EU deal turns out to be a trap as Italy faces an autumn crisis and loan from the reviled ESM
Celebrations have been rudely interrupted over the EU’s €750bn (£683bn) recovery fund. Italy is already warning that the money will not come soon enough to avert an autumn liquidity squeeze.
Roberto Gualtieri, Italy’s technocrat finance minister, told leaders of the ruling coalition behind closed doors that the treasury would struggle to both cover a budget deficit near 12pc of GDP and redeem a mountain of old debts falling due over coming months.
He urged a formal request to the EU’s reviled ESM bail-out fund to unlock €36bn of immediate pandemic loans, according to Il Sole.
The warning stunned the Five Star Movement, which was still toasting what it mistakenly thought to be a triumph at the EU’s marathon summit in Brussels. Giuseppe Conte, the premier, was given a hero’s welcome in Rome. Italian treasury data show that €39bn of repayments fall due in September, a further €39bn in October, and €42bn in November. The combination of rollovers and the fiscal shock of the pandemic may push Italy’s financing costs to almost half a trillion euros this year.
“There is a massive borrowing need. Gualtieri must be looking at the figures and asking who is going to buy all this debt,” said Lorenzo Codogno, ex-chief economist at the Italian treasury and now at LC Macro.
The ESM bail-out fund is political poison for Italy, where it is seen as a
Trojan horse for a “Troika” regime and is tainted by the bitter legacy of the eurozone debt crisis. Any attempt to push it through risks splitting the Five Star movement and setting off a government crisis.
The EU Recovery Fund was not designed for immediate liquidity problems. Brussels says the first tranche of grants will not be disbursed until next June, although a small advance might be possible. Cheap loans will not be available until 2024.
Mr Codogno said foreign funds remained wary of Italian bonds at current compressed yields. The attempt to tap retail investors has “effectively failed”. The first issue of patriotic bonds worth €22bn went well in March but the second issue of BTP Futura bonds in July netted just €6bn.
The European Central Bank (ECB) is soaking up Italian debt under its “pandemic QE” programme, deviating a long way from Italy’s share of eurozone GDP. But there are political, legal, and technical limits to this fiscal absorption.
Unlike the Bank of England, the ECB is not allowed to buy bonds directly in the primary market. It is restricted to securities already trading in the secondary market.
“The Italian treasury must find a way to place the debt in the first place,” said Mr Codogno.
The ECB is navigating a treacherous course after an explosive judgment by Germany’s top court in May, which ruled that the central bank exceeded its mandate during earlier bond purchases and strayed into quasi-fiscal support for insolvent governments. Credits from the Bundesbank through the ECB’s Target2 payments nexus – mostly to the Bank of Italy – are likely to blow through €1 trillion in July and set off a media storm in Germany.
Christine Lagarde, the ECB’s president, has signalled that the bank will step up pandemic quantitative easing if necessary. But the institution’s body language does not match the rhetoric.
Hedge funds are honing in on the apparent insouciance of the ECB over deflation dangers. They have noted its schedule for rapid quantitative tightening (reverse QE) as soon as the immediate crisis is over, as well as the hawkish tone of Germany’s board member, Isabel Schnabel.
“What it all tells you is that the governing council is divided. There is going to be a big day of reckoning over this,” said one fund manager. Five Star’s adamant resistance to an ESM loan is in one sense absurd. The normal EU conditions for a loan from this bail-out fund are being waived on this occasion because of the pandemic.
By contrast, support from the new Recovery Fund comes with draconian strings attached. The instrument is a sort of EU Gosplan with unprecedented levels of centralised control from Brussels. The approvals process is a bureaucratic quagmire.
Borrowers must adhere to the surveillance machinery of the “European Semester” and meet demands laid down in their “Country Specific Recommendation”, which in Italy’s case means pension cuts, higher property taxes – and ultimately austerity when Brussels decides, not when Rome decides. The Netherlands or any of the other so-called frugals can pull an “emergency brake” and demand a freeze in payments if Italy drags its feet.
Yet fiscal transfers under the recovery fund are modest. Although Italy receives a headline €87bn over three years, this has to be set against its position as a net contributor to the EU budget. Goldman Sachs calculates that the net transfer is just €37bn, or 2pc of GDP. It amounts to around 0.7pc of GDP annually.
Five Star seems not to have understood what happened in Brussels. The sums of money are too little to make much difference given the scale of the pandemic shock. Bank of America says the package does “not move the macroeconomic needle”.
Yet the Italian government has nevertheless signed up to what amounts to a Troika enforcement mechanism. The Kanzleramt in Berlin – working in tandem with Ursula von der Leyen in Brussels – has secured what it wanted. This is why hardliners on the German Council of Economic Experts have acquiesced.
While the commission gains powers to borrow large sums on the capital markets for the first time, the summit communique states that this is a temporary facility to cope with a one-off event and should not be taken as a precedent.
The package falls short of fiscal union. There is no joint and several issuance of debt and therefore no Eurobonds. The EU’s constitutional structure reverts to the status quo ante later. Five Star has walked into a trap.
Matteo Renzi, the former premier, says “reality” will soon force the inexperienced Five Star to resile from its former pledges and accept an ESM loan as well. “In the end, the autumn crisis will be such that the bail-out fund will impose itself. Italy’s lurch into nationalism is over,” he said.
Christine Lagarde, president of the European Central Bank