Italy Faces Lower Growth, Higher Inflation Than Euro-area Peers; EU Funding Should Help Avert Stagflation

div classBodysc17zpet90 cdBBJodivpThe prolonged RussiaUkraine war will adversely affect all countries dependent on Russian oil and gas. Economies with large international manufacturing sectors are also exposed to disruption of global supply chains from Chinas continued zeroCovid strategy. In Europe, a hrefhttps:www.fxempire.commacroitalyItalya rated a hrefhttps:www.fxempire.commacrocreditratingsitalyBBBStablea is among the most vulnerable, alongside Germany.p

pGiven Italy‘s energy dependence on Russia – with Russia accounting for 50 of Italian coal, 40 of gas and 17 of a hrefhttp:fxempire.comcommoditiesbrentcrudeoiloila consumption during 2020 – the EU’s increasingly tough sanctions of Russia, set to incorporate oil by the end of the year and possibly gas medium run, dim prospects for growth and stable price evolution over years 202224.pdivdivdiv classBodysc17zpet90 cdBBJodiv

h2 ideffectsofeusanctionsofrussiawillprovefarfromtemporaryforitalyEffects of EU sanctions of Russia will prove far from temporary for Italyh2

pRegardless of government efforts to substitute Russian oil and gas near term, which would only partially offset immediate impact of an embargo, absence of cheap and available substitutes currently at required scale will necessarily result in higher inflation and lower output over coming years. We believe the impact of the EUs sanctions of Russia for Italy will prove far from temporary.p

pAs such, Scope Ratings has revised downward growth forecasts for Italy for 2022 to around 2.02.5 from about 4 before the war. For 2023, we expect growth of around 1.52.0. As a result, Italy will reach prepandemic output only by Q4 of this year.p

pstrongFigure 1. Weakening growth and inflation outlooksbr

strong Average 202226, p

figure ariadescribedbycaptionattachment992331 classwpcaption alignnone idattachment_992331figuredivdivdiv classBodysc17zpet90 cdBBJodivfigcaption classwpcaptiontext idcaptionattachment992331Nb. ‘IT – Stressed’ assumes gas shortages, and thus negative growth of about 0.75 in 2022 and 2023 and inflation of 8 4 in 2022 2023. Source: IMF World Economic Outlook April 2022, October 2021 Scope Ratingsfigcaption

pA growth baseline for this year of 2.02.5 implies average quarterly growth of 0 for the remainder of this year. After Italian real output contraction of 0.2 during Q1 this year, zero growth for remaining quarters would presently result in 2.2 annual growth given favourable base effects.p

divdivdiv classBodysc17zpet90 cdBBJodivh2 idbaselineprojectionsassumenogasshortagesBaseline projections assume no gas shortagesh2

pCritically, our baseline economic projections assume no a hrefhttp:fxempire.comcommoditiesnaturalgasgasa shortages. Should these materialise in line with Banca d‘Italia’s adverse macroeconomic scenario, the economy would contract by 0.51.0 in 2022 and 2023, while inflation would increase to circa 8 in 2022.p

pUnder such a stressed economic scenario, assuming annual growth of around 1 and inflation of around 3 for 202326, broadly in line with latest IMF forecasts, Italy would experience the most adverse combination of low growth and high inflation dynamics among large, advanced economies – a reflection of nearterm vulnerabilities to surging energy prices and weak mediumrun growth prospects.p

pItaly‘s inflation rate in April stood at 6.2 YoY, down from 6.5 in March, pointing to early signs of peaking of price pressure. Still, even under a very unlikely scenario of convergence towards a 2 inflation rate by yearend, Italy’s annual inflation rate would average about 4.5 for the 2022 calendar year. The energy price index component rose about 70 YoY over a past three months.p

h2 idweestimatemediumrungrowthpotentialofabout08supportedbyeufundingWe estimate mediumrun growth potential of about 0.8, supported by EU fundingh2

pLooking at the mediumrun economic outlook, we estimate Italy‘s mediumterm a hrefhttps:www.fxempire.commacroitalygdpgrowthrategrowtha potential at about 0.8, incorporating declining workingage population projections and modest productivity improvement. This compares with the IMF’s mediumterm growth estimate of only 0.5, significantly below the governments own forecasts for mediumterm growth of around 1.4.p

pItaly‘s growth prospects would be even worse, with stagflation over 202223 a more likely outcome, were it not for the EU’s significant, and now very timely, recovery financing. The EU is set to disburse about EUR 70bn, or about 4 of 2021 GDP, for Italy over 202224 under Next Generation EU, equivalent to an annual boost of output of around 0.5 of GDP.p

pIn addition to direct EU stimulus, associated reforms of Italys tax system, judiciary, public administration and competition ought to gradually bolster the economic growth outlook, potentially adding more than 10pps to real output over a long run, according to government estimates.p

pStill, despite frontloading of targets related to reforms under the Mario Draghi government, implementation of growthfriendly reforms after 2023 might falter ahead of next year‘s elections, particularly given Italy’s fragmented political environment, which weighs on the mediumrun growth outlook and informs our conservative growth estimates.p

pFor a look at all of todays economic events, check out our a hrefhttps:www.fxempire.comtoolseconomiccalendareconomic calendara.p

pemAlvise Lennkh is the Deputy Head of Sovereign and Public Sector ratings at ema hrefhttps:eur01.safelinks.protection.outlook.com？urlhttps3A2F2Fwww.scoperatings.com2F23home&data047C017Cd.shen40scoperatings.com7C08602ca0db87428fa05c08d8a4dc7c007C211c49c3c44249769bd4c0fecdd6dfa97C07C07C6374406141581384907CUnknown7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn03D7C1000&sdatazaY2w4sCzq3V8PCcju5rAY6Pjn8D5BesKnwZGmzxQNs3D&reserved0 relnofollow noopener noreferrer target_blankemScope Ratings GmbHemaem. Giulia Branz, Analyst at Scope Ratings, contributed to writing this commentary.emp

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