VZCZCXRO3790
RR RUEHFL RUEHNP
DE RUEHRO #0770/01 1821413
ZNR UUUUU ZZH
R 011413Z JUL 09
FM AMEMBASSY ROME
TO RUEHC/SECSTATE WASHDC 2336
INFO RUEHFL/AMCONSUL FLORENCE 3703
RUEHMIL/AMCONSUL MILAN 0129
RUEHNP/AMCONSUL NAPLES 3903
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHBS/USEU BRUSSELS 4838

UNCLAS SECTION 01 OF 02 ROME 000770 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD IT
SUBJECT: ITALY - AUTUMN MARKS DO-OR-DIE FOR ECONOMY 
 
¶1. (SBU)  Summary - A recent stream of economic forecasts and 
data suggest that, while Italy's economy may have touched 
bottom in the current global downturn, recovery remains 
elusive.  Sobering GDP growth forecasts and unemployment 
projections counterbalance encouraging signs in consumer and 
business confidence surveys.   Most economists believe the 
economy can continue to limp along until the fall, when sales 
need to recover to avoid a second, possibly more painful, 
round of layoffs and business failures.  Absent recovery in 
external demand, battered consumers and domestic businesses 
represent the only remaining potential drivers of growth, as 
export markets remain a question mark and the government 
remains hobbled by debt.  End Summary. 
 
Gloomy Figures Persist 
---------------------- 
 
¶2.  (U) Over the previous two months, economic observers and 
Italian policymakers have issued various assessments and 
forecasts for the Italian economy through 2010.  The 
consensus of the various projections, including from the 
OECD, the Italian Central Bank and private economists, is 
that Italy's GDP will shrink by between 4.7 and 5.2 percent 
in 2009 and recover very mildly (less than one percent) in 
¶2010.  The government recently revised downward its official 
figures for first quarter GDP, to minus 2.6 percent.  The 
reasons and particulars of the severe contraction are 
various, starting with a deep decline in exports (including 
tourism services) of over 17 percent through 1Q 2009, 
depressed internal demand for durable goods, and firms 
cutting inventories.  Falling sales are begining to hurt 
firms' ability to repay loans, as evidenced by a doubling of 
non-performing corporate loans in the first quarter. 
 
¶3. (U)  Other reports, including from international 
organizations, show Italy losing ground in virtually every 
measure of economic health including transparency, 
ease-of-doing business, and net international investment 
flows.  With the shrinkage of private sector activity and 
increase in public spending, the share of Italian GDP spent 
by the public sector is nearing 50 percent.  On the plus 
side, consumer confidence surveys show households remain 
slightly optimistic about prospects for recovery, while 
surveys of purchasing managers and the manufacturing index 
for May point to a resurgence in orders in the second half of 
¶2009. 
 
 
Bank Credit and Jobs Are Key 
---------------------------- 
 
 
¶4.  (SBU)  Looking ahead, analysts and policymakers are 
keeping an eye especially on credit flows to business, the 
external sector and the employment picture.  In his annual 
report to the Assembly of the Central Bank on May 29, 
Governor Mario Draghi focused also on Italian companies' lack 
of competitiveness noting that on the eve of the crisis many 
small and medium firms had at last begun to address their 
lack of global competitiveness by investing in new equipment, 
training workers and seeking new markets.  The crisis caught 
them at midstream, however, leaving many of them 
over-indebted as sales dried up. Draghi urged Italy's banks 
to study closely such firms' longer-term prospects in 
evaluating future loan requests.  He moreover noted a serious 
reduction in the rate of credit growth to households and 
firms, which he attributed to bank's difficulties in funding 
themselves and to borrowers' reduced demand for real estate 
and durable goods.  To address the former he called on the 
state to offer guarantees on certain financial instruments in 
order to give a boost to the moribund Italian securitization 
market. 
 
¶5. (U) As regards employment, Draghi and others note that 
firms have exhausted most measures aimed at avoiding layoffs, 
whether shortening work weeks, sending employees on 
involuntary (paid) vacations, or freezing new hiring.  Many 
employers have begun to decline renewing temporary workers' 
contracts and even laid off permanent workers.  Where 
eligible, (about a third of the Italian workforce) laid-off 
workers have maintained income through Italy's unemployment 
compensation fund scheme funded by employers.  In all, these 
measures have succeeded in keeping unemployment under 8.5% 
and household purchasing power (aided by falling prices) 
relatively constant. 
 
 
ROME 00000770  002 OF 002 
 
 
¶6.  (U) Economists' big concern now is what might happen in 
the fall, when many unemployment benefits, temporary 
employment contracts and nationwide collective bargaining 
accords expire. Household income and spending have held up 
respectably so far (income up 0.1 percent in 1Q09) but an 
accelerating loss of jobs and benefits could further depress 
domestic demand.  Absent a clear trend toward increased 
sales, especially exports, firms and households could be in 
line for a second, more serious shock that could cause 
domestic demand to fall significantly further, sending many 
firms over the edge.  Fortunately, there are some signs that 
Italy can avoid a catastrophic turn. 
 
 
Bankers Cautiously Hopeful 
-------------------------- 
 
¶7.  (SBU) In the view of many bankers with whom the Mission 
consulted recently, the pace of GDP decline is slowing, 
bolstered by relatively healthy household finances featuring 
very low total debt as a percentage of income (49 percent vs 
EU average of 100 percent) that has allowed them to keep up 
demand for basic consumption goods.  On the business front, 
banks report that Italian exports to Asia (especially China) 
and Russia are starting to pick up.  The key to recovery of 
industrial production, say the bankers,  will be a robust 
recovery of export markets. Domestically, industry got a 
boost from car-buying incentives introduced by the government 
in the first quarter, but bankers expect no more such stimuli. 
 
¶8. (SBU) Meanwhile bankers bristle still at the charge that 
they have turned over-cautious with credit to business.  They 
claim to be ready to lend but that demand for loans remains 
weak.  Firms counter that loan approvals take much longer 
today and that banks are demanding greater guarantees, fees 
and slightly higher interest rates.  Various knowledgeable 
economists have told us that Italian firms tend to be 
undercapitalized and banks' tightened conditions reflect 
their expectation that business owners should risk more of 
their own capital, and not just the bank's funds. As regards 
banks' funding, various banks report a healthy inflow of 
retail deposits (as Italians perhaps brace for further pain 
or eschew all but the safest investments for their money) and 
a slow resumption of liquidity in the interbank market. 
 
¶9.  (SBU) Comment:  Bankers and private sector leaders agree 
that the fall will be a critical time for the future 
direction of Italy's economy.  While maintaining cautious 
optimism, they worry that consumers will lose heart if they 
see no change in their income prospects when they return from 
summer vacations.  Until now, consumers have told surveyors 
that their personal economic situation was satisfactory, even 
as they opined that the broader economy was in poor shape. 
This attitude has kept consumers spending, with cutbacks 
noticeable only in the durable goods sector.  If in fall they 
believe hard times will be around a while still, consumers 
may tighten their belts further, damping hopes of recovery. 
Exports are currently a mixed, but largely unknown factor for 
near-term recovery.  The rebound of energy prices bodes well 
for sales in certain markets, but will do little to aid 
recovery of formerly vibrant exports to Eastern Europe and 
South Asia.  The other potential engine of growth, business 
investment, is an unknown quantity.  If, as the Central Bank 
alleges, Italian industry is in the process of modernization, 
firms might decide to continue such plans, irrespective of 
current conditions.  They would have to fund new investment 
with their own capital most likely, boosting the economy in 
any event.  The current government recognizes that Italy's 
regulatory, labor and tax regimes act as disincentives 
in-part to such risk-taking and last week approved a Council 
of Ministers decree offering tax rebates on new capital 
investment.  We will track the decree's impact. Post will 
likewise report septel on new calls for fundamental reform of 
Italy's broken economic model. 
DIBBLE