Italian GDP contracted for the last 12 months and the country is now looking at a longer and deeper recession than was previously expected.
With Spain already expected to request a sovereign bailout, investors are worried that the giant Italian economy might be the next domino to fall. So the big question on everyone’s mind: Is Italian debt sustainable? i.e. can Italy meet its debt without debt relief and avoid default.
In answering that Societe Generale’s James Nixon points out three key points about Italian debt and its economic growth:
- Italy has extremely high debt-to-GDP and to bring this in control, the government is pushing austerity. This austerity along with a credit crunch are hurting economic growth. Nixon projects Italian GDP to decline 2.3 per cent in 2012, and 1.4 per cent in 2013, and expects it to be flat in 2014. The IMF puts Italy’s long-term growth rate at 0.5 per cent per annum.
- Rising unemployment is impacting consumer confidence and has caused a drop in private consumption.
- Finally, to achieve fiscal consolidation Italy is raising taxes on consumption and property, both sectors that are being hit hard by unemployment and tight conditions in the banking sector. “Italy also faces a significant increase in its service costs which, if not addressed, threatens to wipe out all of the consolidation planned for next year.”
Photo: Societe Generale
In this backdrop, Nixon writes that Italy is likely to miss its deficit target, and there is concern that such a slippage could impact its overall debt sustainability.The target is to cut deficit to 1.7 per cent in 2012, and 0.5 per cent in 2013. But Nixon thinks Italy is more likely to reach 2.9 per cent in 2012, and 2.1 per cent in 2013:
“What our models serve to illustrate, however, is that Italy has precious little room for manoeuvre. If there is significant slippage beyond what we are forecasting, then Italy’s debt position could easily slip to the other side of the saddle path equilibrium and Italy could find itself on an unsustainable debt trajectory. Despite Italy’s low absolute deficit, it is precisely this fear that is reflected in current Italian spreads.
Italy therefore looks perilously close to losing market access and finding itself on an unsustainable debt trajectory…Thus, there is a good chance that the EU will seize the opportunity to impose deep and meaningful reforms on Italy – something that at the moment all the political parties inside Italy appear keen to avoid.”
To avoid this Italy needs to boost growth and become competitive again. In the absence of this Italy should heed German chancellor Angela Merkel’s warning that conditionality would be attached to any ECB assistance.