The situation in Italy is front and centre this morning, after S&P downgraded its outlook for the country on Friday, and its stocks and credit markets got slammed this morning.The political situation in Italy is an utter shambles. Its president, caught up in a sex scandal, has spent more time defending his public image then working to deal with the country’s debt crisis. Italy has not enacted the type of austerity measures its PIIGS siblings have, and hasn’t put a pro-growth program in place either. Instead it enacted some education reforms, which have resulted in huge protests in the country.
And the country’s debt outlook is ugly.
From Societe Generale’s Vladmir Pillonca:
Italy’s Achilles heel is the combination of a high debt ratio (119% of GDP in 2010) coupled with a very low trend GDP growth rate, which in turn reflects very weak productivity dynamics (we estimate Italy’s potential growth rate in the 0.6-0.9%yoy range, approximately one full percentage point below that of the euro area). For these reasons, looking ahead, we expect the Italian economy to grow by just 0.8%yoy on average between now and 2014, with real GDP not returning to pre-crisis levels until 2014-2015.
For these reasons, in the absence of additional policy efforts, we expect the debt ratio to remain broadly stable around 120% of GDP in the coming years. Above all, policy measures should not be confined to spending cuts alone, and should focus at least as much on lifting Italy’s weak growth potential.
Originally, Pillonca didn’t expect Italy to take action on its debt until 2012-2013. Now, with the S&P outlook downgrade, it may not have that long to wait. But it may also not have a government capable of taking action, with Berlusconi wrapped up in his political scandals, and rapidly losing support, evidenced in recent local elections.
That leaves the question of who is exposed to things getting worse. Beyond Italy, where growth is already meek, it’s the banks that hold the country’s debt. And there’s plenty of it to go around, with the country having a debt to GDP ratio of 119% in 2010.
From the looks of it, it’s Italian banks with most of the exposure to the country’s debt. But those exposures are significant, and should explain the sharp selloff in their shares today.