The Italian government’s decision to suspend mortgage payments for its quarantined citizens is a drastic step in the battle to mitigate the impact of the coronavirus, but commensurate with the predicament the country finds itself in.
Italy is the eurozone’s weak link. Even before the current lockdown it was facing a fourth recession in little more than a decade and there has been only minimal growth in living standards in two decades. Its manufacturing sector is dominated by low-cost producers vulnerable to disruption in the global supply chain. Government debt is high, its banking system is weak and it is a strategically important economy, the eurozone’s third biggest.
Put simply, if there was one EU country that the European commission in Brussels and the European Central Bank in Frankfurt would have chosen to avoid a severe coronavirus outbreak it would have been Italy.
The issue is not whether Italy will have a recession. With schools, universities, theatres and cinemas shut and its hugely-important tourist industry facing a washout summer, the economy is going to shrink in both the first and second quarters of 2020.
Nor is it really a question of how deep the downturn will be, although early estimates are that it is going to be a bad one. Jack Allen-Reynolds, senior European economist at Capital Economics, thinks the economy will shrink by 1% in the first three months of the year and by a further 1.5% in the second quarter. That assumes the quarantine lasts until the end of April and is then gradually lifted. Were the economy to remain effectively immobilised until the end of June, he says there could be a 4.5% drop in output in the second quarter.
It is reasonable to assume that government economists in Rome are coming up with similar sorts of projections, hence the mortgage holiday. This would represent a form of helicopter money – cash drops to see consumers through hard times – in the event that households were never required to make up for the monthly mortgage payments they will avoid.
Details of the scheme remain hazy, but it is highly unlikely that the Italian government has gone this far. For one thing, its banks are already stuffed full of bad loans and can ill-afford a permanent blow to profits. For another, helicopter drops would have to be underwritten by the ECB. The chances of it doing so are remote.
That said, for the rest of Europe Italy is a country that is too big to fail. So what’s really at stake is not whether Italian GDP contracts by 1.5% or 4.5% in the second quarter but whether its financial crisis proves contagious. As it might.
Charles Dumas, of TS Lombard, says: “The banking system is unlikely to be able to remain solvent or liquid in the current conditions of nationwide lockdown. The tourist industry is effectively dead for 2020. Fiscal stimulus could be counterproductive if, as is possible, investors demand a much wider credit spread to accept fresh Italian paper. Italy will need massive support from eurozone partners to avoid going the way of Greece.
“So far, at the level of declaration, support is assured. Hopefully, when it comes to real money, that support will be clear enough to enable the country to issue its debt at reasonable rates, and without onerous conditions that could worsen the slump and/or lead to ‘internal devaluation’ [aka huge wage cuts] of the type imposed on peripheral eurozone countries in 2012-15.”
Less than six months into her stint as ECB president, Christine Lagarde is under pressure to come up with an emergency package of measures when the central bank’s governing council meets on Thursday, but in reality it can only do so much. The ECB’s key interest rate is already negative and quantitative easing is subject to the law of diminishing returns. The expected targeted help to small and medium-sized businesses with their cashflow will be largely cosmetic.
Instead, the onus is on individual governments and the European commission to show that they have learned lessons from the counterproductive obsession with the budgetary orthodoxy that delayed the eurozone’s recovery from the 2008-09 financial crisis.
Italy’s response to the coronavirus will bust Europe’s budget deficit rules, no question, leaving Europe’s policymakers with a choice. Do they take the opportunity to rebalance policy so that governments have greater leeway to borrow and the ECB is not required to provide all the stimulus? Or do they treat Italy the way they treated Greece and insist there is no alternative to austerity? Italy is much bigger than Greece and the consequences of making the wrong choice should be obvious.
