The European Union has often been described as an economic impossibility. However, a conclusive and overlooked fact remains that since the birth of the euro, the EU has produced a better growth outcome than the US and Japan.
Observing only the experience of the past five years might lead to the conclusion that Europe is structurally flawed. However, this overlooks the 18 year history of superior growth in real GDP per capita.
We like to use real growth per head because it actually determines wellbeing and living standards and the best resolution mechanism of indebtedness for a society as a whole. High nominal growth via inflation may sound appealing to a highly indebted society, but it misses the point that one person’s debt is another’s asset. Inflation reduces the burden on debtors by robbing creditors – not a great longer-term wealth creation outcome.
Real GDP per capita for several European countries tells a very interesting story. Very interestingly, Germany lagged in the early periods of the euro due to a combination of high unemployment from the post reunification phase – which led Germany to enact sweeping structural labour reforms in 2002 to improve competitiveness. In fact, in 2015 Italy modelled its version of labour reform on this German framework. But post the global financial crisis, the recovery in both Italy and Spain lagged.
However, in 2013 Spain achieved a remarkable recovery in real GDP per capita, while Italy unfortunately did not. Spain through the assistance of the European Union, rebuilt the capital positions of its banking system.
Obstacles to Italian growth now being removed
Examining net non-performing loans (NPL) to the total equity capital in the banking system demonstrates that Spain managed to restore solvency, something that has eluded Italy until now. Based on our calculations, Italy required approximately €55bn of additional capital to restore confidence and health. Through a combination of private and public market solutions, Italy has finally restored solvency, albeit at a snail’s pace. It would be a bold statement to say the Italian banking system is now healthy, but it is far closer to being so than it was in the past.
Italian net NPL to total equity capital is now at the same point it was for Spain in 2013. While this does not guarantee that Italy will exhibit the same growth trajectory, it is important to recognise that the obstacles to growth are being lowered at a time when market sentiment towards Italy is still very negative. For example, through the process of raising capital and forced mergers, the Italian banking system is now more consolidated compared to Spain.
Antipodes Partners has been highlighting the opportunities within European domestic industries for over 18 months, in particular the banking sector. European banks now on average are priced at approximately 1.1x book – however Italian banks remain at a significant discount, trading at about 0.7x book, reflecting thus far lacklustre growth and ongoing ‘tail risk’ concerns.
Growth recovery will be critical for Italy now and would further help Italian banks build further capital and continue the recovery. The Italian bank exposures in our Antipodes Global Fund – UCITS portfolio include Unicredit and Mediobanca, each a highly-differentiated business in its own right.
Jacob Mitchell is CIO and portfolio manager at Antipodes Partners