In recovering world trade

In 2023, world trade in goods fell sharply (-1.9%), even larger than assumed in last October's report (-1.0%). The factors that contributed to the fall are numerous and still present at the beginning of 2024: sluggish demand for manufacturing and investment goods; interest rates at record highs; energy prices stably above pre-pandemic prices; high tensions and increasing geopolitical fragmentation. In Europe, the German recession is also weighing heavily.

The outlook for world growth appears, however, to be gradually improving. The return of inflation is increasing the purchasing power and confidence of households, which is supporting consumption; this return is also bringing closer the fall in interest rates and, therefore, the rise in investments. Industrial production is expected to gradually strengthen, thanks to greater demand for goods (after the recovery in services), the need to adjust inventory levels and also favourable industrial policies in some countries, such as the USA.

World trade in goods is thus expected to return to growth this year and next year, albeit at a modest pace (Table A), and at the end of the two-year period it will catch up with the pace of world GDP expansion.

In the two-year forecast period, global GDP will remain on an expansion path, albeit at a moderate pace. Growth will be sustained: by the emerging economies, which will accelerate slightly; by the US economy, which in aggregate does not seem to have been much affected by the high rates, but is expected to slow down gradually, also due to the increase in uncertainty linked to the presidential elections; and only in 2025 by a better dynamic in the Eurozone, which will still remain on the 2023 pace this year.

There are, however, significant downside risks concerning an increase in geopolitical tensions, anescalation of ongoing military conflicts and further disruptions in global supply chains, especially in international transport. On the positive side, on the other hand, a possible resilience of the robust US growth pace and a faster rebound of the European economy, starting with the German economy, could be surprising, especially in the case of a faster-than-expected rate hike.

It should be added that the price of oil has risen in recent months, driven by demand from emerging economies and production restrictions from Opec countries and Russia, and is approaching the $90 mark this year. And the price of gas will also remain largely stable at current values, which are low compared to 2022, but high compared to the pre-pandemic period.

Two powerful driver for Italian growth

Italian growth surprised on the upside in 2023, reaching +0.9% per year despite high rates and inflation. Although decelerating from the very high rates of 2021-2022, which incorporated the post-pandemic recovery, the Italian economy grew at a much higher pace than the modest pre-pandemic rates, and twice as fast as the Eurozone average. Moreover, had it not been for the extraordinary decumulation of stocks (-1.3% the contribution to GDP in 2023), Italian GDP growth would have even reached +2.2%. This was possible thanks to various factors, above all the expansion of investments, still driven by incentives for construction (see Focus no. 1), which was accompanied by the completion of the recovery in the services sector, which kept household spending high despite the contraction of disposable income in real terms.

In the two-year forecast period 2024-2025, in addition to an improvement in global demand that will give a new boost to exports, two factors will be able to sustain Italian growth at a significant pace.

The first is the interest rate cut (Chart A). The ECB has been waiting for some months to see in the data whether the hikes that brought the official rate to 4.50% are able to accompany European inflation to the target of +2.0%. Inflation, however, almost stopped falling a few months ago, standing at +2.4% in March (same value as last November). In addition, price dynamics net of energy and food have so far only slowed to +2.9%, which is still too far above target. In Italy it is much better: total inflation at +1.3% and core at +2.3%. This, moreover, underpins the expected recovery in real household disposable income, an essential fuel for growth.

High rates weaken the dynamics of the economy, through the restrictive impact on domestic demand, i.e. consumption and investment. In the latest official announcements, it has become clear that the ECB is no longer thinking about further hikes and sees the beginning of a phase of cuts. According to the markets, rates will remain stable for two more months, before starting to fall in June 2024, July at the latest. A timeline corroborated, informally, by some members of the Board ECB. This would be a shift from the estimates of a few months ago, as the first cut was expected in May, and before that in April. The forecast scenario follows these indications, and assumes a first cut in June, to be followed by three more by the end of the year, of a quarter of a point each, to reach a rate of 3.50%, one point lower than today; three more cuts will follow in 2025, up to 2.75%. At these levels, monetary policy will continue to be slightly restrictive at the end of the forecast horizon, much less than today. This may give more impetus to investment and also to consumption.

With respect to this scenario, the risk of a rate hike can be considered minimal. While it cannot be ruled out that a greater persistence of European inflation above the +2.0% threshold could induce the ECB to postpone the rate cut again. All the more so if the Fed decides to wait longer, as the future (cut postponed to September) after the recent upward surprise on US inflation. For the Italian economy, this would act in an unfavourable direction, because it would prolong the monetary tightening, which is already excessive in light of Italian inflation that has fallen well below +2% since October 2023.

The second driver of growth in the two-year forecast period is the implementation of the PNRR, which is now coming into its own: in 2024 and 2025, in fact, the amount of resources to be spent on investments and reforms envisaged by the Plan is equal to EUR 42 and 58 billion, respectively, i.e. over 2 GDP points per year. Although it is difficult to make precise hypotheses on the overall impact that the resources of the NRP will have on the growth of the economy, partly because there is a lack of information on various aspects of the recent remodelling of the Plan, the boost to GDP from its full implementation will in any case be very strong, and will be decisive in keeping Italian growth high.

In terms of expenditure, the resources disbursed until early 2024 amounted to about 45 billion, less than a quarter of the total budget of more than 194 billion to be spent by 2026. This is 72 billion in grants, i.e. European resources that do not have to be repaid, and 123 billion in loans. Critical issues remain in the monitoring of the Plan but, compared to other countries, the Italian NRP is one of those that is moving faster, in terms of conditions met and instalments requested and disbursed by Europe.

An important point is that, although the resources disbursed so far are only a quarter of the total allocation, those 'committed', i.e. for which there is already a payment obligation, are more than half (about EUR 100 billion; see Focus no. 6). And this bodes well, also because a good portion of the resources subject to the recent remodulation will be disbursed through automatic instruments: this should favour faster spending and make it easier to reach the targets. The remodulation of the Plan has also led to a greater focus of resources on businesses: out of the total remodelled resources, about 12 billion is earmarked for them, of which 6.3 billion for Transition 5.0 (for which the actual 'grounding' is awaited) and 2.5 billion for sectors green e net zero technologies.

Various factors restrain growth

In contrast to these two powerful growth stimuli in Italy, there are various factors that will tend to dampen Italian GDP over the two-year period. The net effect is still expected to be positive. But clearly this also means that there would be room in 2024-2025 for even stronger economic growth than can be expected today.

First, the cost of electricity paid by businesses remains higher in Italy than in the main EU countries and also compared to other major international competitors, such as the USA and Japan (see Focus no. 4). With the jump in gas prices in 2021-2022, the gap widened and remained wider in 2023 (Chart B).

This depends, first of all, on the electricity generation mix, which in Italy is largely tied to thermoelectric generation from natural gas, while in other countries there are technologies such as nuclear (particularly in France), coal (e.g. in Germany) or a combination of nuclear and renewables (as in the case of Spain), which cover larger volumes and reduce prices. Market rules also count, where the price (the so-called PUN) is formed by the marginal technology, in Italy precisely gas-fired power plants in the majority of hours each year, with consequent volatility depending on trends in the value of the commodity. Added to the market price are the infrastructure costs for maintaining the safety and adequacy of the system and public policies, with burdens related to incentivising renewable energy, promoting energy efficiency and ETS emission allowances. The overall cost of electricity is then reduced for certain types of companies, characterised by high consumption, but this is also the case in other EU countries, in some cases more significantly. This creates a competitive disadvantage for Italian companies.

A greater integration of the European system, a reform of the electricity market, with the separation of generation from fossil fuels and renewables, which are expected to have progressively lower costs, as well as the development of new technologies and the implementation of careful policy measures (increased resources for compensation of indirect ETS costs, implementation of Energy Security DL measures, etc.), could mitigate Italy's energy costs and reduce (although not eliminate) foreign dependence.

The second brake is the gradual weakening of the Superbonus, already due to expire at the end of 2023 in terms of the rate at 110%, and the other building incentives. Residential construction, in terms of added value and thus contribution to GDP, is expected to be strongly affected by this planned reduction of incentives, already in 2024 and to an even greater extent in 2025. In 2023, on the other hand, the largest contribution to investment growth in Italy, although not the only one, came from housing.

A further negative factor are global transport bottlenecks and their impact on Italian industry (see Focus No. 5). The issue of transport security does not only concern the Red Sea, a crucial hub for the exchange of goods between Europe and Asia, but also numerous other fragilities along international transport routes, for example in the Strait of Malacca (in Asia) and the Panama Canal (in America). In Italy, more than half of the incoming goods volumes arrive by sea and ships carry 42% of the exported quantities. There are also several critical issues in regional transport routes, which are mostly overland: for Italy in particular along the Alpine arc, for connections with other EU countries. With regard to the crisis in the Red Sea, in particular, the impact of recent increases in maritime transport costs, which have more than doubled, on Italian industry's producer prices is estimated to be moderate overall, but is strong in specific sectors such as chemicals, metallurgy and paper.

Added to these three main braking factors are the negative effects of two other ongoing structural trends. First, the demographic decline: the overall population in Italy is decreasing, particularly the working age population (which has been shrinking for over a decade), and this will increasingly act as a brake on economic growth in the coming years. Second, the reconfiguration of global trade in goods more and more between 'friendly' countries and less and less with more geopolitically 'distant' countries: an analysis of the cross-market shares between the EU, the US and China shows some signs of decoupling (see section 2.2), which are not good for world trade and, in particular, for the economic growth of a country of manufacturing and export transformation, such as Italy.

Investment slows down, but Italy will continue to grow at a high pace

Italy's GDP trend in 2024 is expected to be in line with the good performance recorded in 2023: annual growth is expected to be +0.9% (Table B), i.e. 0.4 percentage points higher than in last October's scenario. Growth in 2025 is expected to be slightly higher, at +1.1%.

In the first quarter of 2024, economic activity indicators point to near stagnation. In quarterly terms, however, GDP is expected to return to more robust growth from the second half of 2024 and during 2025, thanks to the two driver (rate cut and implementation of the NRP) mentioned above, the strengthening of world trade and the recovery of real disposable income.

Seen from the supply side, GDP was driven in 2023 by construction and services, while industrial activity declined. Services enter 2024 still in moderate growth, which is expected to be strengthened later in the year by a recovery in real disposable income and, especially in 2025, by better conditions for access to credit. In the two-year forecast period, industry will join services in driving Italian GDP, recovering what was lost in 2022-2023; this will be thanks to the recovery of world trade, hence of exports of goods, and the easing of the monetary squeeze.

The outlook scenario presents mostly downside risks, some of which are interlinked: energy prices rising more than expected, due to numerous outbreaks of geopolitical tensions; lower inflation, and central banks postponing rate cuts further; but also possible delays or incomplete implementation of the NRP.

Private consumption is expected to be weak in 2024, more buoyant in 2025. In fact, after falling in Q4 2023, Italian household spending is expected to recover moderately in 2024 (+0.2% on average per year), while gaining momentum in 2025 (+1.2%). Low inflation and recovering disposable income are the two drivers of the expected strengthening. In 2023, the overall favourable dynamics of consumption (+1.2% on average per year), despite the decline in real disposable income (-0.5%), reflected the maintenance of a higher propensity to consume than pre-pandemic values. It is also true that households' (housing) investments increased a lot last year, but these did not take significant resources (accumulated extra savings) away from consumption. Very generous government incentives (Superbonus at 110% and other building bonuses), in fact, have 'returned' or will return to households a large part of the resources spent in 2022 and 2023 on housing investments. Moreover, thanks to the mechanism of transferability of the tax credit, part of the expenditure for building renovations was never even disbursed.

Gross fixed capital formation is expected to grow modestly, +1.0% on average in 2024 and +0.7% in 2025, a much reduced pace compared to last year (+4.7%) and even more so compared to the post-pandemic two-year period (+20.3% in 2021 and +8.6% in 2022). On the other hand, the strong growth of Italian investments in recent years has been a unicum compared to other major European countries. The slowdown comes as a result of the sharp drop expected in 2024 and especially in 2025 in investments in residential construction, in the wake of the weakening of the Superbonus and other building incentives, the spending component that had driven the high growth rates of investments the most in recent years. In 2024-2025, however, several factors will act to support the dynamics of investment: public investment will continue to grow at a high rate thanks to the implementation of the NRP projects; spending on non-residential buildings is also expected to grow; spending on plant and machinery, above all, will be driven by the cut in interest rates and also by the new incentive programmes (Transition 5.0).

In the forecast scenario, Italy's exports of goods and services, after almost stagnating in 2023, will return to growth in the two-year period at a more marked pace (+2.2% and +2.5%), slightly above world trade, although still lower than in 2021 and 2022. Imports, which had even shrunk in 2023, will also reverse the sign and return to expansion (+1.3% in 2024 and +2.4% in 2025). The expectation of a slow recovery in foreign sales is based on the still weak international context at the beginning of 2024, in particular the anaemic growth in the Eurozone, which is the main destination market for Italian goods, not offset by the more dynamic growth in the US market. Exports by Italian companies, however, are adapting quickly to the changed contexts: the speed of the recomposition of manufacturing trade by destination market and by product has increased significantly in the last four years; on the import side, which is directly exposed to critical supply issues, the recomposition is even more pronounced.

Employment, measured in terms of full-time equivalent units (FTEUs), will advance at a slightly slower pace than GDP over the forecast horizon: +0.71 FTE5T in 2024 and +1.01 FTE5T in 2025. This is after the fact that, in 2023, AWU dynamics were stronger than GDP dynamics, a phenomenon that should also be read in light of the fact that economic activity and labour input (in levels) had become misaligned in the early stages of the energy crisis (labour input had grown less than activity). The recent good performance of employment has allowed the unemployment rate to return, falling to 7.4% in early 2024 from its peak of 10.2% in spring 2021. This rate is expected to fall in 2025 to 7.1%, thanks to a further increase in employment and a labour force that will continue to advance but at a moderate pace.

The analysis of the changes in employment, in terms of quantity and characteristics, shows an improvement in the Italian labour market, both in coming out of the pandemic crisis and with respect to a time horizon extended to the last fifteen years, although the changes are not all one-sided (see Focus no. 2). On the one hand, the number of employed persons, especially those on permanent contracts, has increased more than the number of self-employed persons; the employment rate has also risen, especially for young people in recent years (although as a result not only of the increase in the number of employed persons but also of the contraction of the population). On the other hand, the number of hours worked per capita has decreased and employment has been lost in industry, in favour of sectors with lower labour productivity on average.

In the two-year period 2024-2025, while employment growth will be dampened, the pace of increase in real wages per capita is expected to accelerate. The strengthening of wage dynamics, at the same time as the marked return of inflation, will allow for a recovery, albeit not complete, of real wages, which will advance by +4.3% cumulatively over the two-year period. The recovery has already started in 2023, driven by the private sector, as a result of the contractual wage adjustment mechanism agreed between the social partners in 2009 and confirmed in 2018, which spreads out over several years the purchasing power adjustments resulting from 'imported' inflationary flares, such as the recent one.

The adjustment of public accounts

The estimate of the public deficit in 2023 was recently strongly revised upwards by Istat, to 7.2% of GDP from the 5.3% projected in last September's NaDEF. The revision is linked to changes in the accounting treatment of the resources mobilised by the Superbonus and Transition 4.0, which led to a sharp increase in capital expenditure. In the forecast scenario, the deficit reduction will be substantial in 2024, reaching 4.4% of GDP, slower in 2025, at 3.9%. This is due to positive revenue dynamics and contained expenditure, when measured net of the NRP.

Overall, growth in PA consumption will make an important and positive contribution to GDP in 2024-2025, with its components expected to have differentiated and somewhat opposite trends. Labour income will grow this year and especially next year (+1.2% and +3.0%, after -0.5% in 2023), as a result of the positive dynamics of wages and salaries and despite a decline in public sector employment. On the other hand, intermediate consumption will slow down this year (+1.0%, from +3.2% in 2023) and shrink next year (-0.6%), discounting a more moderate price dynamic.

Italy's public debt is estimated to rise to 139.1% of GDP in 2024, i.e. +1.8 GDP points higher than in 2023, and in 2025 it is expected to continue rising by another 2.0 points, to 141.1. This is due to two factors: the difference between the average cost of debt and nominal growth becomes positive again; there is an unfavourable accounting reclassification effect related, as mentioned, to some tax breaks (Superbonus and Transition 4.0).

On public accounts, the rules of the Stability and Growth Pact (see Focus no. 3) come back into operation this year. These rules, largely modified and mostly for the better, will require Italy and several other EU countries to take action to improve the deficit and debt, to bring them back towards the set parameters that, in short, impose a debt ratio stably and significantly below 3%.