Italy Country Analysis

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT ASSIGNMENT On COUNTRY ANALYSIS OF ITALY

Submitted to submitted by Mr. K.T.Rengamani Mahendran Associate dean, VIT Business School Sandhya VIT Usha Srinivas Velmurugan Vijay Kumar.B

ITALY Crisp info on Italy:Official name Italian Republic Legal system Based on constitution of 1948 National legislature Bicameral: Senate of 315 seats; Chamber of Deputies of 630 seats National elections April 13th-14th 2008; next election due in April 2013 Head of state The president, elected for a seven-year term by an electoral college of the Senate, the Chamber of Deputies and regional representatives, has no executive powers. Elected in May 2006, the term of the current president, Giorgio Napolitano, runs until mid-May 2013 Prime minister: Silvio Berlusconi (PDL) National government Council of Ministers headed by a prime minister, appointed by the president on the basis of ability to form a government with parliamentary support. The present government was formed by Silvio Berlusconi in May 2008 Political coalitions and parties

The main parties represented in parliament are: Government: the right-of-centre Popolo della Liberta (PDL), comprising Forza Italia (FI), Alleanza Nazionale (AN), Democrazia Cristiana per le Autonomie (DCA) and several other micro parties Some important figures:-

Annual data Population (m) GDP (US$ bn; market exchange rate) GDP (US$ bn; purchasing power parity) GDP per head (US$; market exchange rate) GDP per head (US$; purchasing power parity) Exchange rate (av)€:US$

2007(a) Historical averages (%) 58.1 Population growth 2,101(b) Real GDP growth

200307 0.1 1.1

1,785

Real domestic demand 1.2 growth 36,139 Inflation 2.2 30,703

Current-account balance (% of GDP) 0.731(b) FDI inflows (% of GDP)

-1.8 1.4

Unemployment Rate -7% External Debt (2006E) - $2.0 trillion Exports (2006E) -$415 billion Exports - Commodities -engineering products, textiles and clothing, production machinery, motor vehicles, transport Equipment, chemicals; food, beverages and tobacco; minerals and nonferrous metals Exports – Partners- Germany 13.7%, France 12.1%, US 8%, Spain 7.3%, UK 6.9%, Switzerland 4.1% Imports (2006E) - $427 billion Imports – Commodities- engineering products, chemicals, transport equipment, energy products, minerals and Non ferrous metals, textiles and clothing; food, beverages and tobacco Imports – Partners- Germany 18.1%, France 10.7%, Netherlands 5.8%, Spain 4.7%, Belgium 4.4%, UK 4.3%, China 4.1% Current Account Balance--$42 billion

Background. Post-war Italy has been characterized by a weak political structure and a strong, but recently declining economic base. In 1996 Italy moved to a bipolar political system, dominated by a right-of-centre alliance led by Silvio Berlusconi and a broad left-of-centre coalition, led by Romano Prodi until early 2008. Despite the defection of a small centrist group, Mr. Berlusconi won a clear victory in the April 2008 election. The centre-left led by Walter Veltroni refused to enter into an alliance with the hard left, who failed to win any seats. PEOPLE Italy is largely homogeneous linguistically and religiously but is diverse culturally, economically, and politically. Italy has the fifth-highest population density in Europe--about 200 persons per square kilometer (490 per sq. mi.). Minority groups are small, the largest being the Germanspeaking people of Bolzano Province and the Slovenes around Trieste. There are also small communities of Albanian, Greek, Ladino, and French origin. Immigration has increased in recent years, however, while the Italian population is declining overall due to low birth rates. Although Roman Catholicism is the majority religion--85% of native-born citizens are nominally Catholic--all religious faiths are provided equal freedom before the law by the constitution. Europe's Renaissance period began in Italy during the 14th and 15th centuries. Literary achievements--such as the poetry of Petrarch, Tasso, and Ariosto and the prose of Boccaccio, Machiavelli, and Castiglione--exerted a tremendous and lasting influence on the subsequent development of Western civilization, as did the painting, sculpture, and architecture contributed by giants such as da Vinci, Raphael, Botticelli, Fra Angelico, and Michelangelo. Political structure. Italy has been a democratic republic since June 2, 1946, when the monarchy was abolished by popular referendum. The constitution was promulgated on January 1, 1948. The Italian state is centralized. The prefect of each of the provinces is appointed by and answerable to the central government. In addition to the provinces, the constitution provides for 20 regions with limited governing powers. Five regions--Sardinia, Sicily, Trentino-Alto Adige, Valle d'Aosta, and Friuli-Venezia Giulia--function with special autonomy statutes. The other 15 regions were established in 1970 and vote for regional "councils." The establishment of regional governments throughout Italy has brought some decentralization to the national governmental

machinery, and recent governments have devolved further powers to the regions. Many regional governments, particularly in the north of Italy, are seeking additional powers. Parliament is elected for a maximum of five years. A reform of the electoral system returned Italy to a system based on proportional representation (PR) for the 2006 and 2008 elections. The president, who is elected by parliament for a seven-year term, decides whether to call an election or to nominate a prime minister to try to form a government in the event of a political crisis. He also promulgates laws and may return a law to parliament for reconsideration. Executive power lies with the cabinet, which is nominated by the prime minister and approved by parliament. The prime minister cannot dismiss ministers without forming a new government. POLITICAL CONDITIONS Until recently, there had been frequent government turnovers (more than 60 and counting) since 1945. The dominance of the Christian Democratic (DC) party during much of the postwar period lent continuity and comparative stability to Italy's political situation. From 1992 to 1997, Italy faced significant challenges as voters--disenchanted with past political paralysis, massive government debt, extensive corruption, and organized crime's considerable influence--demanded political, economic, and ethical reforms. In 1993 referendums, voters approved substantial changes, including moving from a proportional to a largely majoritarian electoral system and the abolishment of some ministries. However in 2005, parliament passed a new electoral law based on full proportional assignment of seats. Major political parties, beset by scandal and loss of voter confidence, underwent far-reaching changes. New political forces and new alignments of power emerged in March 1994 national elections. The election saw a major turnover in the new parliament, with 452 out of 630 deputies and 213 out of 315 senators elected for the first time. The 1994 elections also swept media magnate Silvio Berlusconi--and his Freedom Pole coalition--into office as Prime Minister. Berlusconi, however, was forced to step down in January 1995 when one member of his coalition withdrew support. The Berlusconi government was succeeded by a technical government headed by Prime Minister Lamberto Dini, which fell in early 1996. New elections in 1996 brought a center-left coalition to government for the first time after World War II. A series of center-left coalitions dominated Italy's political landscape between 1996 and 2001. In January 2008, the Prodi government fell when small coalition partner UDEUR withdrew support. In February, the President dissolved parliament and Silvio Berlusconi returned to power after defeating former Rome Mayor Walter Veltroni by a comfortable margin in elections on April 13-14, 2008. Berlusconi's winning coalition was composed of the People of Liberty (a union of Forza Italia and National Alliance), the Northern League, and the Movement for

Autonomy. Berlusconi was sworn in as Prime Minister on May 8. Veltroni now heads the opposition.

ECONOMY The Italian economy has changed dramatically since the end of World War II. From an agriculturally based economy, it has developed into an industrial state ranked as the world's sixth-largest market economy. Italy belongs to the Group of Eight (G-8) industrialized nations; it is a member of the European Union and the Organization for Economic Cooperation and Development (OECD). Italy has few natural resources. With much land unsuited for farming, Italy is a net food importer. There are no substantial deposits of iron, coal, or oil. Proven natural gas reserves, mainly in the Po Valley and offshore in the Adriatic, constitute the country's most important mineral resource. Most raw materials needed for manufacturing and more than 80% of the country's energy sources are imported. Italy's economic strength is in the processing and the manufacturing of goods, primarily in small and medium-sized family-owned firms. Its major industries are precision machinery, motor vehicles, chemicals, pharmaceuticals, electric goods, and fashion and clothing. Italy continues to grapple with budget deficits and high public debt--2.0% and 105.6% of GDP for 2007, respectively. Italy joined the European Monetary Union in 1998 by signing the Stability and Growth Pact, and as a condition of this Euro zone membership, Italy must keep its budget deficit beneath a 3% ceiling. In June 2006, the European Commission warned Italy it had to bring the deficit down to that level by 2007. The Italian Government has found it difficult to bring the budget deficit down to a level that would allow a rapid decrease of that debt. Italy's economic growth averaged only 0.66% for the five years ending in 2005; 2006 GDP growth reached 1.9%, the highest since 2000, largely due to export growth to the Euro zone area. The economy continues to grow less than the Euro zone average, and growth is expected to decelerate from 1.7% in 2007 to under 1% in 2008 as the Euro zone and world economies slow. Italy's closest trade ties are with the other countries of the European Union, with whom it conducts about 60.3% of its total trade (2006 data). Italy's largest EU trade partners, in order of market share, are Germany (14.9%), France (11.1%), and the United Kingdom (5.3%). Italy continues to grapple with the effects of globalization, where certain countries (notably China) have eroded the Italian lower-end industrial product sector.

The Italian economy is also affected by a large underground economy--worth some 27% of Italy's GDP. This production is not subject, of course, to taxation and thus remains a source of lost revenue to the local and central government.

Policy issues. Weak economic growth contributed to a sharp deterioration in the public accounts in 2001-05. This trend was reversed in 2006-07. Liberalization of protected service sectors has begun, but remains incomplete. Limited reforms in 2003-04 to improve labor-market flexibility and check the rise in pension outlays have been diluted. Tax cuts will be the new government's top economic policy priority. A referendum to be held in 2009 will keep electoral reform on the agenda. The new government's tough stance on immigration has drawn criticism from within the EU. Taxation: In 2007 the income threshold on the top rate of personal income tax (43%) was lowered and the scope for additional regional and municipal taxes increased. The corporation tax rate was cut from 33% to 27.5% in 2008. Following a surprise European Court of Justice ruling, the additional regional business tax (IRAP) to fund health services remains in place. The basic rate was reduced from 4.25% to 3.9%, but a higher rate of 5.25% can be applied in regions with large deficits. There are two tax rates on savings (27% on interest and 12.5% on income from financial investments). Markets: The Borsa Italiana S.p. A., based in Milan, is Italy's main stock exchange. It was privatized in 1997, and was acquired by the London Stock Exchange in October 2007. In 2005 the companies listed on the Borsa were worth US$ 890 billion. Type Founded Headquarters Industry Products Parent

subsidiary of public company 16 January 1808 Milan, Italy Financial services Stock market London Stock Exchange Group plc (LSE.L)

Borsa Italiana organizes and manages the Italian stock market with the participation of nearly 130 domestic and international brokers who operate in Italy or from abroad through remote membership, using a completely electronic trading system for the real-time execution of trades. In addition, it performs organizational, commercial and promotional activities aimed at developing high value-added services for the financial community.

The stock market is divided into five parts. The electronic share market (MTA) trades Italian shares, convertible bonds, and warrants; the covered warrants market is an electronic share market. The STAR (Segment for High Requirement Shares) market is within the MTA and includes companies capitalized from 40 million to 100 million Euros that are already listed and traded in more traditional sectors. Nuovo Mercato is dedicated to innovation-driven companies. Stocks, bonds, warrants, and options not admitted to the official exchange are traded on Mercato Ristretto. Premi Market is for premium contracts on stock exchange products. The afterhour’s market enables trading of financial instruments after the daytime session closes. In 2008, Borsa Italiana reaches its 200th anniversary. Borsa Italiana regulates, develops and manages the Italian equities markets, (MTA/MTAX and Expandi Market), the Italian Derivatives market (IDEM), the Securitized Derivatives market (SeDeX), the electronic Fixed Income market (MOT), the electronic ETFs and ETCs market (ETFplus) and the Electronic Market (MTF) where Closed-end Funds are traded. MTA- Italy’s equity market MTA is Borsa Italiana’s electronic market on which shares, convertible bonds, warrants and option rights are traded. Expandi is the market dedicated to smaller size companies. On September 19th, 2005 a new market structure was introduced. In particular, within MTA, companies are now divided into 3 segments: Blue Chip, Star and Standard. • •

•

Blue Chip is the segment dedicated to companies with a capitalization of over 1 billion euro. STAR is the segment for companies with a capitalization of less than 1 billion euro which voluntarily comply with strict requirements on liquidity, transparency and corporate governance Standard is the market for all companies with a capitalization between 1 billion and 40 million euro.

The Expandi market is specially designed for small cap companies operating in traditional sectors, with consolidated positions in their markets and a positive track record of economicalfinancial results. It is appealing for all small cap issuers as it is a market characterized by simplified admission requirements and a fast listing process. Italy Balance of Payments April 2008 In April 2008 Italy's current account deficit stood at 4,129 EUR million compared to a deficit of 4,726 EUR million in April 2007. Positive movements in the services balance (650 EUR million) and the goods balance (352 EUR million) were partly offset by negative movements in the income balance (211 EUR million) and in current transfers (194 EUR million). In the 12-month period to April 2008, the current account recorded a deficit of 38,297 EUR million compared to a deficit of 39,089 EUR million a year earlier. A positive change in the goods balance (10,176 EUR million) was almost entirely offset by a negative change in the

income (6,704 EUR million), services (1,349 EUR million) and current transfers (1,331 EUR million) balances. In April 2008 direct investment showed a net outflow of 1,106 EUR million and portfolio investment showed a net inflow of 14,454 EUR million. ‘Other investment’ recorded a net outflow of 13,708 EUR million. Compared to April 2007, Italian direct investment abroad decreased by 2,193 EUR million, and Italian portfolio investment decreased by 16,576 EUR million. Foreign direct investment decreased by 758 EUR million and foreign portfolio investment increased by 7,929 EUR million, reflecting investment in 'debt securities’. In the 12-month period to April 2008, direct investment showed a net outflow of 27,701 EUR million compared to a net outflow of 26,086 EUR million a year earlier. Net portfolio investment increased by about 94 EUR billion from a net inflow of 5,560 EUR million to a net inflow of 99,670 EUR million. On the one hand Italian investment in equities and debt securities decreased respectively by about 60 and 31 EUR billion and foreign investment in debt securities increased by about 25 EUR billion. On the other hand foreign investment in equities decreased by about 22 EUR billion. Insurance In Italy The insurance sector in Italy is continued to play a major role in Italy's financial markets due to the deficit of the national pension and health system and the increased importance of the newly created private pension funds. A unique and helpful feature of Italian insurance company reports is the inclusion of financial statements of major subsidiary or affiliated companies. The Italian insurance market was traditionally characterized by a relatively large number of insurers with no one organization dominating the industry. Among the top ten Insurance companies operating in the sector,eight are large Italian insurance companies led by “Assicurazioni Generali” There are a number of foreign insurance companies operating through subsidiaries in Italy: these are primarily French and German companies. Countries whose firms have the strongest market presence are Germany (Ras, Lloyd Adriatico), Switzerland (Winterthur Assicurazioni) and France (Axa Assicurazioni). Presently so many US Companies are doing business in Italy (including AIG Europe, Cigna Life Insurance, Chubb Insurance, Prumerica Life and Allstate). Italy's market indicates moderately low penetration when compared to North America and Northern Europe, especially for life products. In recent years, the volume of life products has increased quite rapidly as the consumer has become aware that the Italian Social Security System

benefits will have to be supplemented by individual savings and as insurance awareness has increased through advertising campaigns and the distribution of insurance products through the extensive branch banking system of the country. U.S. companies are expected to take advantage of greater opportunities in Italy due to the liberalization of the EU insurance services market, as well as to the newly introduced Italian tax incentives for insurance covers involving individual supplemental allowance and long-term care plans. Foreign influence and industry consolidation in the Italian insurance industry is expected to rise due to the adoption of the euro and the emerging willingness of Italian companies to mount hostile takeover bids. Much of the new merger-mania expected to sweep Italian insurance is projected to come from the banking sector as banks continue to expand their interests in insurance sales. Top Insurance Companies in Italy

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Agenzia Immobiliare Desidera GRUPPO ASSITECA Gruppo Smile ISVAP Italy Investigator Italian Detective Bodyguard Investigative Investigation Services Rastelli Assicurazioni Rastelli Assicurazioni Studio Scaglione The Italian Association of Loss Adjusting Experts UMS GENERALI MARINE: The number one in marine transport insurance

Banking system in Italy The Banca d'Italia, the central bank, was the sole bank of issue and exercises credit control functions until Italy's accession to the European Central Bank, which now controls monetary policy and the euro, the EU's common currency (excepting the United Kingdom, Denmark, and Sweden). La Banca d'Italia is still responsible for controlling domestic inflation and balance of payments pressures. In 2002, five banks are of nationwide standing: Intesa-Bci, San Paolo-IMI, the Banca di Roma, Unicredito Italiano, and the Banca Nazionale del Lavoro. Major international banks with branches in Italy are Chase, Citibank, Bank of America, HSBC, and others.

The Istituto Mobiliare Italiano is the leading industrial credit institution; it also administers important government industrial investments. In 1987, the government privatized Mediobanca, another major industrial credit institution. A new banking law was passed in 1993, to bring Italy into conformity with the EU's Second Banking directive, which lead to model of universal banking. It allows banks to hold shares in industrial concerns; and it eliminates the distinction between banks (aziende di credito) and special credit institutions (aziende di credito speciale), thus allowing all banks to perform operations previously limited to specific types of intermediary. Foreign trade: According to the Banca d'Italia (the central bank), the value of exports of goods (fob) was €366bn (US$501bn) and imports (fob) €364bn in 2007. The current-account balance showed a deficit of €36.6bn (2.4% of GDP). Major exports 2007

% total Mechanical machinery 20.8 Metals & metal 12.0 products Transport equipment 11.4 Chemicals 9.5

of Major imports 2007

% total Energy minerals 14.0 Metals & metal 13.4 products Transport equipment 12.8 Chemicals 12.8

of

Leading markets 2007 % total Germany 12.9 France 11.4 Spain 7.4 US 6.8 EU27 60.1

of Leading 2007 Germany France Netherlands Belgium EU 27

of

suppliers % total 16.9 9.0 5.5 4.3 57.0

FOREIGN RELATIONS Italy was a founding member of the European Community--now the European Union (EU). Italy was admitted to the United Nations in 1955 and is a member and strong supporter of the North Atlantic Treaty Organization (NATO), the Organization for Economic Cooperation and Development (OECD), the General Agreement on Tariffs and Trade/World Trade Organization (GATT/WTO), the Organization for Security and Cooperation in Europe (OSCE), and the Council of Europe. It chaired the CSCE (the forerunner of the OSCE) in 1994, the EU in 1996, and the G-8 in 2001 and served as EU president from July to December 2003. Italy began serving a two-year term on the UN Security Council in January 2007. Italy firmly supports the United Nations and its international security activities. Italy actively participated in and deployed troops in support of UN peacekeeping missions in Lebanon,

Somalia, Mozambique, and Timor-Leste and provides critical support for NATO and UN operations in Afghanistan, Bosnia, Kosovo, and Albania. Italy, under NATO's ISAF, maintains approximately 2,500 troops and a Provincial Reconstruction Team in the western Afghanistan province of Herat. In December 2006, Italy completed the deployment of some 3,000 troops who supported international efforts to stabilize Iraq and continues to support reconstruction and development assistance of the Iraqi people through humanitarian workers and other officials, particularly in Dhi Qar Province. Currently over 8,000 Italian troops are deployed, including 2,250 in Kosovo, 2, 350 in Lebanon as part of UNIFIL, and over 2,500 in Afghanistan. The Italian Government seeks to obtain consensus with other European countries on various defense and security issues within the EU as well as NATO. European integration and the development of common defense and security policies will continue to be of primary interest to Italy. Exchange rate system in Italy In March 1979, Italy became a founder member of the European Monetary System (EMS) and its Exchange Rate Mechanism (ERM). During the first ten years of its membership, the lira was allowed to diverge by up to 6% against other member currencies before action had to be taken, compared with2.25% for other ERM currencies Entry into the mechanism, the Maltese lira will be pegging to the euro from the current basket arrangement. Moreover, the Maltese authorities have declared that they will maintain the exchange rate of the Maltese lira at the central rate against the euro as a unilateral commitment, thus placing no additional obligations on the ECB. Conclusion Italy in itself is continuously changing and adapting to the various needs and demands of the world. Changes like liberalization of public sectors in 2006 and decrease in the corporate tax rate form 33% to 27.5%, betterment of banking and insurance policies have not gone unnoticed. Increase in the debt securities by 25 EUR billion while a decrease in the equities by 22 EUR billion portray mixed reactions. Investment in insurance sector has a potential growth much of the new merger-mania expected to sweep Italian insurance is projected to come from the banking sector as banks continue to expand their interests in insurance sales and the awareness amongst the public has seen a significant rise. The political conditions and slower economic growth ac compared to other European nations are factors that make any investor think twice, while positive reforms and measures to develop the country are sure indicators of better times.