ECB official sceptical of Italy's alternative cash plan

FRANKFURT, May 18 (Reuters) - A top European Central Bank official is sceptical of a proposal by Italy’s would-be government to pay its bills by issuing small-denomination bonds that would work as a form of parallel currency.

Under a government accord published on Friday, Italy’s two anti-establishment parties said the government could pay debt it owes to companies and individuals by issuing bonds that can be traded -- known in market parlance as IOUs.

It is one of several unconventional ideas in a “contract” signed by the League and the 5-Star Movement, which has still to be approved by their memberships in informal votes to be concluded by Sunday.

The ECB has made no comment on the proposal, which could be deemed in breach of EU rules giving the central bank exclusive power to issue currency in the euro zone.

But, regardless of any legal objection, a senior ECB policymaker speaking on condition of anonymity said any such IOU, branded MiniBOT after the Italian Treasury bill, would not work.

This is because this form of parallel currency was unlikely to be widely accepted - for example by sellers who have foreign suppliers or who fear an Italian exit from the euro zone - causing it to trade at a discount to the euro.

Economist Roberto Perotti also said in a recent article MiniBOTs would increase purchasing power but their success will depend on how many shops are prepared to accept them as a means of payment.

Still, Italians would be able to use these IOUs to pay back the government, for example through taxes or fines.

The League’s spokesman on economy matters, Claudio Borghi, was defiant in an interview published on Friday, saying MiniBOTs will be “spent anywhere, to buy anything” when they are introduced.

Past evidence is mixed.

Several Argentinian provinces and, eventually, the federal government issued parallel currencies during 2001-02 crisis in a bid to circumvent limits on printing pesos, which was then pegged to the U.S. dollar.

These IOUs, which were issued at par with the peso and in some cases paid interest, did not lose value against the national currency.

Economists Augusto de la Torre, Eduardo Levy Yeyati and Sergio Schmukler estimated in a 2010 article that this was due to strong demand for these currencies, which could be used to pay taxes, at a time when pesos were scarce.

Ironically, this also meant this quasi-money failed to alleviate Argentina’s problems by making it cheaper for foreign buyers and investors. The country abandoned the fixed exchange rate with the dollar in January 2002.

California also resorted to IOUs after a severe revenue slump in 2009, issuing paper that carried a 3.75 percent interest rate to meet its short-term debt obligation.

Some major banks refused to accept them and the state’s credit rating was downgraded. California eventually slashed spending, secured fresh funding and repaid its IOUs. (Additional reporting by Gavin Jones in Rome)