Ratings and Spread

As the results of the Italian elections came in last week, it was blindingly obvious that the country was in for a rough ride economically. There is a contrast between the internationalists and “Europeans” on the one side and the “Italianists” on the other; there is another division which almost matches the first between supporters of a continuing austerity programme and those who would like to spend now in order to get us out of the recession (the terms are not quite right they will do as shorthand).

The reality of the Italian economy did not change with the results; businesses are closing (more than 100,000 last year) and unemployment continues to rise, especially among the young. The good news is that there is a primary budget surplus (income covers expenses before interest on the national debt is paid) and a balanced budget is not far away though precisely when this will happen is a matter of discussion between the Italian government and the European Commission.

The other good news for the time being is that miraculously, the traditional Italian “welfare system” has prevented the serious unrest that we have seen in Greece… the problem is that the “welfare system” is wholly informal, based on private savings, the family and the grey economy all of which may and indeed are changing for the worst.
So Friday’s news (after the markets had closed) that Fitch had downgraded Italian bonds to BBB+, just three rungs above junk was less than earth-shattering. Once again, the ratings agencies reflected a change that had already taken place rather than predicting future developments.

There is much concern in Italy and talk, again, that the agencies are in some conflict of interest because they work for banks and therefore cannot give independent advice. This is curious as the agencies actually work in a communion of interests. They do not pretend to be independent observers; their first clients are the banks to whom they try and give sound advicein their own interet in order not to lose the job. They do not work for us the taxpayers or governments. And sometimes they are catastrophically wrong as in the case of the Lehman brothers in 2008.

And at least partially because of those mistakes, their pronouncements are taken a lot more circumspectly today than they were five years ago.

Agencies are subject to what can conveniently be called the “lexicographer’s paradox”. Does the dictionary just reflect the way we use a word or is it normative and instruct us on how a word should be used? Both of course; and ratings agencies do much the same.

The Minister for the Economy Vittorio Grilli said yesterday that he was “confident” that the next round of Italian bonds would sell without any problems on Tuesday and Wednesday which seems likely but he was also said that there would be a new government “in the next few days” which is highly unlikely.

The Monti reforms encouraged by the EU and implictly by the markets are still in place and will continue to be applied until a new government takes office and decides to modify them so in the short term, the prospect is not rosy but not grim either. There is a serious lack of credit available to wobbling Italian businesses and, a problem which needs to be faced and the massive unpaid public sector bills to private businesses would be enough get the economy started again. So in the medium to long term, there is a need for structural reform in Italy and that will need a government, and a strong one too.

Italy is not Greece with a weak economy and spending and debt out of control but it is not Belgium either where the economy could support the country and public spending quite happily for 541 days without a government.