Sunday 18 February 2018

Is the Italian economy too big to fail?

Q & A

Bruno Waterfield

What happened yesterday to throw Italy into crisis?

Amid concerns over the state of its economy, Italy's borrowing costs -- the yield on its benchmark 10-year bonds -- rose above 7pc.

This is seen as the tipping point at which the cost of servicing debt repayments while continuing to pay government bills becomes unsustainable.

As a result, the markets take fright and the country's borrowing costs rise even further. Once the 7pc figure is reached, it can be very difficult for a highly indebted country like Italy to escape the spiral.

When the yields on Greece's bonds hit 7pc, the country lasted just 13 days before being forced to ask for a bailout from the eurozone's rescue fund, the EFSF. Ireland tried hard but caved in after 15 days. Portugal fought valiantly but surrendered after 49 days.

Why can't the EU just bail out Italy as well?

The problem this time is that Italy is the eurozone's third largest economy. Its debt is €1.9 trillion, the equivalent of 120pc of its GDP. Greece's debt is tiny by comparison.

Many economists fear the country is simply too big to bail out. The EFSF has a pot of rescue funds of €440bn. This is only just enough to cover the cost of the loans Italy has to repay next year. Besides, the EFSF only has around €250bn of this money left after taking into account the funds that are going to be lent out to Greece, Ireland and Portugal.

The EFSF was supposed to be ready with new ways to help provide countries like Italy with up to €1trn in loans or cash to help with borrowing costs. But nothing is ready yet. Remember British PM David Cameron and the IMF telling the eurozone it had six weeks to sort it out? Well that was eight weeks ago.

The European Central Bank has trillions, why not use that?

Because the ECB is not allowed to defend the EU single currency by printing more euro for Italy or by large purchases of Italian debt.

Germany won't allow it. It is a red line for Chancellor Angela Merkel who is worried that allowing the ECB to print money could lead to 1930s-style inflation.

Her voters are also deeply hostile to paying to bail out southern Europeans who are regarded as lazy compared with thrifty, hard-working Germans.

On top of that, Ms Merkel has personally questioned the track record of the Italian government's austerity measures.

Bill Gross, the founder of PIMCO, the world's biggest bond fund, tweeted yesterday: "Only one balance sheet can save Italy, but ECB wears lederhosen, and refuses to staunch destructive debt deflation."

But surely Germany can't stand by and let the euro go down because of Italy? And what about the IMF?

It may be too late. Italy might just be too big to bail out, even for the ECB. "I do not think the ECB on its own could bring back the market to the point before Italy succumbed to contagion," said Alberto Gallo, an RBS credit analyst.

The IMF, like the EU, will also be reluctant to throw good money after bad unless a new Italian government can show it is serious about austerity measures. The markets were rattled yesterday by the leak of a secret European Commission letter that warned Italian austerity plans would "not ensure a balanced budget for 2013". "Additional measures will be needed," it noted.

Even Silvio Berlusconi's resignation has not been enough to convince lenders that Italy can get its economy back on track.

So we are in gridlock. What happens now?

Put simply, until Italy can convince investors it is serious about imposing austerity measures, then nobody will want to lend it money, and if that happens, then Italy won't be able to repay its debts -- the situation that forced Greece to the precipice.

The crisis could then spread to other countries such as Spain or even France, with serious implications for the single currency and the EU.

It seems that some kind of bailout for Italy is ultimately inevitable. The question that remains unanswered is where is the money going to come from?

Irish Independent

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