*NEWS*ITALY MAY PROMPT FIRST EURO EXIT

[Anonymous]

Italy’s Economic Woes
May Prompt First Euro Exit

May05-Looking for a bet on Europe’s most unexpected economic event of the
next decade? How about a wager on Italy leaving the euro area? Who knows, you
might even be able to collect your winnings in lira.

In the past few months it has become painfully clear that Italy, which was
the euro’s most fervent supporter before the single currency’s introduction, is
its most prominent victim.

No other country has suffered so much from the disciplines that the euro
imposes. The door marked “Exit” must be looking increasingly attractive.

That Italy has now been plunged into an economic crisis is clear from even a
cursory glance at the figures.

Last week, it was announced that Italy had slipped back into recession, the
country’s second in two years.

Gross domestic product shrank 0.5 percent in the first quarter, the steepest
drop in six years. That came after a contraction of 0.4 percent in the previous
three months, according to the statistics office Istat. In total, the Italian
economy, the fourth-largest in Europe, has lagged behind the rest of the euro
area in eight of the last nine years. It has dropped to 47th place in a ranking
of competitiveness compiled by the World Economic Forum. No other major economy
in Europe has such a dismal record.

Don’t expect it to get better anytime soon. “Problems of specialization and
necessary restructuring cannot be postponed indefinitely and regular
devaluations are not a solution, either,” said Olivier Gasnier, an economist at
Societe Generale SA in Paris, in an e-mailed response to questions.

Tax Cuts

“One can probably argue that it would be helpful today, given the extent of
difficulties faced by exporters, but it will not be a durable solution.”

For the early part of this decade, Italy seemed to be in the same boat as
Germany and France, which have also been suffering. Yet as those two countries
stage modest recoveries, Italy’s woeful underperformance looks even more stark.

Why is it so bad? “There is a lot of discussion about demand management and
tax cuts,” said Vincenzo Guzzo, an economist at Morgan Stanley in London, in a
telephone interview. “Tax cuts would be a good thing, but really it is more of
a disease of the supply side. It is a structural problem.”

Italy specialized too much in low-growth traditional consumer and capital
goods, while slipping behind in areas such as electronics, chemicals and
pharmaceuticals.

That has made Italy sensitive to exchange rates, and it has suffered as the
euro has jumped in value against the dollar.

Budget Deficit

Big companies such as carmaker Fiat SpA have been cutting production and
firing workers. Yet the bulk of the Italian economy consists of small
enterprises, which have found it hard to reorganize and are now getting squeezed
out of the market.

The result? An economy that is stuck in a cycle of decline. The government
has tried tax cuts, with little success, and now faces a rapid decline in its
own finances. The budget deficit may reach 5.7 percent of GDP in 2006, Societe
Generale said in a note to investors last week, citing Milan-based institute
Richerche per l’Economia e la Finanza. That rules out further tax cuts.

In the old days, the fix would have been obvious: devalue the lira. With the
euro, that isn’t possible.

It turns out that a weak currency wasn’t an obstacle to Italian success. It
was one of the foundations of the Italian economic model.

The lira was always inflationary and prone to devaluation. Yet in that
currency’s final years, Italy was a relatively successful economy that was
growing as fast as its main rivals.

`Constant Devaluation’

“In the past, the Italian economy relied on the oxygen of constant
devaluation,” Guzzo said. “Now it needs to look at structural solutions.”

Because the euro is weighing on the Italian economy, the lira is now viewed
as part of a golden age.

Nobody is preparing to abandon the euro right now. In a television interview
this month, Italian Prime Minister Silvio Berlusconi ruled out a return to the
old currency. Still, if such an action were impossible, you wouldn’t need to
rule it out. When politicians deny something, it is at least a topic of
discussion.

Could it happen?

There are few technical obstacles to getting out of the euro. Yet only an
Italian leader of impeccably pro-European credentials could do that. Funnily
enough, the most likely person to become Italy’s next prime minister is just
such a man. Romano Prodi, the former president of the European Commission, led
Berlusconi in an April poll by SWG Srl, with 61 percent support. Nobody could
accuse Prodi of wanting to undermine the European Union.

Italy’s economic woes will trigger a departure from the euro area? It’s a
long shot, though it may be worth a bet.

[Author]

May 29, 2005 at 11:21 AM