EuropeanNov 19 2015

The Italian recovery

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The Italian recovery

With two solid quarters of growth in the first half of 2015, Italy’s recovery from the financial crisis is clearly underway.

However, the country’s Gross Domestic Product lingers at 10 per cent below 2007 pre-crisis levels. To consolidate the Italian economy’s promising recovery, development of infrastructure will be key.

Indeed, as Standard and Poor’s research shows, infrastructure investment creates a ‘multiplier effect’. That is, spending on infrastructure translates into greater future returns for the overall economy. By boosting supply in the short term and spurring demand in the long term, GDP rises, employment grows and productivity improves. Italy should be no exception: developing infrastructure will engage its own multiplier effect and support economic recovery.

However, Italian infrastructure faces an investment deficit. Since the financial crisis, the country has suffered public funding shortfalls. Meanwhile, a lack of transparency surrounding the country’s project pipeline deters private sector investment. These obstacles must be overcome to fully grasp the economic opportunity presented by the infrastructure investment multiplier effect.

Certainly, the economic potential Italy could unlock from its multiplier effect is considerable. Our analysis suggests that each additional euro spent on infrastructure in one year would contribute €1.40 to GDP over the following three years. This could create, overall, an estimated 136,000 jobs, ultimately stimulating economic growth in the country.

Of course, Italy requires the right investment in order to reap the benefits of the multiplier effect. Average spending in infrastructure in central and western Europe in 1992-2011 was about 2.6 per cent of GDP. Applying this historical expenditure to Italian GDP forecast for 2015-2030, it comes out that Italy should spend about €840bn (£593bn) on infrastructure development from 2015-2030. This includes stepping up foreign direct investment as well as stimulating domestic interest in existing brownfield developments (especially in energy) and new greenfield sites (notably for transport).

To hit such targets, public funding will remain imperative, in the short and medium terms. But as Chart 2 shows, the impact of the financial crisis has been significant: from 2009, Italy’s public infrastructure investment constantly decreased, falling from more than 3 per cent to just 2.2 per cent of GDP in 2014.

This plunge was the fourth worst fall in Europe, surpassed only by Ireland, Spain and Portugal. It is a real concern, given that spending on Italian infrastructure is already below the EU average of 2.9 per cent of GDP.

To make matters worse, the EU Stability and Growth Pact has had the negative side effect of restraining public spending on infrastructure. Although it was meant to preserve fiscal stability by preventing governments from running excessive deficits, its austerity measures have reduced public investment just when infrastructure growth would be best served to motivate Italy’s economy.

At the same time, poor project planning has hindered infrastructure development. The EU, through its European Regional Development Fund, allots finances to countries for regional investment in key infrastructural sectors. But Italy has not taken advantage of all of the structural funds available between the 2007-2013 programming period. In 2013 alone, €5.7bn (£4bn) of available EU funds were not spent. A chief reason is that Italian local authorities have failed to clearly prioritise key infrastructural projects.

This represents a critical missed opportunity, and matters are made worse when major Italian infrastructure projects – notably the Grandi Opere (great works) projects for road and rail transport – are already subject to increased costs, protracted delays and even corruption.

The public sector clearly has much to do in securing investment. Yet, it can build on some promising progress. In this respect, the European Investment Bank and Italy’s public sector development bank, Cassa Depositi e Prestiti, are continuing to invest in Italy’s key sectors: transport, energy, technological, environmental and social infrastructure.

Indeed, the European Investment Bank has made significant headway in this regard, investing more than €45bn (£32bn) from 2010-2014. CDP’s loan agreements – which totalled around €1.1bn in 2014 – will also provide more funding to infrastructure.

Meanwhile, the Italian government’s €12bn (£8.5bn) fibre-optic broadband plan for 2020 will increase Italy’s productivity by ensuring that businesses are better connected, and allowing companies to maintain efficient technological links. This development is particularly encouraging, as analysis from the International Monetary Fund suggests the low integration of communications infrastructure in Italy’s services sectors reduces productivity.

However, Italy cannot rely on traditional avenues, such as the public sector and bank loans, to address its infrastructure deficit alone. More private investment must step in if the country is to reach its infrastructure spending target of €840 billion by 2030.

In fact, Italy has adopted public-private partnership schemes. These projects aim to cap the costs and timeframes associated with public procedures, relying instead on private capital and expertise to maintain efficiency – transferring risk to the private sector.

Yet the length of the tender procedures and the time it takes to attract financing for these PPPs can cause plans to go out of date, resulting in cost overruns and legal disputes. Meanwhile, a number of Italian PPP tenders have struggled to appeal to the private sector in the first place. For example, participants may be unable to satisfy contractual conditions, or rates of return on projects may be too low to attract enough interest, which means that some PPP tenders have not even received any bidders.

Consequently, Italy’s PPPs have suffered high failure rates – from 2002-2011, 56 per cent of concession tenders were not awarded. In fact, Italy has not closed more than five deals per year for the last half decade – compare this with the UK that organised 24 PPP concessions in 2014 alone (see Chart 3). The effects are substantial: Italy’s south – a region in dire need of economic development – is significantly under represented in the PPP market.

Such a poor track record deters national and international investors from the Italian market. Indeed, slow judicial frameworks, rising costs and lengthy project timeframes hinder investment in Italian infrastructure. Therefore, greater transparency and better planning are high priorities.

With this in mind, the Italian government has worked on regulatory and legal reforms to speed up the procurement systems for strategic projects, and the recent amendments are encouraging. For instance, The Italian Code of Public Contracts, which regulates negotiations with private initiatives for strategic infrastructure projects, now requires concession agreements to secure the required financing within 24 months or face expiration. This will commit lenders sooner and help to close project deals earlier.

What is more, Italy could complement the PPP progress with other measures. In this regard, capital markets can play their part, thanks to the 2012 ‘Liberalisation’ and ‘Growth and Development’ Decrees. With attractive yields, infrastructure project bonds represent a key source of potential. A case in point is the Brescia-Padua highway bond, which attracted huge interest – with domestic and European investment requests amounting to around €2bn.

To this end, increased transparency and new legislation on project bonds would sustain valuable investor confidence. In Italy’s relatively new project bond markets, supplying performance histories and financial information on this asset class is important for attracting private investment, which will help to bridge the infrastructural financing gap and ultimately drive economic progress in the future.

Stefania Belisario is ratings analyst, EMEA Infrastructure Finance Ratings at Standard & Poor’s

Key points

Italy’s gross domestic product lingers at 10 per cent below the 2007 pre-crisis levels

The public sector has much to do in securing investment

The length of the tender procedures, and the time it takes to attract financing for PPPs, can lead to plans going out of date