Rome Mario Draghi has only just begun to outline Italy’s long-term financial planning when a sentence falls that the prime minister coined in a similar way as head of the European Central Bank: The government will “do everything that is necessary” to protect families and companies help. “Whatever it takes”. While the financial crisis was still about saving the euro, now it’s about Draghi’s home country.
The war in Ukraine is dramatically slowing down the growth of Europe’s third largest economy. In autumn, the government was still expecting gross domestic product (GDP) to increase by 4.7 percent this year. Now the forecast has shrunk to 3.1 percent. This only applies if there is no debate about a boycott of Russian gas at EU level.
And economists consider even this forecast to be quite optimistic. “There are still a lot of downside risks,” says Lorenzo Codogno from the LSE. The industry association Confindustria expects only 1.9 percent growth.
In the first quarter of this year, the economy even shrank by half a percentage point. There is hardly any improvement in sight: According to the statistics institute Istat, the order forecasts for the manufacturing industry have recently deteriorated further. If the economy also collapses in the second quarter, Italy would be in the middle of a recession.
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Italy’s upswing with 6.6 percent growth last year after the Covid dent, which brought the country out of the pandemic better than many other EU countries, has thus been stopped for the time being. And the trust that Europe’s former problem child built up among investors and partner countries under Draghi is in danger of disappearing again.
Projects of the reconstruction fund are delayed
The gap between Italian and German government bonds (spread) has recently risen sharply again and was more than 160 percentage points. Last summer, the value had leveled off at 100 to 120 percentage points.
Inflation, mainly driven by energy costs, is expected to be 5.8 percent for the current year. On top of that, the global shortage of raw materials could mean that projects for the multi-billion euro reconstruction fund are delayed – actually one of the biggest growth drivers for the coming years.
The consequences of the Ukraine war remain the great unknown. Also because Italy – unlike Germany – would support an EU-wide embargo on Russian natural gas. Rome is as dependent as Berlin: around 40 percent of Italian gas imports come from Russia.
>> Read also: These are the pitfalls of an oil embargo against Russia
The government has also revised the forecasts for the coming year downwards, expecting only 2.4 percent growth for 2023 instead of the previous 2.8 percent.
In order to prevent a recession, the government wants to free up five billion euros by the end of the month to further curb fuel costs and to support companies and families particularly affected by the energy crisis. The money should come from the current budget.
Draghi and his finance minister, Daniele Franco, also remain firm in other respects: Ministries and governing parties had announced budget requests for tens of billions of euros that would have increased new debt, and all requests were repelled. Franco is said to have argued with the risk of an even higher spread. Draghi also sees new borrowing as a bad signal for the markets and the EU.
Imminent negative scenario in the event of a gas boycott
Draghi prefers to create new leeway in another way: the 74-year-old has been insisting for a long time on reforming the EU’s growth and stability pact. Together with French President Emmanuel Macron, he is calling for investments in the green conversion of the economy not to be included in new borrowing.
The Maastricht criteria, according to which a state may only take on new debt with three percent of economic output and achieve a maximum total debt of 60 percent of GDP, are currently suspended due to the pandemic.
At around 150 percent of economic output, Italy’s debt is currently almost at Greek level. This will not change in the short term: the value is expected to fall faster than originally planned – an effect of the high inflation, which inflates nominal GDP and thus causes the debt ratio to fall. Nevertheless, Finance Minister Franco is still planning a government debt of around 141 percent in 2025.
New debt of 5.6 percent of GDP is expected for the current year. Only in 2025 should this value drop below the three percent threshold again at 2.8 percent.
Two scenarios for a boycott of Russian gas
If there is a Russian gas boycott, the government expects two scenarios: In the more positive scenario, the gas that is no longer available could be replaced almost entirely from other sources. Although the price of gas would double in the coming heating period, GDP for the current year would only shrink by a further 0.8 percentage points.
In the negative scenario, Italy would have to ration the existing gas. This would severely slow down economic output: Then there would only be mini growth of 0.6 percent in the current year and 0.4 percent in the following year. Draghi’s “whatever it takes” could mean only one thing: increasing new debt.
More: Interview with Finland’s Foreign Minister: “We must now support Ukraine with all the weapons it needs”