down from a 5 percent increase in 2007.

SIIQ (Societa di Investimento Immobiliare Quotata) the Italian version of the US REITS (Real Estate Investment Trusts), have recently been introduced into the Italian legislative framework. SIIQs are real estate investment vehicles which allow investors to invest in real estate indirectly ie by investing into a vehicle which invests into real estate assets. Piccardi says: “Though SIIQs have been welcomed as a ground-breaking investment tool, today there is a number of tax issues which make them less interesting to investors than real estate investment funds.”

The Italian financial act of 2007, ratified in December 2006 made official the SIIQ on the Italian stock exchange. The Ministry of Economy and Finance just released decrees regulating implementation, which should see the first SIIQs being launched in the second-quarter of 2008.

Another investment tool which has boosted the Italian property market in 1999 was the real estate investment fund managed by an SGR (a fund asset management company regulated by the Bank of Italy). The fund is fiscally advantageous for private investors, including individuals and non –resident investors.

Since 2000, the managed asset industry has grown from Euros2bn in 2002 to more than Euros24bn of investment in 2007.

Italian banks have also been fortunate in relation to the fall-out from the US sub-prime mortgage crisis. As Italian banks have been more selective with regards to choosing clients to lend to than other international banks.

Critical size
Last year, saw the Italian financial services landscape change beyond recognition with the Banca Intesa, SanPaolo IMI merger to form Intesa SanPaolo and UniCredit, Capitalia merger.

Piaccardi says: “The creation of two major Italian banks has surely provided Italy with players with a critical size to carry out pan-European business. Unicredit Group has been very active in Eastern Europe acquisitions, whereas SanPaolo has mainly concentrated on its domestic operations. A third bigger player, MPS is keeping up through the acquisition of Antonveneta by Santander and strategic alliances in asset management and bancassurance.”

In addition to this, Italy’s Senate has made improves to the legal system. Last November, Italy’s Senate approved an amendment to the 2008 Budget that would introduce collective “class action” lawsuits to the legal system.

But, according to Dal Cerro: “Class lawsuits may have produced impressive case-law abroad, but its current Italian version is not acknowledged as a reliable tool at all to start a legal action. For the time being, the main bottleneck is such an instrument is that it is not accessible to anyone, but only to a limited number of plaintiffs.”

In conclusion, Italy faces an economic and political struggle in 2008. The hope of a newly elected government in April might bring some political stability to the country. Only when some sort of political stability is achieved then economic and legal reform can begin effectively. The country also has to ride out the global economic downturn which will inevitably have a knock-on effect for even the strongest Euro zone countries.

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