Business Irish

Saturday 24 March 2018

'Irish' bailout for Italy may kill off euro

Market fears over Europe's debt crisis will only ease when all eurozone governments get their public finances back in order, writes Louise McBride

Panic about the cavernous debt in Italy and Spain -- which had been subdued somewhat in the wake of last month's emergency summit -- reawoke last week. European stock markets plunged to their lowest level in about a year. Britain's top share index, the FTSE100, tumbled to an 11-month low. Borrowing costs for Italy and Spain soared well above what they were before the second bailout was agreed for Greece 17 days ago. An intervention on the bond markets by the European Central Bank (ECB) last Thursday fell flat on its face, clearly failing to calm fears about Italy and Spain.

It now looks like it is a question of when -- rather than if -- Italy and Spain get a digout from Europe.

That digout could come before October, according to David Watts, European credit strategist with the British research firm, Credit Sights. Watts believes this will only be avoided if European leaders "can hatch another proposal to prop up the market or if investor confidence stabilises of its own accord -- which is an increasingly unlikely prospect given the backdrop of a slowing US economy".

Elisabeth Afseth, a fixed income analyst with the investment bank, Evolution Securities, also believes that Italy and Spain could need some kind of financial support from Europe soon.

"Italy and Spain may need support but in a different form

'Europe doesn't have the financial muscle to bail out Spain or Italy'

to the Greek and Irish bailouts -- because Italy and Spain are too big," said Afseth.

She is not the only one who believes that the answer to the Italian and Spanish debt woes is not a simple as an 'Irish' bailout.

"Italy and Spain, along with other spendthrift governments, need to get their finances in order pronto, and undertake painful reforms," said Ciaran O'Hagan, fixed income strategist at Societe Generale. "The ECB repeats that advice incessantly, to no avail. All other measures might help for a little while, but are just a palliative. All other measures mean someone else pays your debt or carries the can for the risk. It is obvious to me that charity is never going to work, and certainly not in a currency union of sovereign, self-interested states like the euro."

Even if Europe wanted to bail out Italy and Spain, it doesn't currently have the financial muscle to do so. The most that its current bailout fund, the European Financial Stability Facility (EFSF), can lend is €440bn.

"It has so far earmarked €17.7bn worth of that towards Ireland and €26bn to Portugal," said Watts. "A further €73bn of EFSF funds could be earmarked towards Greece's new bailout. That leaves €325bn."

Italy however has €1.6trn of debt.

The EFSF will expire in 2013 and be replaced by another EU bailout fund, the European Stability Mechanism.

The European Commission President Jose Manuel Barroso is clearly aware these EU bailout funds are woefully inadequate -- last week, he called for a rethink of the scope and size of the funds. "That's a sensible call," said Afseth. "As it stands, these rescue funds are much too small to deal with Italy and Spain."

Beefing up EU bailout funds for the sake of Italy and Spain could, however, drag other European countries down.

"Italy is the third biggest market in the world," said O'Hagan. "It's difficult to put in place a fund that will take this risk off the table, without severe repercussions elsewhere."

Willem Buiter, chief economist with Citigroup, believes the EFSF needs about €2,500bn firepower -- to become a lender of last resort for countries that are solvent but short of cash.

"The eurozone has 17 sovereigns and a central bank that cannot lend to governments because of treaty restrictions," said Buiter. "As a result, there is a black hole where the sovereign lender of last resort ought to be. This is a fundamental design flaw in the European and Monetary Union, which is now only beginning to be addressed. The EFSF needs around €2,500bn to be a credible lender of last resort for solvent but illiquid sovereigns."

Laurence Boone, head of developed Europe economics with Bank of America Merrill Lynch, described the situation in Spain and Italy as "very different from" the other periphery countries getting a bailout (that is, Ireland, Greece and Portugal). "What is needed for Italy are measures to boost growth," said Boone. "If Italy can come up with a structural reform programme that is more evenly spread over the years of fiscal adjustment, there does not seem to be a need for a European bailout in the sense of Greece, Ireland and Portugal." Boone believes the current bailout fund would be enough to handle Spain -- as long as Italy does not need a bailout.

The current European debt crisis runs a lot deeper than Spain and Italy, however.

O'Hagan believes that market fears over the European debt crisis will only abate when all governments get their public finances back in order and "significant structural reforms are undertaken". "Such measures will seriously stoke growth," he said "Unfortunately, that entails very painful costs. Western politics is not designed to allow such measures to be taken, and so quickly."

Is the eurozone up to the job?

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