One of the features of modern day life is that we rarely get told the truth by official bodies and even if we get some of it we rarely get all of it! Today has opened with news in this respect from Italy and it relates to a familiar topic which is the massaging of budget and debt statistics back in the late 1990s when Italy was preparing to ditch the Lira and join the Euro. From the Financial Times.
Rome was flattering its accounts by taking upfront payments from banks in order to meet the deficit targets set by the EU for joining the first wave of 11 countries that adopted the euro in 1999.
Italy had a budget deficit of 7.7 per cent in 1995. By 1998, the crucial year for approval of its euro membership, this had been reduced to 2.7 per cent, by far the largest drop among the Euro 11. In the same period tax receipts increased marginally and government spending as a proportion of GDP fell only slightly.
So as we note that the Italian deficit figures improved considerably in the late 1990s we also note that the Financial Times is pointing out that the usual factors that lead to such an improvement appear to be missing. In other words something else looks as though it contributed and just in time some derivatives contracts appeared on the scene which allowed Italy to put some of its deficit and debt off its balance sheet. It has obtained a 2012 Italian Treasury Report and analysed it to discover this.
The report does not specify the potential losses Italy faces on the restructured contracts. But three independent experts consulted by the FT calculated the losses based on market prices on June 20 and concluded the Treasury was facing a potential loss at that moment of about €8bn, a surprisingly high figure based on a notional value of €31.7bn.
This is not the first flash of insight into Italy and losses on derivative contracts as it was revealed last year that it paid JP Morgan some 2.57 billion Euros to finally settle one from 1994. But we do now have further insight into something which looks quite a can of worms as we wonder what other deals exist?
The President of the European Central Bank was involved as he was the Director General of the Italian Treasury between 1991 and 2001. It will not help sentiment that he then moved to the Vampire Squid itself Goldman Sachs which no doubt will one day be discovered to be involved in the derivative contracts. We do know that Goldman Sachs was involved with derivatives contracts in Greece which attempted (successfully at the time) to hide her true fiscal position at Euro entry although Mr.Draghi denies he had anything to do with them.
Unfortunately for Mr.Draghi the issue of hidden derivatives contracts has come up before. Regular readers will recall the case of Monte dei Paschi di Siena or MPS which was discovered to have taken out some disastrous derivatives contracts leading to a bailout being required from the Italian state. At that time Mario Draghi was the Governor of the Bank of Italy and was accordingly responsible for its supervision.
This adds perspective for the Euro area plan to make the ECB, headed of course by Mario Draghi, in charge of Euro area bank supervision.
Of Debts and Deficits
A fundamental issue underlying this situation is that Italy has a high level of public-sector indebtedness. As of April the Bank of Italy tells us that the General Government Debt amounts to 2,041 billion Euros. Thus it is now 130% of her economic output in 2012 and even worse we know that output is declining in 2013 so far.
If we move to the budget or fiscal deficit numbers we see something that was considered to be under control and if we skip back a couple of years there were projections of budget balance and maybe even a surplus. Unfortunately for Italy in fact its deficit numbers have worsened alongside its economic prospects. Whilst the Bank of Italy points out that tax revenue rose by 3.9% on a year before in April it omits to point out that budget expenditure rose by 29%! Even if we make an allowance for monthly variability it is true that each of the last three months have shown higher expenditure than in 2012 leaving the deficit numbers worse than those of 2012. So one more time it looks as though Euro area austerity involves both higher spending and higher deficits in something of a perversion of the official claims.
The Italian economy
If we look back we see that the other issue for Italy has been a lack of economic growth where even in what were considered to be good years the average growth rate was only around 1% per annum. This of course intertwined with the public-sector debt issue. The contraction caused by the credit crunch was accordingly particularly unwelcome but even worse after a brief recovery Italy’s economy turned downwards again. The latest data on this front brought more unwelcome news.
In the first quarter of 2013 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.5 per cent with respect to the fourth quarter of 2012 and by 2.3 per cent in comparison with the first quarter of 2012.
So the recovery ended in the second quarter of 2011 and has been followed by these quarterly growth rates; -0.1%,-0.7%,-1%,-0.6% -0.2%,-0.9% and now -0.5%.
If we look to domestic demand in Italy the picture is as follows.
In April 2013 the seasonally adjusted retail trade index decreased by 0.1% with respect to March 2013 (-0.7% for food goods and +0.2% for non food goods). The average of the last three months compared to the previous three months decreased by 0.8%. The unadjusted index fell by 2.9% with respect to March 2012.
So no signs of a recovery and in fact a continuation of a consistent fall only broken last June. The seasonally adjusted underlying index is at 95.3 using 2010 as a base of 100.
Last week we discovered this.
With respect to the same month of the previous year the calendar adjusted industrial turnover index decreased by 7.2% (calendar working days being 20, one more than April 2012).
In April 2013 the unadjusted industrial new orders index decreased by 1.6 per cent with respect to the same month of the previous year.
As turnover numbers are boosted by inflation these again are disappointing.
The Purchasing Managers Index report for services had a grim headline.
Steepest decrease in new work in 2013 so far
Against this there were hopes for a recovery in Italian manufacturing so overall the report suggests that the economy of Italy is still contracting.
Government Bond Yields
This is something which has turned against Italy. The worldwide trend to lower bond prices and higher yields has been copied here too. This began in early May when the benchmark ten-year yield fell to a 2013 low of 3.76% but this improvement ended and yields began to rise. This was added too last Wednesday as international bond yields surged and now it is at 4.84%.
Whilst this is a long way still from the peaks of above 7% as 2011 moved into 2012 a highly indebted nation like Italy can ill afford it as she has to issue new debt regularly which currently is more expensive further exacerbating future debt and deficit problems.
The underlying situation here is essentially one of public-sector deficits and debt accompanied by low and now negative economic growth. It is hard for such a story to end well! Having set a benchmark for a national debt to GDP ratio of 120% during the Greek crisis it is inconvenient to say the least for both Euro leaders and officials and Italy that its ratio is now at 130% and rising. The fall in bond yields following the announcement of the so far mythical Outright Monetary Transactions of the ECB more than offset this for a while but now yields have risen and pose questions again.
The Italian Treasury has responded to the derivatives issue already. Via Google Translate
TREASURY: THERE IS NO DANGER TO THE NATIONAL ACCOUNTS
There‘s absolutely no foundation for the hypothesis that the Italian Republic has used the derivatives at the end of the nineties to create the conditions required for the entry into the euro.
I am reminded of the words of Jim Hacker from Yes Minister which I gather may have originated with Otto Von Bismarck.
Never believe anything until it is officially denied