Ignazio Visco: Overview of economic and financial developments in Italy
Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary
Meeting of Shareholders 2012 - 119th Financial Year, Bank of Italy, Rome, 31 May 2013.
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Ladies and Gentlemen,
In these remarks I will give an account of a difficult year and speak about the severe test that
we have all had to face. I will recall you of what has been done, describing the role of the
Bank of Italy. I will speak about the progress made, even if it is insufficient; about the results
achieved, although these are still fragile; about the need not to waste but to defend and
consolidate these achievements in order to set the recovery process in motion; and lastly
about the conditions for a return to balanced growth.
Allow me to start with a farewell, in fact with more than one. On 28 April, in this delicate
moment in the life of the country, our Director General Fabrizio Saccomanni was called to
join the Government as Minister for the Economy and Finance. Endowed with outstanding
personal and professional qualities, he has worked in almost all of the Bank's institutional
and administrative fields of action. His experience, his thorough knowledge of the European
and international organizations in which he has held prominent positions and performed
important tasks for Italy, the competence and balance he has demonstrated in his many
years of service to the Bank, for which we owe him a debt of gratitude, will be even more
essential in the test that awaits him. We extend our warm best wishes to him.
He is succeeded by Salvatore Rossi, our former Deputy Director General, who has for many
years combined broad managerial responsibilities with economic analysis attentive in
particular to innovation and development. As Director General, he is also Chairman of the
Insurance Supervisory Authority, which at the beginning of the year was placed by law under
the direction of the Governing Board of the Bank of Italy, assisted by two outside directors.
In July 2012 Anna Maria Tarantola, the first woman on our Governing Board, left the Bank to
become president of the state broadcasting corporation RAI, a challenging assignment that
recognizes her management skills and professional rigour. In December, at the end of a
career that was exemplary for commitment, dedication and analytical and institutional
contributions, Deputy Director General Giovanni Carosio concluded his mandate. I would like
to thank both of them warmly for their contribution of ideas and activity on behalf of the Bank.
Between October 2012 and 10 May the Governing Board was brought back up to strength
with the appointment of Deputy Directors General Fabio Panetta, Luigi Federico Signorini
and Valeria Sannucci. The new members of the Governing Board previously held positions of
responsibility at the highest levels in the fields of monetary policy, financial stability,
supervision, internal administration, and coordination of the activities connected with the
Bank's participation in the Eurosystem and the banking union project.
The Bank of Italy is required to submit a yearly report on its activities to Parliament and the
Government. Starting this year, the report has been enlarged and will be presented together
with the annual report and financial statements. In this way we will be able to give a full
account of the Bank's operations and activities, its analyses, guidelines, administrative
actions and organization.
The fundamental responsibilities of the Bank of Italy for monetary policy within the
Eurosystem and for supervising the national banking and financial system are well known. At
the same time the Bank is a complex organization providing services that benefit both
intermediaries and the general public. We administer the resources entrusted to us with
diligence. The report on operations describes the steps taken to rationalize our procedures,
improve the quality of our services and achieve greater efficiency.
As a member of the Eurosystem, the Bank is involved in the payment systems, in the
production of banknotes, and in ensuring the business continuity of common IT systems,
often as lead institution in charge of joint activities and projects. Together with the three other
largest central banks of the euro area we are creating a centralized platform for the
settlement of securities transactions.
At home, last year we made further progress in automating the centralized state treasury
service and promoted the widespread adoption of the European format for payment services,
thereby helping to cut costs and foster competition. Against a background of worsening
economic conditions and risks for financial stability, we further strengthened our supervisory
controls on banks and other intermediaries, stepped up inspections, and broadened our
checks on compliance with the rules for consumer protection and against money laundering.
The European Central Bank, the national central banks and the national supervisory
authorities are working to create the single supervisory mechanism. This far-reaching
institutional innovation will require an organizational adaptation as significant as, and even
more complex than, the one leading to the single monetary policy. The project must
capitalize on the best national practices; it must aim to achieve a common system of
supervisory rules and practices ensuring pursuit of high and strict standards. We attach
special importance to aspects that are a fundamental part of our tradition, such as the central
role of inspections, methodologically robust analysis, and continuous discussion and
dialogue with banks' boards of directors and top management.
The single supervisory mechanism will be based on the close integration of European and
national structures in the case of the largest banks, and on the direct responsibility of
national authorities - within the framework of common guidelines - for the rest; the tasks of
customer protection, combating money laundering and supervision of non-bank
intermediaries will continue to be conducted at national level. The delicate launch phase will
require substantial investment in human and technical resources. The workload will not
diminish, either for us or for the supervisory authorities of the other countries, as we strive to
combine frameworks that differ in many respects.
Concerning the events involving Monte dei Paschi di Siena, a detailed account of the
supervisory initiatives and the measures adopted was made available on the Bank of Italy's
website at the end of January and has since been updated. Supervision of Monte dei Paschi
has been continuous and increasingly stringent in recent years; the judicial authorities will
assess whether this activity was obstructed by former directors and managers. From 2010 to
2012 we demanded that steps be taken to restore a balanced liquidity position, thereby
staving off serious threats; we requested a marked strengthening of capital and of the
internal control system; we prompted a radical change of management. We are working
closely with the judiciary, to the benefit of our respective institutional objectives: safeguarding
stability and suppressing illegal actions. The contribution of the Financial Intelligence Unit is
fundamental. We have operated properly and with diligence and care, within the scope of the
law; we welcome constructive comments.
In 2012 the Bank of Italy considerably increased the volume of its assets, participating in
exceptional single monetary policy interventions, particularly the expansion of bank
refinancing operations. This has resulted in larger profits, but also in the need for greater
precautionary allocations to risk provisions. The Treasury will receive a payment of
€1.5 billion, on the basis of the Statute and subject to approval of the financial statements.
The taxes owed by the Bank on its income and productive activities for the 2012 financial
year amount to almost €2 billion.
From 2008 to 2012 the Bank's operating costs fell by more than 10 per cent; its staff was
reduced by about 700 to just over 7,000. Technology has made possible large savings in
resources and improvements in services in the payment sector. We have reduced internal
administration and reinforced banking and financial supervision. The Governing Board and
the Board of Directors agree on the objective of eliminating most of the Bank's network at the
provincial level.
We have not ceased to recruit staff, using transparent and merit-based procedures, including
innovative methods, to select highly qualified young people. Women account for 35 per cent
of all personnel and 23 per cent of employees with managerial responsibilities; both
percentages are rising. We promote gender equality in recruitment, in the assignment of
positions and in career progression. We will continue to do so in the interest of good
administration.
I wish to convey my personal thanks and those of the Governing Board to the managers,
directors and all the staff who work for the Bank of Italy, proudly performing their public
duties with discipline and honour, as the Constitution requires; capable, when times are hard,
of an outstanding, self-sacrificing commitment of effort, skill, passion, dedication and
openness to change. The Bank and the country know they can count on them.
Monetary policy in the euro area
Conditions on the global financial markets have improved, but the world economy has yet to
return to a steady growth path. The economic situation differs markedly in the main regions.
The major emerging countries are still growing at rapid rates. Among the advanced
countries, the United States appears to be gradually returning to the rates of growth that
characterized the most recent expansions. In Japan, aggressively expansive policies, not
devoid of risk, are seeking to stimulate economic activity. The euro area is struggling to pull
out of recession: demand is dampened by the immediate effects of public and private
deleveraging in many countries; cyclical weakness is spreading to the economies not directly
exposed to the sovereign debt crisis.
Recovery in the euro area requires help from every sphere of economic policy. Including by
recourse to "unconventional" instruments, monetary policy has made an essential
contribution to averting serious consequences for financial stability; it has safeguarded price
stability. The tools of intervention have been chosen based on the characteristics of the
financial system, the origin of the tensions and the institutional structure: we have aimed first
and foremost to support the liquidity of the banks, which in the euro area, more than
elsewhere, play a pre-eminent role in financing the economy, and to prevent sovereign debt
market distortions from impeding the proper transmission of monetary policy.
We remarked a year ago that the levels to which sovereign interest rates had risen in many
countries of the area reflected not only the deterioration of national growth and fiscal
prospects, but also a systemic risk factor, subsequently called "redenomination risk",
connected with fears of a break-up of the monetary union, due in part to the incompleteness
of its institutional design. We documented this risk swiftly and analytically; our results have
been confirmed by the studies of other institutions and have been adopted by the
Eurosystem.
At the end of June the summit meeting of euro-area heads of state and government
approved flexible and efficient utilization of the financial support mechanisms - the European
Financial Stability Facility and the European Stability Mechanism - to stabilize the financing
conditions of the countries exposed to the sovereign debt tensions, provided they honoured
their European commitments. The possible use of those mechanisms for the direct
recapitalization of banks, after the creation of a single supervisory mechanism, was
envisaged.
In early August the ECB Governing Council announced the introduction of outright monetary
transactions (OMTs) for purchases of government securities on the secondary market, with
no quantitative limits. A few days before that the President of the ECB had promised to do
whatever was necessary to safeguard the euro. In September the details of the scheme were
defined.
Countering the increase in interest rates on sovereign debt when that increase stems from
redenomination risk and distorts the transmission of monetary policy falls fully within the
Eurosystem's mandate. The benefits of the announcements of the new measures were
immediate: medium- and long-term yields came down in the countries under pressure; the
fragmentation of markets along national lines lessened.
The steps taken by the Eurosystem in the last two years have counteracted the worsening of
credit conditions in the euro area and its repercussions on the macroeconomic situation. In
Italy, according to our estimates, they have helped to buoy output by at least two and a half
percentage points over that span. Our estimates, however, cannot measure the effects of the
financial collapse that could have occurred in the absence of these interventions, with
disastrous consequences for the national and European economies.
In recent months the fears concerning the single currency's survival and financial conditions
in the area have abated further; one factor has been the expansion of global liquidity, which
has spurred a search for high yields on the part of institutional investors. In Italy, interest
rates on government securities have also declined on the longest maturities, returning to the
levels prevailing at the beginning of 2010.
Yet these advances have not been accompanied by an improvement of the real economy;
economic activity continued to be weak throughout the euro area in the first quarter. Credit
conditions still differ from country to country, owing not only to the diversity of
macroeconomic situations but also to the residual uncertainty as to the future conditions of
funding in the national banking systems.
At the beginning of this month, considering the contraction of demand, the prospect of
prolonged cyclical weakness and the decline of both actual and expected inflation in the
medium term to well below 2 per cent, the ECB Governing Council lowered the rate on main
refinancing operations further, taking it to a new historic low of 0.5 per cent. The Council
reiterated that the unlimited supply of liquidity at fixed rates would continue for as long as
necessary and in any case until July of next year. The ECB, in concert with other European
institutions, is examining initiatives to promote a market in securities backed by loans to
nonfinancial corporations.
The Governing Council stands ready to intervene again as new information becomes
available and to consider all possible measures for maintaining credit conditions throughout
the area consistent with the monetary policy stance. The ECB's management of official
interest rates has proven effective; the effects of last year's reductions have spread to the
countries hardest hit by the tensions.
The measures taken, in particular the announcement of outright monetary transactions, are
conducive to the national and European reforms which alone can eradicate redenomination
risk. Monetary policy can guarantee stability only if the area's economic fundamentals and
institutional architecture are consistent with that objective.
Every country must do its part. The procedure for the activation of OMTs presupposes the
emergence of very serious tensions; it can only be applied to countries that have previously
requested, possibly on a precautionary basis, a European financial assistance programme,
and it is subordinated to compliance with the conditions attached. These reflect the
awareness that the fears of euro reversibility are not disjoined from those for the
sustainability of the public debt and the growth prospects of individual countries.
More than any conditionality, however, what is essential is the shared determination to
advance towards a complete European Union: monetary union, banking union, fiscal union
and finally political union. Important strides forward have already been taken. Under the
pressing time constraints dictated by the crisis, there has been uncertainty, mistakes have
been made, decisions have not been easy. But the way ahead is clear.
We must proceed along the path of integration. The banking union project is designed to
break the spiral between sovereign debt and the conditions of banks and credit. The
importance of this has been further underscored by the handling earlier this year of the
banking crisis in Cyprus, which was resolved only after problems of coordination between
European and national authorities had emerged. The creation of a single banking
supervisory mechanism in which the ECB and the national authorities play a pivotal role is
the first step. It must be completed by rapid introduction of a common bank resolution
scheme and common deposit insurance.
The contours of the project for the common budget for the euro area must be defined and a
timetable for its realization drawn up. The report of the European Commission last November
and the one drafted by the presidents of the European Council, the Commission, the
Eurogroup and the ECB move in this direction. The institution of common mechanisms of
financial support for structural reforms in single member countries can constitute the
occasion for the launch of the project and the issue, on a trial basis, of joint debt securities.
The Italian economy
Italy's weak recovery following the global financial crisis ended in the second half of 2011,
when our government securities market came under pressure. There ensued a vicious circle
between the state of the public debt, of banks and credit, and of the real economy. Economic
activity contracted by 2.4 per cent last year.
This year too will register a substantial fall in output and employment. A cyclical upturn
towards the end of the year is possible; it will depend on the acceleration of world trade, the
implementation of appropriate economic policies, positive developments in expectations and
investment conditions, and the availability of credit.
The recession is deeply undercutting potential output and threatens to erode social cohesion.
In 2012 Italy's gross domestic product was 7 per cent smaller than in 2007, households'
disposable income was more than 9 per cent lower, and industrial production was down by a
quarter. Hours worked were down 5.5 per cent, and more than half a million jobs had been
lost. The unemployment rate, at 11.5 per cent this March, has practically doubled since 2007;
it is nearly 40 per cent among young people and higher still among those in the South.
The financial and international origins of the crisis, on which economic policy makers have
mostly focused, must not blind us to the fact that in Italy more than in other countries the
cyclical ups and downs are superimposed on serious structural weaknesses. In the ten years
preceding the crisis, this was already evident in the overall performance of the Italian
economy, which fared worse than those of nearly all the other major advanced countries.
We failed to respond to the extraordinary geopolitical, technological and demographic
changes of the last quarter-century. The adjustment required, and put off for so long, is
historic in scope. It will affect the accumulation of tangible and intangible capital, product
specialization and the organization of production, the education system, skills, career paths,
the characteristics of the welfare system and income distribution, the positional rents that are
incompatible with the new competitive environment, and the working of government. An
adjustment of this magnitude needs a decisive contribution from the political system, but the
response of society and all the forces of production is essential.
Firms are called upon to make an exceptional effort to ensure the success of the
transformation by investing resources of their own, seizing the opportunities for growth,
adapting their corporate structures and organization, relying on innovation and their ability to
hold their own in the most dynamic markets. They have demonstrated their ability to do so at
other times in our history. Some are doing so now. But too few have been willing to take the
plunge; at times, instead, the illusory solution of public support is advocated.
This year's Report contains a special section on innovation in Italy. The ability to renew
products and processes, to export to emerging markets and to internationalize, including by
heading or joining global production chains, divides the firms that are continuing to expand
sales revenue and value added from those that, instead, are struggling to remain on the
market. The recession has deepened this divide and made the inadequacy of some parts of
the productive system glaringly obvious.
Transferring activity from ailing to growing sectors and firms requires profound changes in
employment relationships and in the education system. The point is not so much to foresee
which sectors and activities will attract consumption and investment demand in the decades
to come as to facilitate the transition, reduce the social costs, and capitalize on opportunities.
Many occupations are disappearing; in the years to come young people cannot simply count
on replacing their seniors as they retire. Now is the time to establish the right conditions for
the birth and growth of new enterprises and to generate new job opportunities. Lifelong
vocational training must be developed to cover working careers characterized by mobility and
change, with workers safeguarded by reinforced safety nets and insurance systems, both
public and private, during periods of inactivity. Schools and universities must support this
process by ensuring education of adequate quality and quantity, acting with determination to
raise levels of academic achievement and develop new skills.
Italy needs conditions that are conducive to enterprise and to the reallocation of productive
factors. The lag we have accumulated is accentuated by a redundant regulatory framework,
by complex and costly administrative obligations that must be drastically reduced, law that
must be rendered more certain, widespread corruption that must be stamped out, and
insufficient protection from crime. Immediate, visible progress in removing these serious
obstacles can stimulate productive investment, including from abroad, in all the country's
regions, especially in the South, where what is most critical is the environment for business
activity, on which the balanced development of our economy ultimately depends.
The programme of reforms launched in the last two years stems from these considerations.
But in many instances, after the enactment of reform laws, the implementing measures have
been slow to follow; in some cases they are still lacking and administrative practices remain
unchanged. This is a recurrent feature of our country's history: the chief difficulties reside not
so much in the substance of the laws as in their effective application.
The pace of reform has slackened in the past year, owing in part to the progressive
deterioration of the political climate. In resuming the path of reform with determination - as
the European Commission too urges in the recommendations accompanying the closure of
the excessive deficit procedure - it is vital to adopt a comprehensive approach that fixes
medium-term objectives from the outset. Structural reforms take time; they can be
implemented in succession, provided that they are designed as part of a bigger picture that
immediately clarifies their goals, implications and benefits. A credible programme can have
an impact on expectations at once, dispelling uncertainties, fostering investor confidence and
favouring the prospects of employment and income, above all for the young, who today find it
difficult to imagine any future in our country.
The consolidation of the public finances was also postponed for too long; in the face of
demographic pressure on important expenditure items, the priorities for the allocation of
resources were not clearly set. In 2007 public expenditure excluding interest payments was
43 per cent of GDP, two percentage points more than in 1997; the primary surplus had
contracted by more than three points. In the same period in Germany primary expenditure
decreased by more than four percentage points of GDP to just under 41 per cent.
The response of budgetary policy in the wake of the collapse of Lehman Brothers was
prudent in Italy: the support to economic activity in 2009 was provided through discretionary
measures affecting the composition of the budget, without increasing the deficit.
From 2010 onwards, the budgetary stance became restrictive. Following the explosion of
sovereign risk, to avoid a potentially devastating confidence and liquidity crisis, in the second
half of 2011 a correction to the public finances of the order of 5 per cent of GDP was
introduced. This made it possible to bring the deficit down within the 3 per cent limit in 2012
and to aim at structural balance as early as this year.
The adjustment had a negative impact on GDP growth in 2012 of about one percentage
point. A larger impact, of about two points, resulted from the effects of the liquidity crisis on
the cost and availability of credit for the private sector, the slowdown in world trade, and the
increase in uncertainty and the related loss of confidence. The adjustment of the public
finances helped to reduce the tensions on the government securities market, thereby
preventing even worse developments.
The advances made must be preserved. Squandering them would have grave
consequences. It would be illusory to imagine we can overcome the crisis by means of
budget deficits: investors and market participants allow us only a thin margin of confidence
today. The volume of government securities to be placed every year to finance the deficit
and, above all, to roll over the maturing debt is on the order of €400 billion.
This year there is no room for any further increase in the deficit, since the margin available
has been earmarked to pay general government's commercial debts in relation to capital
outlays. These payments can be brought forward, however, and those relating to current
expenditure, which affect the debt but not the deficit, can be increased; above all, no new
debts of this kind must be formed. The conditions need to be created for taking full
advantage of the existing instruments and subsidies to enable young people to enter and
remain in the labour market.
The European Commission has undertaken to examine ways to allow national budgets to
deviate temporarily from their medium-term objectives - keeping the deficit below 3 per cent
of GDP - in order to finance investment projects, subject to specific conditions. In Italy, this
could benefit investment to protect and enhance the value of the environment and our artistic
and cultural heritage.
Reductions in taxation, which are necessary in the medium term and which could be planned
now, will necessarily be selective, giving priority to labour and production: the tax wedge on
labour acts as a brake on employment and business activity. Tax evasion distorts the
allocation of the factors of production, gives rise to unfair competition, hinders growth in firm
size and increases the burden borne by law-abiding taxpayers. It needs to be fought at the
supranational level as well. A significant contribution to better fiscal conduct can derive from
the simplification and rationalization of taxes and formalities. The certainty of tax rules and
their careful and balanced formulation can influence expectations, and hence demand, more
and better than immediate tax cuts of uncertain sustainability.
A reallocation of expenditure in favour of the more productive components is possible by
pursuing improvements in efficiency and recoveries of resources across the board. If this
method is adopted permanently, the functioning of general government can more nearly
approach international standards. Significant results will not be possible without involving
local government. Transferring resources on the basis of standard costs, with any excess
expenditure borne by the local authorities concerned, encourages the dissemination of best
practices. The efficient use of public resources requires a reassessment of the different
levels of government, with the elimination of redundancies.
The banks and lending
The outlook for domestic demand also depends largely on credit access conditions. Lending
to firms slowed sharply in the second part of 2011 and since the beginning of December of
that year has contracted by about €60 billion. The decline, which was particularly abrupt at
first owing to the banks' severe difficulties in raising funds on the international markets due to
heightened sovereign risk, continued at a more moderate pace during 2012; in the first four
months of 2013 the contraction accelerated again, to nearly 4.0 per cent on an annual basis.
Lending to households has also declined but less so. The cost of credit to firms, which rose
in the course of 2011, declined for most of last year but stopped falling in the autumn. Bank
lending rates are still higher than the euro-area average by about one percentage point for
loans to firms and by half a point for mortgage loans to households.
The banking system is the main source of funding for our economy. At the end of 2012 bank
credit to firms and households amounted to just under €1.5 trillion, or 94 per cent of GDP;
banks' investment in government securities came to around €350 billion. The highly
unfavourable state of the economy depresses credit demand today. The contraction in
lending reflects the decline in business investment, the fall in purchases of durable goods
and the weak property market. But the decline in lending is also due in significant measure to
the tightening of supply, which is in turn linked to a deterioration in customer creditworthiness
and its impact on banks' asset quality. In turn, the credit supply conditions have an adverse
effect on economic activity, creating a negative spiral that must be broken.
The acute restriction of credit supply at the end of 2011 in response to funding difficulties
was attenuated by the unlimited supply of three-year liquidity by the Eurosystem and by the
increase in the range of the assets eligible as collateral for refinancing operations. The Bank
of Italy allowed Italian counterparties to use less creditworthy illiquid assets, in this case
charging all the associated risks to its own balance sheet. The collateral pledged with the
Bank of Italy based on bank loans currently amounts to around €180 billion, which represents
slightly less than a third of all the assets eligible for central bank refinancing and half of those
actually in the collateral pool.
Thanks to these measures immediate liquidity risks have been averted. The funds obtained
through the three-year refinancing operations do not constitute a permanent resource,
however. Tension on the government securities markets has not completely dissipated.
There is still uncertainty regarding the banks' ability to regain full access to the international
markets, particularly the long-term segments. We are working, through discussions with the
banks and in collaboration with the ECB, to expand the range of eligible assets.
An increased risk of corporate default is driving up the interest rates on loans. Since the
middle of 2012 this has offset the effect of the lowering of official rates and, more recently, of
the decline in yields on government securities.
The credit supply tensions seem to be affecting even firms with a balanced financial
situation, albeit to a smaller degree. The difficulties are greatest for small and medium-sized
firms, which are less able to tap other sources of finance. Gross issues of corporate bonds
amounting to €35 billion last year were attributable almost exclusively to large groups. In
2012 the interest rate differential between bank loans of up to €1 million and those for larger
amounts averaged 160 basis points, about twice the value recorded in the three years prior
to the crisis.
At the end of 2012 the stock of bad debt had risen to 7.2 per cent of total lending, compared
with 3.4 per cent in 2007; and that of other non-performing loans to 6.3 per cent, up from
1.9 per cent. For corporate loans, the new bad debt ratio recently rose to over 4 per cent on
a seasonally adjusted annual basis, a level not reached for twenty years. The leading
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