Mario Draghi: Overview of economic and financial developments in Italy
Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the
Financial Stability Board, at the Ordinary Meeting of Shareholders 2008 - 115th Financial
Year, Bank of Italy, Rome 29 May 2009.
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Ladies and Gentlemen,
The reorganization of the Bank is going ahead as scheduled. Eighteen branches have
already been closed and others will cease operations over the coming months. By the end of
this year, 58 of the original 97 branches will still be operational, including 6 specializing in
banking and financial supervision and 25 assigned, with a streamlined structure, to the State
treasury service and to providing information services to the public. Banknote production will
be reorganized, with the agreement of the trade unions, in order to expand output and
increase efficiency.
Following the absorption of the Italian Foreign Exchange Office, for more than a year the
Bank of Italy has had the function of combating money laundering through a Financial
Intelligence Unit that operates within the Bank but with special autonomy. It has been
endowed with substantial resources and expertise. In carrying out its tasks, the FIU has
developed fruitful synergies with the banking and financial supervision area. This benefits the
stability and the reputation of the banking system. The Unit cooperates closely with the
judiciary and with the Finance Police, to which a constantly growing stream of complaints
and reports are submitted.
This January Antonio Finocchiaro left the Governing Board to assume the office of chairman
of the Pension Fund Supervisory Authority. In the course of a long career, Mr Finocchiaro
served the Bank of Italy with rigour and dedication, making important contributions in a
diversity of fields ranging from the original development of the Bank's IT system to the
management of human resources and trade union relations, to operational organization and
management. Let me offer him my most affectionate and grateful salutation. His place on the
Governing Board has been filled by Anna Maria Tarantola, former Managing Director for
Banking and Financial Supervision.
The Bank's staff last year faced an extraordinary commitment, commensurate with the
difficulties of the economic and financial crisis we are experiencing and the exceptional
response required at every level. The earthquake in Abruzzo has posed a painful additional
challenge. All are responding with self-sacrifice, putting the great professional and human
qualities that distinguish our team to the best possible use. I thank all of them on behalf of
the General Council and the Governing Board.
The question of the Bank's ownership structure remains to be dealt with. For over seventy
years now the present arrangements have ensured the independence and decision-making
autonomy of the central bank. However, the evolution of the structure of the banking system
has brought to light a formal anomaly that it is advisable to remove. We are prepared to
design, together with our shareholders and with the Government, a solution that will work to
the benefit of the entire system.
The global crisis
Since mid-March tensions in the financial markets have eased and share prices, despite
fluctuations, have recovered, returning to the levels recorded at the beginning of the year; the
qualitative indicators of the real economy point to a subsidence of recessionary pressures.
These are encouraging signs. The likelihood of deflation, in the sense of a protracted decline
in the general price level, now appears slight, also because longer-term inflation expectations
remain close to 2 per cent. However, in view of their seriousness, the persistent risks to the
unfolding economic scenario require that the economy continue to be supported decisively
using all available instruments. There is awareness of the need to prepare in advance
strategies to reabsorb the large budget deficits and exceptional liquidity creation that
characterize the current situation.
It is not yet possible to point with certainty to a definitive cyclical inversion: the forecast is for
a return to growth in 2010. The general expectation is for falling levels of employment and
revenue, accompanied by continuing volatility in the financial markets, with adverse effects
on consumption and investment.
The task of economic policies is to attenuate the negative spiral of unemployment and
consumption. The response has been prompt, vigorous and coordinated at the international
level. Up to now there has been no sign of a significant resumption of protectionism.
Official interest rates have been cut drastically in all the main economies. Between October
2008 and the beginning of May, the Governing Council of the European Central Bank
lowered the rate on main refinancing operations by 3.25 percentage points, to 1 per cent, the
lowest level ever reached in the euro-area countries.
The reduction was reflected in market rates: the three-month Euribor rate is currently 1.3 per
cent, over 4 percentage points lower than in the first ten days of October. Twelve-month
interest rates in euro are aligned with those in dollars and slightly lower than the sterling
rates.
The expansionary measures taken by all the central banks significantly enlarged their
balance sheets in ways that reflect differing national financial structures. Bank credit in the
euro area is relatively more important than in the United States (around 140 per cent of GDP
compared with 60 per cent). Accordingly the Eurosystem has so far focused on banks.
The introduction in October last year of a system of bank funding at a fixed rate, limited only
by the availability of collateral, was a highly important development; this, along with other
measures, enabled banks to meet their liquidity requirements in a situation of money market
paralysis. It also provided certainty regarding the rate they would have to pay for a much
longer period than in the past: the maturities of longer-term refinancing operations were
extended up to six months and, from next June, to twelve months. Against these loans banks
can now post as collateral a much broader range of securities than were previously eligible.
A global systemic collapse was averted, but neither monetary expansion nor the effect of
built-in stabilizers in government budgets could fully counter the fall in aggregate demand
and the social costs of the recession.
Since last autumn international organizations have been emphasizing the need for decisive
discretionary budgetary measures, coordinated internationally and involving all the main
countries. The Council of the European Union called for stimulus interventions totalling 1.5
per cent of the euro-area GDP in 2009.
In all the industrial countries and in many emerging economies, first and foremost China, the
fiscal policy response has been markedly expansive. The size, duration and makeup of the
interventions have varied, reflecting in particular the uneven impact of the crisis, the initial
state of the public finances and the scale of built-in stabilizers. The simultaneity of the
stimulus measures adopted enhances their effectiveness.
According to recent estimates by the International Monetary Fund, in 2009 the fiscal deficits
of advanced countries will reach almost 9 per cent of GDP, then fall by 1 percentage point in
2010. Between 2008 and 2010 government gross debt is forecast to increase by 27
percentage points of GDP in the United States, to almost 100 per cent, and by 16 percentage
points in the euro area, to 85 per cent.
The need to place massive volumes of government securities on the market in the next two
years puts upward pressure on interest rates; these will intensify with the easing of the
recession and attendant rise in demand for private debt securities, checking the recovery of
the economies. Once the crisis has passed, the public debt must be reduced sharply.
However, history teaches us that without the restoration of the banks to health and without
the resumption of credit flows, the recession will be more drawn out and the recovery slower,
despite the exceptional expansion of budget deficits.
After the failure of Lehman Brothers last September, government interventions to guarantee
bank deposits and liabilities and to support recapitalization prevented additional collapses;
they were insufficient to avert a contraction of credit. Financial markets are still struggling to
become fully functional again. Risk aversion remains high.
Worldwide, in the past two years banks have recorded losses of over $1,000 billion in their
balance sheets. Just under half of the funds used to rebuild their capital base came from
government intervention.
Looking ahead, banks' capital requirements must be met by reactivating the market. This
depends on the total transparency of banking assets. The cloud of uncertainty that continues
to hang over banks' balance sheets limits the inflow of private capital, increases the level of
capital ratios demanded by the market and makes the incentives to reduce assets more
stringent.
Action must be taken to re-establish the certainty and credibility of the asset side of bank
balance sheets. The measures announced by a number of countries to insure or transfer to
separate entities part of their assets can prompt the emergence of the most problematic
securities. But to restore confidence in the major international financial institutions, there
remains the need for a full, internationally coordinated, consistent, rigorous and transparent
stress testing of banks' balance sheets, which has already been launched in the United
States and is being prepared in Europe.
Promoting financial stability
The crisis is rooted in distortions in the markets' functioning, regulatory and supervisory
shortcomings and the conduct of intermediaries in the world's leading financial centres. The
exceptional liquidity that flowed into those centres as a result of the prolonged disequilibria in
savings rates and payments balances contributed to keeping interest rates, volatility and the
cost of protection against insolvency at abnormally low levels. This led to a general
underestimation of risk with a consequent overvaluation of financial assets and real estate.
The defects in regulation and the management of risk by the world's largest banks were
concealed. An accommodating monetary policy contributed to the artificial dilation of financial
volumes and permitted the continuation of a situation rendered fundamentally unstable by
the distortions and shortcomings mentioned above. The market rejected economic policy
interventions despite their timidity; blinded, it lost its diagnostic capacity, its self-correction
mechanisms were paralysed.
A financial system that combines innovation and solidity, profit and support for households
and firms will have to have more rules, more capital and less debt. The global strategy that is
emerging is based on three pillars: the international financial institutions, the regulatory
authorities and the central banks.
The International Monetary Fund has taken on a crucial role; its resources have been more
than doubled and its ability to intervene has been enhanced. Today the IMF can support
countries in difficulty, especially the emerging economies that are suffering most from the
adverse economic cycle; the Fund's assistance in managing imbalances is preventing the
systemic propagation of the crisis. The IMF, together with the Financial Stability Board, has
been entrusted with analysing and signalling threats to the stability of the global financial
system. It is encouraging that the leading countries have at last accepted periodic IMF
examination of the soundness of their financial systems.
More rigorous multilateral surveillance than in the past will contribute to the global
consistency of national economic policies. But the orderly correction of current account
imbalances will have to hinge on a world capital market that is fully functioning and free from
defects in regulation and control.
This belief underlies the establishment by the G20 Heads of State and Government of the
Financial Stability Board. The new body has a broadened membership and mandate by
comparison with the Financial Stability Forum; in April 2008 the latter had produced the first
report on the steps to be taken to overcome the shortcomings of regulation. The Board is
now responsible for monitoring national authorities in the application of those
recommendations, coordinating the many committees of regulators and accountants that
determine the standards for banks, and proceeding with the establishment of international
colleges of supervisors for the largest financial institutions. More rigorous capital and liquidity
requirements, the extension of the scope of regulation to non-bank institutions, the
completion of Basel II and amendment of the accounting rules in order to reduce their
procyclicality, and more demanding supervision and regulation for institutions whose size
makes them a systemic risk; these are the measures describing the path of the Financial
Stability Board's work in the coming months.
The Italian presidency of the G8 is conducting the work to set global standards for the
transparency, propriety and integrity of international economic and financial activity.
The crisis has considerably broadened the consensus on the need for central banks to
expressly include financial stability among their objectives; restricting their task to taking
corrective action after a crisis is no longer deemed sufficient. The idea is gaining ground that
the functions of monetary policy and supervision reinforce each other. The debate on these
issues is complex and far from over.
In Europe the revision of large parts of the system of banking and financial supervision is
already under way. The fundamental aspects of this process appear correct; in some points it
needs to be strengthened.
The assignment of supervisory tasks aimed at systemic stability to a European council is a
good idea if it has real powers of intervention and operates in close coordination with the
national supervisory authorities.
In at least some areas the common supervisory standards should be binding and directly
applicable at national level. It is necessary to harmonize deposit guarantee systems and the
mechanisms for crisis management.
The repercussions of the crisis in Italy
According to the latest forecasts, the world crisis will cause GDP to fall in Italy by about 5 per
cent this year, after decreasing by one per cent in 2008.
The collapse of foreign demand has triggered a sharp contraction in industrial production and
investment. The reaction of firms, especially those most exposed to the international cycle,
was immediate: the temporary closure of entire factories and production lines; temporary and
permanent reductions in the workforce; postponement of purchases of intermediate and
capital goods; and unusually long delays in paying suppliers. In the six months from October
2008 to March 2009 GDP fell by more than 7 per cent on an annual basis compared with the
previous six months.
The recent signs of an easing of the most acute phase of the recession come from the
financial markets and opinion surveys, more than from the statistics available to date on the
real economy. For a return to sustained growth there must be a stable recovery of the world
economy, the weakness of the labour market must not have an even more severe impact on
domestic consumption, and the structure of our productive system must be strengthened.
Employment and consumption
Among the prudential measures that firms have taken to cope with the recession, those
involving labour have been of three types: a reorganization of shifts and working hours and a
freeze on hiring; recourse to the Wage Supplementation Fund; and non-renewal of fixed-term
contracts and layoffs of permanent employees. Nearly all firms have used measures of the
first type. Ordinary wage supplementation was also used extensively, quickly reaching the
peak levels recorded in the 1992-93 recession; the cover it potentially provides is
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nonetheless limited one third of payroll workers in the private sector and it provides
workers with a maximum monthly benefit that is less than half the average gross earnings in
industry. It is estimated that two fifths of the industrial and service firms with 20 or more
workers will reduce their staff this year; the reduction will probably be most pronounced
among the smallest firms. More than 2 million fixed-term workers will see their contracts
expire this year; more than 40 per cent work in private services, nearly 20 per cent in the
public sector; 38 per cent work in the South.
Workers on wage supplementation and job seekers already amount to about 8.5 per cent of
the labour force, a share that could rise above 10 per cent. Households' disposable income
and consumption are expected to go on falling, despite the substantial decrease in inflation.
The governmental measures in favour of less well-off households and the incentives for the
purchase of durable goods are providing temporary support.
A first risk of the current cyclical phase is a sharp reduction in domestic consumption, to
which firms could react by further restricting their purchases of capital goods and inputs.
Firms and the crisis
Thanks to the commitment of our regional branches, we have conducted a particularly
thorough survey of the state of the Italian economy, the difficulties that firms are
encountering and how they are reacting to the crisis.
Expectations of a sharp fall in turnover (of more than 20 per cent according to many firms)
and great uncertainty as to the duration of the crisis have caused investment plans for this
year to be reduced by 12 per cent in industry and services overall and by more than 20 per
cent in the manufacturing sector - exceptionally high figures by historical standards.
Restructuring in large parts of the economy began in the first half of this decade. Prior to the
crisis, some positive results were already visible in terms of productivity and competitive
strength on foreign markets, but these difficult times jeopardize the process.
According to our survey, about half of the 65,000 industrial and service firms with 20 or more
employees are engaged in restructuring. They expect a much smaller than average drop in
turnover in 2009. At one extreme, the more financially solid among them are now buffering
the impact of the recession by consolidating their technological edge and diversifying their
outlet markets. There are a fair number of such firms, we estimate more than five thousand,
employing nearly a million people. Some appear ready to take advantage of the crisis by
repositioning themselves in the market. At the other extreme lie the firms that, having
decided to grow in size and technological intensity, and to open up internationally, had taken
on debt. Now, with the crisis, they are faced with the drying up of cash flows, more rigid bank
credit, and considerable problems in accessing capital markets. At least six thousand
companies, once again with almost a million workers, are affected in this way.
The effects of the crisis are being felt above all by firms with fewer than 20 workers. In
manufacturing alone there are nearly 500,000 such firms, employing just under two million
workers. The very survival of those subcontracting for larger firms that are cutting orders and
deferring payments is sometimes at stake.
The coming months will be decisive; excessive mortality due to financial strangulation of too
many companies that have the potential to prosper after the crisis has passed is a second,
serious, risk for the Italian economy.
Financing the economy
The deterioration of the economy tends to curb bank lending. In April the quarterly rate of
growth of credit to non-financial firms was nil; it had been 12 per cent a year earlier. Lending
to households has also continued to slow.
A part of the deceleration can be explained by a decline in manufacturing and real estate
investment and in the consumption of durable goods. But the supply of bank lending has also
been curtailed, mainly owing to difficulties in raising medium and long-term funds and to the
increase in credit risk.
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Our survey found that the loan applications of 8 per cent of firms were rejected the highest
figure since the mid-1990s; it was less than 3 per cent a year ago. Over 10 per cent of firms
state that since last October they have been asked for early repayment. This happens more
frequently in the South of Italy but affects the whole country and even some larger
companies.
Banks cannot be asked to be less prudent in granting credit; a banking system that risked the
integrity of its balance sheets and the confidence of those who entrust their savings to it
would not serve the interests of the economy. What can, and must, be asked of our banks is
to improve their ability to recognize creditworthiness in the present, exceptional
circumstances. Special attention must be paid to the longer-term prospects of the firms that
apply for financial assistance. When evaluating and making decisions, banks must take
account of technology, organization and the dynamics of firms' main markets.
The Government's recent initiatives to increase the Guarantee Fund for small and
mediumsized firms can strengthen banks' support to smaller companies.
Consideration should also be given to the possibility of making a public loan guarantee
scheme available to a broader range of firms, as in other countries, for a limited period of
time and with safeguards to reduce distortions in resource allocation.
However, it is also important to reactivate the Italian securitization market; if properly
tranches
structured these instruments will remain a key channel for financing. The less risky
backed by portfolios of mainly newly-granted loans could be covered by government
guarantee. The State would not be required to make an immediate outlay of funds and its
guarantee would be adequately remunerated.
Anti-crisis measures
Economic policy currently presents more difficulties in Italy than in other countries. Action to
bolster demand is restricted by government debt from the past. Measures taken to date to
mitigate the social costs of the recession have relied mainly on funds allocated to other
purposes.
But firm and credible action to set the public finances right within an agreed time frame can
provide scope for a more incisive economic policy.
The first concern is the danger of a further deterioration of labour market conditions. The
crisis has highlighted long-standing deficiencies in our system of social protection, which
continues to be fragmented. Otherwise identical workers are treated differently only because
they are employed in a craft firm rather than in a larger company. It is estimated that 1.6
million employees and quasi-employees have no right to any assistance if they are
dismissed. More than 800,000 full-time workers in the private sector, that is 8 per cent of
potential beneficiaries, are entitled to an allowance of less than €500 a month.
A good system of social buffers for the unemployed that balances out financially over the
economic cycle lifts some anxiety from workers, supports consumption, improves mobility
between firms and sectors, and helps redirect individual skills into more productive
employment. Well-defined, nondiscretionary assistance, conditional upon engaging actively
in a job search - stronger controls being essential here - increases people's sense of
security, gives their life-plans substance, and makes it less necessary to save for a rainy day;
it narrows the disparities between workers with and without safeguards.
In a welcome move, the Government has already included temporary income support among
its anti-crisis measures, including in the case of shutdowns in companies not covered by the
Wage Supplementation Fund. It has also made provision for experimental measures in
favour of some quasi-employees.
The time is ripe for a rigorous, comprehensive reform that will rationalize the current system
of social buffers and provide more universal benefits. There is no need to overturn the
existing system. It can be re-designed around the two traditional instruments of the ordinary
Wage Supplementation Fund and unemployment benefits, suitably adjusted and graduated.
These should be accompanied by income support for the cases they do not cover, as
happens almost everywhere else in Europe and as proposed in the Government White
Paper. A form of tax credit could be considered for those on low wages: this system has
been successfully adopted in many countries and could help to regularize informal
employment.
Among the anti-crisis measures for the productive system, priority must go to action to ease
firms' financial problems, such as the plan of intervention being drawn up with the assistance
of Cassa Depositi e Prestiti and SACE, the export credit insurance agency. Additional and
more direct support could be provided by cutting payment times for general government
trade payables, which amount to about 2.5 per cent of GDP. A further move would be made
in this direction by temporarily suspending the requirement to pay into the National Social
Security Institute, INPS, the part of contributions to severance pay not allocated to a pension
fund, amounting annually to 0.3 percentage points of GDP. While both actions would entail
greater recourse to the financial markets, neither would worsen the central government's net
financial position.
Measures to stimulate private investment in residential property, which it is hoped will be
introduced in suitable form very shortly, will assist the recovery of capital accumulation.
Existing building work should be completed at the earliest opportunity and encouragement
should be given to local projects, many of which are fairly small and could be launched
without delay.
The adjustment of the public finances and structural policies
The recession is slowly producing an effect on the tax yield: having decelerated for most of
2008, it fell during the last two months. VAT receipts decreased by 1.5 per cent in the year as
a whole, compared with an increase of 2.3 per cent in consumption, partly due to the shift
towards essential goods carrying a lower rate. In the first four months of this year, VAT
receipts were down 10 per cent on the same period of 2008. Revenue from corporate income
tax, which dropped by more than 9 per cent in 2008, could fall by a still larger amount this
year. Only the revenue from personal income tax is holding up.
The action of built-in stabilizers is likely to raise the public deficit by around 2 percentage
points this year, to more than 4.5 per cent of GDP. In 2010 the deficit could exceed 5 per
cent.
Even without additional measures to support the economy, by the end of the crisis the public
debt will have increased considerably in terms of GDP, back to the levels of the early 1990s.
The ratio of primary current expenditure to GDP, which in 2008 reached the highest value
recorded since the Second World War, will rise by 3 percentage points in 2009. Total public
expenditure will be well over 50 per cent of GDP, and unless steps are taken it will tend to
stay at that level in the years to come. There is a danger that the economy will have to bear
the burden of extremely heavy taxation for many years.
After the crisis has been overcome, Italy will find itself not only with more public debt but also
with an endowment of private capital - physical and human - impoverished by the sharp
drop in investment and the rise in unemployment. If we were to do no more than return to a
low growth path like that of the past 15 years - starting, moreover, from decidedly worsened
conditions - it would be difficult to pay down the debt, while the necessity for restrictive
policies to ensure its sustainability would become more stringent. We must aim, immediately,
at achieving faster growth in the medium term. It is necessary to act on two fronts: to ensure
the consolidation of the public finances and to implement the long-awaited reforms that will
enable our economy to be an active partner in the world economic recovery.
The measures reducing current expenditure must be introduced into legislation immediately,
even if the effects are deferred, not put off to further legislative acts or administrative
decisions. In many cases this simply means proceeding more resolutely on the courses
already embarked upon.
The gradual raising of the average age at retirement will guarantee adequate pensions. A
higher employment rate among those between the ages of 55 and 65 will increase both
households' disposable income and the economy's potential output.
In 2008 occupational pension funds recorded negative yields of 6 per cent and open funds
lost 14 per cent. These results must not induce us to modify the process launched in the
early 1990s to foster the development of a second, funded retirement pillar. In the long run a
mixed system is preferable to a straight pay-as-you-go system. Nevertheless, some
adjustments and additions may be advisable. It is necessary to encourage the introduction of
products that automatically diminish the riskiness of portfolios as retirement nears and to
offer securities allowing for better management of risks over the long term.
The implementation of fiscal federalism must make a contribution to curbing government
expenditure. By strictly linking spending and taxation decisions, without forgoing the principle
of solidarity, it can lead to more efficient use of public resources. A crucial feature of the
reform enacted by Parliament is the replacement of historical expenditure by standard costs
as the criterion for the assignment of resources to local authorities. Until now the reference to
historical expenditure has made public budgets more rigid, institutionalizing inertial
mechanisms in expenditure trends.
Much is expected from the planned reform of the public administration. The breadth of the
plan, the emphasis it places on transparency and on the measurement of government
performance and the recognition of merit are all important elements of change. The efficacy
of the reform will depend on the design of evaluation systems and on the organizational rules
adopted.
Progress has been made in simplifying and reordering regulations and in reducing red tape,
in particular for business start-ups. Yet new regulatory provisions continue to be both
complex and opaque. The bureaucratic costs for business activity remain high, with
substantial differences from region to region.
Regulatory simplification and effective public action are necessary conditions for reducing the
incidence of the underground economy, which is estimated to account for more than 15 per
cent of overall economic activity in Italy. The concealment of a considerable proportion of the
tax base increases the burden on law-abiding taxpayers. It undermines the competitiveness
of the majority of firms, creates inequities and disrupts the social fabric. Progress in fighting
underground economic activity would make it possible to lower official tax rates, attenuating
distortions and unfairness.
It is necessary to improve the quality and increase the quantity of human capital and physical
infrastructure. Last year on this occasion I dwelt on the urgent need to elevate educational
attainment in our schools and universities. The drive for reform in this area must proceed and
intensify. Physical infrastructure is a crucial factor in competitiveness. In the last twenty years
the gap between Italy's infrastructural endowment and that of the other leading EU countries
has more than tripled. As regards major public works, the failure to set long-term priorities
has resulted in discontinuity and the dissipation of funds on a multitude of projects. The list of
high-priority strategic infrastructures, originally 21, has now swollen to over 200. The time
and the costs for high-speed rail lines and motorway network extensions, and even for short
road links and bypasses, are far greater than in other European countries. A kilometre of
motorway can cost over twice as much as in France or Spain. The causes are the uncertain
attribution of powers and jurisdiction between national and regional government, poor initial
cost estimation and shortcomings in reporting and continual project alterations. Regulatory
defects limit recourse to project financing.
The process of liberalization undertaken in years past must not halt or retreat. In the
countries where services are less liberalized, th