Italy has come under fire in the last few days as the new eye of the sovereign debt hurricane.But although market pressure on sovereign borrowing is mounting and PM Silvio Berlusconi is headed for the door, the former is more a result of investor skittishness rather than historical unsustainability in Italy’s debt burden.
Two compelling arguments reinforce this view: 1) Italy’s has maintained a public debt to GDP ratio north of 100%—with cyclical fluctuations that raised that number—since 1992, and 2) its government will run a surplus of approximately 0.9% this year, according to Bank of America.
True, the country’s debt-to-GDP ratio is still overwhelming at 120% and it has experienced little growth, however these are problems that have been going on for years.
BAC’s European Economist Laurence Boone elaborates:
Assuming Italy maintains a large primary surplus (as factored in the current Budget law), Italian yields could even rise to double digit figures for a couple of years before its interest payments as a share of GDP became unsustainable. However, this requires strong political commitment.
This political commitment, Boone suggests, could be what’s in question right now with the future of the government and implementation of stronger economic reforms uncertain. He adds, “We think that the fate of Italy lies mostly in its own hands.”
What is certain is that there is little hope for any EU- or IMF-led bailout under the current system of governance. Moreover, the European Central Bank’s ongoing bond purchases on the secondary market aren’t helping matters because they relieve the pressure on Italy to step up the pace of economic reforms.
On the other hand, too much pressure could push an adverse result that continues to remain off the radar—Italy is the only PIIGS country that might actually benefit from a euro exit in the near term.
Credit Suisse’s Global Equity Strategy team pointed that out two months ago:
Clearly the cost of servicing the public debt (121% of GDP) would soar (assuming the BTP/bund spreads rise to the pre-EMU level of 6% from 3.9% currently, Italy’s interest costs would be c8% of GDP cf. 4.8% now (today they’re even closer to that topping 7%), thus taking c.1.5% off GDP growth; however, with an average maturity of debt of 7.2 years and only 20% of debt coming due within the next year, higher funding costs would only come through with a lag). The cost/benefit of Italy leaving the Euro looks a lot less clear-cut than for the rest of the periphery.
That could have hugely adverse effects on the rest of the periphery, but we could be headed in that direction if bigger steps aren’t taken to stem the rise in borrowing costs soon.