Massive, coordinated action to defend the stability of financial systems - The global financial crisis that began last year in the US subprime mortgage market worsened very sharply in September, bringing down several of the largest American and European financial institutions, causing stock markets to plummet and sparking fears of financial collapse and recession in the advanced economies. Widespread worries over possible counterparty insolvency following the failure of the Lehman Brothers investment bank blocked the wholesale markets where banks procure funds, first of all the interbank market.
In the face of these grave events, governments and monetary authorities reacted with steadily increasing force and enhanced international coordination.
Central banks countered the seizing-up of their national interbank markets with liquidity injections unprecedented both in magnitude and in mode.
On 8 October the European Central Bank, the Federal Reserve, the Bank of England, the Bank of Canada, the Swedish Riksbank and the Swiss National Bank, with the support of the Bank of Japan, decided a concerted half-point reduction in interest rates - again, an unprecedented action.
The United States and some European countries, including Italy, have prepared exceptional measures to recapitalize banks using public funds or to purchase hard-to-value, illiquid assets (as in the US, where up to $700 billion was made available to this end), while simultaneously extending and strengthening deposit guarantees.
Specifically, on 8 October the UK Government unveiled a comprehensive plan to support the British financial system making provision, amongst other things, for State guarantee of new bank liabilities and direct public intervention in banks' capital; on 9 October the Italian Government, in addition to guaranteeing bank deposits, approved special procedures to intervene using public funds in banks' capital and to enable the Bank of Italy to more effectively support banks' liquidity in emergency situations.
On 10 October the G7 finance ministers and central bank governors formally pledged to support financial institutions whose insolvency might have systemic repercussions and adopted all necessary measures to unfreeze the credit and money markets.
On 12 October, the euro-area countries, acting in agreement with the EU Commission and the European Central Bank, approved a concerted action plan and urged the other EU countries to adopt its principles. The plan provides for individual national governments to take coordinated measures to facilitate bank funding (government guarantee for new mediumterm debt issuance) and recapitalization (government subscription of preference shares or other instruments). In the days that followed, the competent authorities were called on to take measures to allow financial and non-financial institutions to value their assets in accordance with reasonable assumptions on default risk rather than immediate market value.
On 13 October the Italian Government followed up on these Eurogroup decisions by adopting measures to enhance the liquidity of banks' securities portfolios and facilitate fund-raising in the market. For its part, the Bank of Italy took steps to facilitate Italian banks' recourse to Eurosystem refinancing.
On 14 October the US Government, acting in agreement with the Federal Reserve, adopted further measures aimed at fostering the recapitalization of financial institutions with public funds, extending the federal government guarantee of their liabilities and assisting the financing of companies through Federal Reserve purchases of commercial paper.
After falling some 30 per cent between 1 September and 10 October, in the days following the main world stock markets recouped part of the loss.
The growth forecasts for all the advanced countries are revised downwards - In early October the International Monetary Fund sharply lowered its growth forecasts for all the advanced countries. GDP growth rates over 2009 as a whole are expected to be close to zero and negative in some cases. The underlying assumption is that the efforts of the authorities to stabilize the markets and economies will succeed, so that activity will start recovering gradually in the course of 2009.
This process is expected to benefit from the recent sharp declines in energy and commodity prices and the continuing growth of the main emerging economies. Inflation is expected to decline everywhere. On the other hand, the IMF lists a series of risks that, should they materialize, would make the recession deeper and longer; these risks have increased with the growing severity of the crisis on the financial and credit markets.
In Italy, the cyclical indicators are negative - In Italy, the rebound in economic activity in the first quarter was followed by a succession of signs of weakness. GDP contracted in the second quarter with respect to the first. The short-term picture indicates stagnation for the rest of the year. Productivity, which reflects the Italian economy's structural shortcomings, is being hurt by the cyclical downturn. Inflation is easing because of the fall in oil prices and the weakness of demand.
Consumption is contracting and the cost of household borrowing rising - The expenditure of Italian households fell by 0.3 per cent in the first six months of the year compared with the first half of 2007. Disposable income grew over the same period by a modest 0.5 per cent; despite the increase in nominal income due to the renewal of some contracts, this was half the figure in 2007 and reflected the rise in the prices of consumer goods caused by that in the international prices of raw materials. The deterioration in the economic cycle influences expectations, making spending decisions prudent and stimulating saving. Italian households remain among the least indebted in the advanced world, but the debt service burden has become heavier with the growth in households' exposure in the last few years and the rise in interest rates.
Employment continued to grow in the second quarter but was outpaced by the increase in labour market participation, which can perhaps be seen as a response to the threat to household incomes brought by economic stagnation. The cyclical difficulties are evident in the sharp increase in the number of persons who have recently lost their jobs among those in search of employment, especially in the Centre and North.
Corporate investment is declining - Corporate investment was virtually stagnant in the second quarter, while that in construction fell significantly. In the residential housing sector there appears to have been a drastic contraction in sales, and prices slowed, although they continued to rise, whereas in many other countries they fell, sometimes sharply.
Exports contracted in the second quarter and are heading towards stagnation in the third, in response to the weakening of world demand and the unfavourable trend in competitiveness, at least through the first quarter of the year. The weakness of the cycle and the deterioration in lending conditions are reflected in a slowdown in firms' borrowing. That from banks grew but gross bond issues in the second quarter were nil, while redemptions amounted to €1.5 billion.
Lending conditions are tightened - According to the Bank Lending Survey carried out in July, in the second quarter of 2008 Italian banks continued to tighten their standards for lending to businesses. In the household lending segment, after almost two years of easier conditions, the restrictions already in being with respect to home mortgages were extended to consumer credit. Further limitations were expected in the second half of the year. The profitability of Italian banks is affected by the global financial crisis, but to a small extent, given their limited exposure to US subprime and Alt/A mortgages, related securities and other "vehicles" in the sector.
The public finance targets were confirmed in September - The budget for the years 2009-2011, which is designed to achieve the objectives set out in the Economic and Financial Planning Document in June, was approved in August. The 2009 Finance Bill contains only some technical measures needed to implement the three-year programme. The Forecasting and Planning Report for 2009, confirming the objectives set out in the EFPD, projects a rise in general government net borrowing to 2.5 per cent of GDP in 2008; primary current expenditure is expected to increase by 0.5 percentage points with respect to 2007 and the incidence of taxation to decrease by 0.5 points. The debt-to-GDP ratio should fall slightly, to 103.7 per cent. According to the Forecasting and Planning Report net borrowing will fall to 2.1 per cent of GDP in 2009. This objective could be jeopardized by the worsening of the economic situation.
The measures to support the financial system now decided by the Government are precautionary and will not necessarily affect the public finances. The State's guarantee of bank liabilities would increase expenditure only by the amount actually used. Any bank recapitalizations or exchanges of government securities for other instruments would have a temporary effect on the level of the gross debt, without changing net debt.
The aim of the budget policy is to achieve balance and bring the public debt below 100 per cent of GDP in 2011. To a large extent these objectives will be achieved by containing expenditure; in this respect, the manner of implementing the measures decided in recent months will be crucial.
