December 1, 2010 / 6:59 AM / 9 years ago

Analysis: Euro debt crisis - Italy no longer quite so safe

ROME (Reuters) - Italy has so far largely avoided the debt crisis that has engulfed Greece and Ireland despite having the region’s weakest growth record, a huge public debt and notoriously unstable politics.

That suddenly seems in danger of changing.

Italian officials tried to reassure markets on Tuesday as concern rose that the euro zone’s third largest economy is becoming embroiled in the region’s spreading debt crisis, with possibly unmanageable consequences.

Unimpressed, investors pushed the interest rate spread between Italian bonds and benchmark German Bunds to a euro-lifetime high as they focused more on Italy’s weaknesses than its strengths.

“Now it is looking like a liquidity crisis on the government bond market, which is critical for Italy with its huge refinancing needs,” said Citibank analyst Giada Giani.

“The markets are already taking for granted that Portugal will need a rescue package and they are targeting Spain and Italy. Now only the ECB can help, by buying government bonds.”

Unicredit analyst Marco Valli said the situation was worrying but had not yet spiraled out of control. He also urged “massive” intervention from the ECB.

“We mustn’t get carried away, the yield on Italian 10-year bonds is still below 4.7 percent which is no problem in terms of refinancing costs,” he said.

Italy has one of the highest absolute debt levels in the euro zone and meeting its refinancing needs for the next three years would cost in excess of 800 billion euros.

EU rescue funds, augmented with IMF backing, can muster a total of 750 billion euros for nations needing aid. The thick end of 100 billion has just been given to Ireland.

“It’s very worrying because Spain is almost too big to be bailed out ... whereas Italy is too big to be bailed out,” said Everett Brown, European bond strategist at IDEAglobal.

For months, economists and officials have insisted that Italy, with relatively sound fundamentals should be immune from market attack, yet markets don’t seem to be listening.


Unlike former high-growth success stories such as Ireland and Spain, Italy, for all its problems, does not look all that different to how it did before the recession of 2008 and 2009.

Thanks to a prudent fiscal policy its public finances have deteriorated much less than in most euro zone countries, it suffered no housing crash, and none of its banks needed to be bailed out with public money.

At around 118 percent of gross domestic product, Italy’s public debt is the second highest in the euro zone after stricken Greece, but it has risen far less than that of its neighbors’ and has more benign future projections.

“The stabilization efforts required of Italy are less than those required of other countries,” Pier Carlo Padoan, the chief economist of the Organization for Economic Cooperation and Development told Reuters on Tuesday.

Italian households and private firms are also far less indebted than their counterparts in countries like Ireland and Britain where families borrowed heavily during the boom years.

Aggregate household and corporate debt in Italy is around 125 percent of GDP, compared to 210 percent in Spain, 240 percent in Portugal and 280 percent in Ireland.

With low debt and high savings, Italian households’ financial wealth is worth 200 percent of GDP, compared with 150 percent in Ireland and Spain and just 100 percent in Greece.

Moreover, only around 50 percent of Italy’s public debt is held by foreign investors, the lowest proportion in the euro zone, making Italian bonds less vulnerable to sudden portfolio shifts by international investors.

“It’s clear that in a moment of crisis Italian banks, insurance companies and citizens will have more of a bias toward buying Italy,” said Luigi Speranza of BNP Paribas.

Italy is also far less in the red than its troubled partners in terms of trade and financial flows. Its current account deficit is just 3 percent of GDP, compared with deficits of some 10 percent in Portugal and Spain.

Italy’s annual budget shortfall, at around 5 percent of GDP, is among the lowest in the euro zone due to its caution during the recession.

All that may not be enough however.


Markets are now focused firmly on the flaws in the euro zone and these need not be the same from one country to the next.

Italy has been one of the world’s slowest growing economies for more than a decade, a trend seen continuing for the foreseeable future because it has proved incapable of raising productivity or passing crucial growth-enhancing reforms.

Its maximum potential, or non-inflationary growth, is now estimated at around just 1 percent. And if the economy does not grow, the debt-to-GDP ratio will not fall fast, if at all.

Consumer spending is chronically weak and analysts say even Italy’s high household savings rate reflects inadequate welfare provision and a lack of trust in the pension system.

Up to now markets have taken a benign view of this stagnant, uncompetitive, debt-laden economy with levels of tax evasion second only to Greece, just as they have ignored its chronic political instability.

But now there are signs they are becoming less indulgent.

On December 14, Prime Minister Silvio Berlusconi faces confidence votes in parliament which could trigger the fall of his conservative government half way through its five year mandate.

With the center-left opposition also in disarray the prospects for strong government and economic reform have rarely looked weaker.

If the government does fall, markets will watch closely for any sign of deviation from the tight grip on public finances imposed by Economy Minister Giulio Tremonti.

And analysts say greater danger for Italy could begin when a firm recovery finally takes hold in the euro area.

“I wouldn’t rule out that Italy will be hit by a market sell-off, but only when interest rates start to rise,” said BNP Paribas’ Speranza.

“When the ECB starts to hike rates the Italian yield could go to 6 percent, pushing debt servicing costs higher and putting Italy in big trouble,” he said. “That won’t happen next year, but it might the year after.”

Additional reporting by Valentina Za, Francesca Piscioneri, editing by Mike Peacock

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