Italy budget debacle puts Europe back in global spotlight

As the eurozone sovereign debt crisis petered out, European officials at annual meetings of the International Monetary Fund were happy to move out of the spotlight over recent years. Europe was not in the eye of the storm. Until now.

The IMF’s annual meetings, normally held in Washington, this year is taking place on the Indonesian resort island of Bali, where a magnitude six earthquake welcomed the world’s 20 top finance ministers on the eve of their talks.

But the tremor, which awoke many of the 10,000 officials from all over he world around 3 o’clock in the morning on Thursday, turned out to be less of a conversation topic than a new menace to Europe’s financial stability — Italy.

“If you talk to serious people here, everybody talks about Italy,” one European official said.

Investors and bank analysts at meetings with European decision-makers were mainly interested in Italy and how the eurozone could deal with it, officials said. “The main topics at the meetings here are the trade war between the US and China and Italy,” a second European participant said.

“On Italy, people ask us what is likely to happen and how we are going to deal with it. They are alarmed but not in panic.” Italy’s new, populist government wants to increase borrowing over the next three years to make good on election promises of higher spending and lower taxes.

But with a debt pile of 133% of GDP, the second highest in Europe after Greece, and relatively slow growth, Rome can hardly afford such luxuries.

Markets also fret that Italian banks, saddled with bad loans, and a massive amount of Italian government bonds, could face crippling losses if debt prices keep tumbling.

Financial markets reacted to the Rome’s plans with a sharp sell-off of Italian bonds — three-year yields rose to five year highs at an auction on Thursday and the benchmark 10-year paper traded at 4-1/2-year highs. The higher deficit also blatantly breaks European Union budget rules, enforced by the European Commission, putting Rome on a collision course with EU institutions once it sends the draft budget for EU checks on Monday.

Many officials are privately concerned about the possibility of Italy sparking another sovereign debt crisis like the one triggered by Greece in 2010 that nearly destroyed the eurozone. Only Italy’s economy is almost 10 times bigger than Greece’s.

But some also caution against doomsday scenarios. “Here in Bali, something is happening that I have seen in IMF meetings again and again.