Analysis-Italy's growth bubble bursts to reveal fragile outlook

By Gavin Jones

ROME (Reuters) - Italy's growth rebound from the COVID-19 pandemic is petering out much faster than expected as structural weaknesses resurface, raising risks for the fragile public finances of the euro zone's third largest economy.

After gross domestic product unexpectedly stagnated in the third quarter, national statistics bureau ISTAT said this month it expected no near-term recovery and forecast 2024 growth of just 0.5%, half the government's official 1% target.

ISTAT's estimate would return Italy to its customary place among the euro zone's weakest performers and contradict an upbeat picture painted by Prime Minister Giorgia Meloni, as well as some economists, just a few months ago.

Recent data has been grim. Business confidence is at its lowest since 2021, a long-running manufacturing crisis is deepening, and the services sector which had propped up the economy for most of the year is now also contracting.

"Italy's business model made up of small firms is no longer conducive to growth, it has insufficient public investment and it is fighting the green transition instead of embracing it as a growth opportunity," said Francesco Saraceno, economics professor at Paris's Science Po and Rome's LUISS university.

Analysts say the situation is even more worrying considering that Italy is receiving a constant flow of tens of billions of euros from Brussels as part of the European Union's post-COVID Recovery Fund.

Spain, the other main recipient of the fund, is growing at least four times as fast.

SHORT-TERM BOOST

Saraceno said Italy's buoyancy in 2021-2022 was based mainly on state-funded incentives for the building sector - the so-called "superbonus" - which powered an investment surge that has reversed this year as the costly scheme has been phased out.

Italy has been the most sluggish euro zone economy since the launch of the single currency 25 years ago, and its latest slump threatens to derail its public finances that have already been compromised by the superbonus.

The public debt, proportionally the second largest in the euro zone, is forecast by the government to rise to around 138% of GDP in 2026 from 135% last year.

If growth in 2025 comes in significantly below Rome's 1.2% target, as most forecasters now expect, that debt ratio will probably climb faster. Investors may then become more reluctant to buy Italian bonds, increasing the government's heavy debt-servicing burden.

Italy is already under EU orders to slash its budget deficit due to massive overshoots in the last two years, removing any hope of spending its way to growth.

SPAIN POWERS AHEAD

The country's weakness stands in stark contrast to Spain, whose GDP is forecast to grow by around 3% this year. Over the last year Spain has expanded at quarterly rates of between 0.7% and 0.9%, while Italy has hovered between zero and 0.3%.

Angel Talavera, head of European research at Oxford Economics, said Spain's success in attracting migrants and integrating them into its economy had been a key driver of its growth, along with a tourism boom and firm consumer spending.

Italy's far fewer migrants rarely do skilled or even semi-skilled jobs, and are often confined to the informal economy.

Meanwhile young Italians are leaving the country in their thousands due to a lack of promising career prospects. The

shrinking population is in itself a source of economic weakness.

"They are quite different types of economies, Spain is strongly reliant on services and tourism, while Italy still has a large manufacturing sector which is increasingly uncompetitive and acting as a brake on expansion," Talavera said.

"Over the last 20 years Spain also seems to have done a better job of modernising its infrastructures and public services," he added.

IT'S EDUCATION, STUPID

Economists agree that an incomplete list of Italy's problems includes under-investment in education, infrastructure and public services, stifling bureaucracy, risk-averse banks, an under-developed stock market and an inefficient justice system - all issues that have lain unresolved for years.

There is also a perhaps surprising degree of consensus on what the top policy priority should be to improve things, a question put by Reuters to five prominent Italian economists.

Roberto Perotti, economics professor at Milan's Bocconi University, Lorenzo Bini Smaghi, a former European Central Bank board member, Andrea Roventini, economics professor at Pisa's Sant'Anna University and Science Po's Saraceno all said the focus should be on investment in education and research.

Lorenzo Codogno, head of LC Macro Advisors and a former Italian Treasury chief economist, said his priority would be further liberalisation of the labour market.

(Additional reporting by Belen Carreno in Madrid, Graphics by Stefano Bernabei, Editing by Christina Fincher)