Italy bud­get fight re­vives eu­ro­zone cri­sis fears

Irish Independent - Business Week - - WEEK IN FOCUS -

AF­TER four suc­ces­sive days of in­creas­ing risk spreads, and af­ter a prom­i­nent politi­cian, Clau­dio Borghi, said there was an ad­van­tage to hav­ing your “own cur­rency,” Italy is back squarely on both pub­lic and pri­vate radar screens as a po­ten­tial source of sys­temic eco­nomic and fi­nan­cial dis­rup­tions. This has led to sug­ges­tions that the coun­try could be­come “a new Greece”.

While there are sim­i­lar­i­ties be­tween the Ital­ian and Greek cases, the dif­fer­ences are big enough to sug­gest that in­vestors in Italy should fo­cus on a dif­fer­ent set of fac­tors.

In less than two weeks, the risk spread on 10-year Ital­ian bonds has climbed about 60 ba­sis points to around 3pc, a level not seen since 2014. This has spilled over onto the eq­uity mar­ket in Italy, and to a lesser ex­tent, else­where in Europe. It has also put pres­sure on the euro.

The im­me­di­ate trig­ger for the widen- ing risk spreads was the govern­ment’s an­nounce­ment of a bud­get deficit tar­get that ex­ceeds the EU’s guide­line. The grad­ual re­duc­tion in pur­chases of Ital­ian bonds by the Euro­pean Cen­tral Bank is also an is­sue for some in­vestors. But the deeper con­trib­u­tors to the tur­moil are the medium-term mix of high pub­lic debt, some un­steady banks and per­sis­tently slug­gish growth.

Mar­ket wor­ries have been ex­ac­er­bated by some un­help­ful pub­lic re­marks, and not just from euroscep­tic Ital­ian politi­cians such as Borghi. Euro­pean Com­mis­sion Pres­i­dent Jean-Claude Juncker told a tele­vi­sion in­ter­viewer that “we have to do ev­ery­thing to avoid a new Greece – this time an Italy – cri­sis”.

The par­al­lel with Greece of a few years ago is un­der­stand­able. The two cases share at least three im­por­tant sim­i­lar­i­ties.

On debt: a frag­ile mix of size­able pub­lic li­a­bil­i­ties rel­a­tive to GDP, lots of re­lated govern­ment bond is­suance re­sid­ing in the do­mes­tic bank­ing sys­tem and medium-term debt sus­tain­abil­ity con­cerns.

On the real econ­omy: a growth model that has re­peat­edly failed to pro­duce high

The sit­u­a­tion is bet­ter – and worse – than Syriza govern­ment faced dur­ing melt­down there, writes Mo­hamed A El-Erian

and in­clu­sive pros­per­ity.

In pol­i­tics: the emer­gence of anti-es­tab­lish­ment move­ments that do not shy away from politi­cis­ing the is­sue of the eu­ro­zone.

Yet there are also im­por­tant dif­fer­ences sug­gest­ing dif­fer­ent dy­nam­ics gov­ern­ing the ex­tent of the sys­temic threat in the two coun­tries. Unlike Greece, Italy is one of the largest economies in Europe and an orig­i­nal mem­ber of the Euro­pean eco­nomic in­te­gra­tion project.

Be­cause of its size, its gross fund­ing needs in euro terms are size­able rel­a­tive to the re­gional safety nets put in place to deal with trou­bled coun­tries. As such, a big prob­lem with Italy would con­sti­tute a much larger and more durable source of sys­temic risk, eco­nom­i­cally and fi­nan- cially. It is no ex­ag­ger­a­tion to say that, if it were to stum­ble very badly, the south­ern Euro­pean coun­try could present an ex­is­ten­tial threat for the eu­ro­zone.

But also unlike Greece, Italy doesn’t have a cur­rent ac­count deficit (it has a sur­plus) and the av­er­age du­ra­tion of its out­stand­ing debt is longer. With lower risk of fi­nan­cial de­fault in the short-term, the main de­ter­mi­nant of pos­si­ble dis­rup­tions re­sides in dis­lo­ca­tions orig­i­nat­ing from do­mes­tic and re­gional pol­i­tics. That is the most im­por­tant fac­tor for in­vestors to mon­i­tor closely.

What ul­ti­mately saved Greece’s mem­ber­ship in the eu­ro­zone a few years ago was the im­mi­nent threat of de­fault. Fear­ing a shock that would tip the econ­omy into a mul­ti­year de­pres­sion and funda- men­tally al­ter many of Greece’s re­gional eco­nomic and fi­nan­cial re­la­tion­ships, the Syriza govern­ment opted for an ortho­dox ap­proach, even though it had won both the elec­tion and the ref­er­en­dum by back­ing a po­lit­i­cal agenda that ad­vo­cated do­ing the op­po­site.

The hope of many in­vestors – as well as EU of­fi­cials, ECB of­fi­cials and sev­eral pol­icy mak­ers in Euro­pean cap­i­tals – is that the Ital­ian govern­ment will per­form a sim­i­lar pivot, even though the im­me­di­ate de­fault risk is lower.

In do­ing so, Rome would need to de­sign a more com­pre­hen­sive pro­gramme aimed at gen­er­at­ing high, in­clu­sive and sus­tain­able growth.

Mama mia!: Clau­dio Borghi, the eco­nomic head of the rul­ing League party, caused con­ster­na­tion when he said there was an ad­van­tage to hav­ing your‘own cur­rency’

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