Assessing the Damage in Italy - Case Study Example

Italian Financial crisis The Italian financial crisis has had a tremendous impact on a system that has been deteriorating for some twenty years caused by economic decline and political instability. Coalitions of both the left and the right have proven incapable of dealing with the problem. Silvio Berlusconi and his government attempted to deal with it in two ways: they supported big firms and banks and cut expenditure. While this policy was recognized as correct by the opposition, it was contested on grounds of inequity, inefficiency and transparency. This crisis also altered the landscape politically, with the predominance of Lega Nord’s in government and there was a shift toward their aims in government policy. This paper aims to discuss the financial crisis in Italy. The collapse in 2008 of Lehman Brothers represents Italy’s economic emergency starting point. During the financial crises, initial stages, Italian investors and banks had suffered minimally. America’s housing market issues had as of yet to hit Italy. Financial institutions in Italy were not in possession of sub-prime bonds in large quantities. The collapse of Lehman Brothers started what was the most dramatic of phases via contracting interbank loan markets. Due to a shortage of liquidity and doubts on the borrower’s financial soundness, banks stopped lending each other money. Governments induced by the liquidity crisis lent loan support to national banks while the ECB lowered the rate of discount. Banks, however, reduced access of credit for clients in order to regain liquidity. At this point, the Italian economy became entangled in the crisis. Large banks are not many in Italy, with most operating on the regional scale (Silvia & Hana 50)1. The crisis affected these larger banks, Lehman Brother’s collapse resulting in them losing funds and from the devaluation of their assets due to the collapse of the stock market. The biggest problem, which Italian banks faced was due to its links with Eastern and Central European countries (Organization for Economic Cooperation 15)2. Since the early 90s, banks extended their branch networks to countries, which had been candidates for EU membership and Ukraine. The risk of imminent collapse in this region caused the banks to lose value on their shares due to doubts about its solidity financially. Government support helped avoid a crisis. Medium and small size banks, however, reacted via reduction of credit to consumers and clients and increasing collateral for new loans. This, in turn, caused a reduction house and machinery investments and threatened medium and small firm viability. Sectors like house building, real estate, and cars collapsed as consumers spent less. Italian banks did not engage in excessive mortgage based securities. In fact, an anathema to the majority of banks in Italy who have among some of the most rigid and conservative lending practices in the world. It is unlikely that a client will be offered a loan in Italy if they do not possess at least 30-40% deposit as a cash committal. In fact, it is even more difficult if one does not have links to the bank itself. Private debt is thus low even while public debt has been increasing at a fast rate. The financial crisis in Italy has caused the economy of Italy to slow down and coupled with rising inflation, most private citizens have seen a reduction in their disposable income. Because of this financial crisis, most multinational corporations have suffered sharp contraction as credit in some affluent countries like the United States has dried up. Some of the enterprises established by these MNCs are encountering various problems in Italy. While the MNCs are publicly giving the Italian government their confidence in resolution of the crisis, the credit crunch has forced them to make some cuts in operation costs in order to remain competitive. The financial crisis has hugely impacted Italy’s economy and the MNCs, which are foreign funded, have not been spared either. Some of the projects that the MNCs were carrying out in Italy have been slowed down or even altogether scrapped. Some of the export-oriented enterprises that are foreign funded have gotten reduced offers from overseas, with some of the enterprises’ performances dropping noticeably. Other MNCs have faced difficulties in their daily operations while their financial situation has deteriorated, with some being forced to cut out operations in Italy altogether. Development and research centers of several MNCs with their headquarters in Italy have substantially downsized their staff (Silvia & Hana 52)3. Some of the MNCs relying on foreign funding have encountered operative difficulties with the total number of projects, which are foreign funded dropping visibly because of the ripple effect of the financial crisis. In 2010, Italy’s actual FDI dropped by 35.8% (Silvia & Hana 52)4. This recorded the fourth month in succession that Italy suffered a drop in this indicator. As the MNCs faced reduction in funding from banks in foreign countries also suffering the effects of the financial crisis, the MNCs began to overlook their corporate responsibility as they looked for avenues to cut costs. One particular avenue used a by a majority of the MNCs was downsizing. This had the effect of raising unemployment numbers to new levels. In Italian society, this was visible by the increase in crime and low college completion rates. Most of the MNCs also reneged on their social projects like housing projects for immigrants (Rehman 20)5. During the late 80s and early 90s, Italy’s economy boasted of a strong export-manufacturing sector. This was especially strong in such high-end product areas as chemicals, clothing and automobiles, which drove sustained and strong growth in the country’s economy. Growth was also fuelled by lower inflation, declining deficit and a reduction in public spending. However, Italy’s strong regulations in its labor market and high corruption levels made Italy unattractive to investors, and there was stagnation in economic growth. Lack of infrastructural development, as well as research, made Italy’s export manufacturing industry become too costly for foreign investors. This hampered the export industry in Italy by reducing investment, and the cost of Italian exports was driven up. This caused Italy to begin competing unfavorably with the Chinese. When the global financial crisis came around, the Italian economy contracted further. This was caused especially by the unprecedented fall in demand from global and domestic markets for Italian exports. The economy shrank 1.3% in 2008, which was followed by a contraction of 5.2% in 2009 (Demirgüç-Kunt et al 67)6. While the government attempted to rectify this by stimulating the economy, the debt levels in Italy rose to a mammoth $i.9 trillion in the year 2011, which was approximately 120% of the country’s GDP. As the economy shrank, investors concern over Italy’s ability to recover its export industry sufficiently enough to pay off its debts grew into doubts. This damaged the viability of further investment in the Italian export market. Italy was adversely affected by the valuation of the Euro after the international credit crunch. Pressure was applied on the Euro as stock markets fell sharply across Europe due to the level of sovereign debt (Organization for Economic Cooperation 20)7. Over borrowing by some Eurozone countries, including Italy, has led to doubts about their ability to repay these loans. Due to the ramifications emanating from the financial crisis, they have been left struggling to pay up their debts. This has caused a spike in cost of borrowing thus further dampening the situation, as investors continue to question the viability of the European Union, especially the monetary branch (Dutta 101)8. The Italian financial implosion brought to light various risks that the country faced due to adoption of the single currency and the subjection of its economy to the direction expressly given by the ECB. Italy, as a member of the Eurozone and Euro being the single currency, it has to abide by the decisions of the European Central Bank, which administers the currency. With the unemployment rate, ranging at 19%, growing deficits in the budget, and increased national debt has seen its GDP contract visibly. If the predictions by various experts are true, probably Italy faces the most severe recession in decades (Organization for Economic Cooperation 28)9. Adoption of the Euro by the Italians placed debilitating restraints on the ability of the government to choose between various monetary policies. These monetary policy decisions are now done from and by the Frankfurt; Germany based European Central bank (Chopra 14)10. What Italy needs to do in an ideal situation is to devalue its currency, which in effect would lower the cost of its high-end fashion, motor industry and chemical exports. This, in turn, would stimulate increased trade ad create fund inflow. However, this option is not on the table since Italy does not have the sovereignty to oversee the administration of the Euro and thus cannot control its value. The instability of the Euro during the global financial crisis was one of the reasons for Italian exports becoming expensive on the global market, and the inability to regulate the Euro left Italy in a seemingly hopeless situation. When it comes to Euro valuation as the zone’s most affluent economy, Germany is the most dominant country with others including Italy relinquishing any power over its valuation, as well as the power to manipulate interest rates or determine how much money is in circulation. Italy was thus left, with three options, to try to rescue its economy from the debilitating effects of the Euro valuation over which it had no power (Chopra 17)11. The first option is the easiest, but most dangerous as it involves doing nothing. This will eventually lead to increased unemployment levels for years on end. The second option has to do with Italy committing to reduce spending drastically and increasingly work towards boosting the economic supply side. This, in effect, would leave it open to attacks from the opposition and labor market. The third option involves abandonment of the Euro, which in theory is simple, yet probably the most hazardous of the options. While it would restore economic stability, it could lead to defaults on all financial contracts that are Euro-based. Work Cited Chopra A. Italy : 2008 Article IV consultation ; staff report, staff supplement, public information notice on the Executive Board discussion and statement by the Executive Director for Italy. Washington, DC: Internat. Monetary Fund, 2009. Print. Demirgüç-Kunt As, Douglas D and George G. The international financial crisis : have the rules of finance changed? New Jersey: World Scientific, 2011. Print. Dutta M. European Union And The Euro Revolution. New York: Emerald Group Publishing, 2007. Print. Organization for Economic Cooperation. Oecd Economic Surveys Italy 2011. Paris: Organization for Economic, 2011. Print. Rehman S. Financial crisis management in regional blocs. Boston: Kluwer Academic, 2008. Print. Silvia S, Hanan M. After the Crisis: Assessing the Damage in Italy. Washington, D.C: International Monetary Fund, 2010. Print. Read More