The war in Ukraine could open to one new phase for the economy Italian company characterized by low growth and high inflation, aided by rising commodity prices and bottlenecks in global supply chains. This is the scenario provided by Promethea – the Bologna study center – in its forecast report for March 2022.
If until a few weeks ago there were all the conditions to leave behind the last two years marked by the pandemic, the invasion of Ukraine has changed the cards on the table, not only for its dramatic implications, but also in geopolitical terms and cheap. Unlike what happened on the occasion of other crises, this time the break with the past is much stronger so as to open a new era for the Italian economy. Prometeia identifies 5 reasons: inflation will cut household and business spending, undermining confidence and purchasing power, global supply chains could suffer new arrests, the different approach of central banks, uncertainty scares the financial markets and, finally, fiscal policies aimed at mitigating the impacts of the increases but currently sufficient to offset these effects.
Italian economy: inflation cuts household and business spending
Inflation of energy goods on an annual basis jumped in these first months of the year to 124% for producer prices, to 46% for consumer prices, with peaks of 96% for gas and electricity tariffs for the families. At the same time, however, the increase in business costs is spreading across the entire price chain: manufacturing costs have reached 12% and core inflation has risen to 1.8% from 0.8 a year ago . Prometheia revised estimates for 2022: growth down to 2,3% (from 3,6% in February) and inflation rising to 5,3% (from 3,5% in February), a level not seen since the 80s, before declining to 1.8% on average next year.
This flare-up will cut household and business spending, undermining their confidence and purchasing power. The interventions put in place by the government, although important, are currently not sufficient to produce these effects. Nominal expenditure will remain unchanged overall but its consideration in terms of goods and services purchased will be absorbed by inflation for as much as 2%. Even for businesses, the effects will vary greatly depending on the energy intensity of production, but on average both the "increase in costs" and the "deterioration of domestic and foreign demand expectations" will weigh.
Global supply chains slow down due to war
Among the reasons that could open up a new era of the Italian economy, according to the consultancy firm, there are also the possible bottlenecks in global supply chains induced by war and economic sanctions, already seriously affected by the pandemic crisis. Just 1.6% of total Italian exports go to Russia and 0.6% to Ukraine; however, the impact can be strong for some specific sectors (machinery, clothing e footwear, the products pharmaceuticals), and for some regions (over 25% of Italian exports to Russia come from Lombardy – 20% of Marche exports are directed to Russia).
Furthermore, Russia and Ukraine hold significant market shares in the supply of some raw materials and semi-finished products (titanium, palladium, germ e but), which are important inputs for the automotive, fertilizer and agricultural sectors. In an interconnected world with complex value chains, the effects on economies could go beyond what trade data suggests.
Regionalizing trade and reducing supply chains for a manufacturing sector open to trade such as the Italian one can undoubtedly have benefits in situations such as those experienced during the pandemic and now with the war, on the other hand it translates into higher production costs and lower purchasing power for families.
The restrictive position of the BC will weigh on the Italian economy
At its March meeting, the ECB sent a restrictive signal, anticipating the closure of the APP (Asset Purchase Programme) purchase programme. The Fed faces inflation that reached almost 8% in February and, with a booming economy, markets are currently expecting increases of 200 basis points overall by 2022. According to Prometeia, the position more restrictive can only weigh on the trend of economic activity, financial markets and climates of confidence. On the other hand, an expansive response of fiscal policy in Europe and a further suspension of European fiscal rules are looming. Furthermore, it could lead to common expenditure for defence, to reduce energy dependence and to welcome Ukrainian refugees.
For the EU, Prometeia continues to predict only at the beginning of 2023 the first hike in monetary policy rates despite inflation which at the end of the year could be between 3.5% and 4%. It is estimated that the deflationary effects of the shock linked to the war in Ukraine will mark a setback for the euro area, which the ECB will have to deal with.
The growth of the EU GDP forecast for this year, 2.2%, in fact underlies a substantial stagnation once the carry-over effect is eliminated (1.9 basis points), even if with significant differences between the main countries of the area. However, the risk that the pandemic could still hold back growth should not be underestimated.
Uncertainty frightens the financial markets and the spread increases
At the moment, less worrying for our country would be the effects linked to financial links with countries at war. Financial relations, and the related sanctions, with Russia involve Italian financial institutions to a limited extent, even if our banks appear to be among the most present on that market. The European banking system is exposed to Russia for about one hundred billion euros between loans and other assets in foreign currency and local currency, equal to 0,7% of European GDP (Italy for approximately 30 billion, equal to approximately 1,5% of GDP). Exposure to Ukraine is much smaller.
However, the effects are amplified by greater uncertainty: conditions have tightened in financial markets around the world, with higher risk premiums that were not slow to be requested also on our sovereign debt, with spreads against the German Bund increasing (which has a greater exposure of Italy to the Russian economy). To all this must be added the possibility that Moscow decides to default on its foreign debt in the event of a prolongation of the conflict.
Fiscal policies to mitigate price increases are not sufficient
The Russian invasion has also changed the prospects for fiscal policy, which in 2022 will also be committed to mitigating the impact of energy increases on households and businesses and to welcome refugees from Ukraine. To mitigate the consequences of the price increases, the executive has already intervened with measures for over 10 billion euros in the first two quarters alone, and according to Prometeia, they will also be repeated for the second half of the year given the persistence of high energy prices. Overall, the support measures included in the scenario "will be compatible with a deficit that would amount to 5,8% of GDP". Furthermore, for 2022, Prometeia is keeping its own forecasts on the PNRR which will contribute approximately 0,4% to GDP growth.
According to Prometeia estimates, the gross domestic product of our country will mark +2,2% for 2022 (against 4% in December). A revision based on the hypothesis that the driving factors of growth have not disappeared and that they will regain the upper hand starting from the summer, after a contraction in the first quarter of the year. However, growth will be held back by constantly higher energy prices and therefore will not recover the levels predicted by Prometheia before the war.
