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Europe’s Debt Crisis Arrives in Italy

Will Italy become the next European country to need help managing its debts?

by
Soeren Kern

Bio

July 16, 2011 - 12:00 am
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Fears are spreading that Italy may soon have to follow Greece, Ireland, and Portugal and seek a financial bailout from the European Union and the International Monetary Fund. Doubts over the sustainability of Italy’s explosive cocktail of high debt and low growth have led to violent routs that saw Italian stocks plunge and bond yields soar in recent days.

Italy is the seventh-largest economy in the world and the third-largest economy in the euro zone (the group of countries which use the euro as their common currency). It is also the third-most indebted country in the world after the United States and Japan. In its European context, Italy’s mountain of debt is more than that of all the other so-called PIGS (Portugal, Ireland, Greece, and Spain) group of financially troubled countries combined.

Given the massive size of the Italian economy, many analysts believe that Italy (like Spain) is too big to be rescued and that a full-blown debt crisis in the country could lead to the collapse of Europe’s single currency.

Confidence in Italy began to erode after Moody’s Investors Service and Standard & Poor’s announced in recent weeks that they are reviewing the country’s sovereign credit rating. The review for a possible downgrade of Italy’s rating comes amid stalled economic growth that will complicate any efforts to reduce the country’s debt load, and political infighting in Rome over budget cuts required to prevent government borrowing costs from spiraling to unaffordable levels.

There is no quick fix for the two most immediate problems ailing Italy: the country’s towering national debt and extremely poor prospects for economic growth.

At 120 percent of GDP, Italy’s debt is the EU’s second-largest by that measure after Greece, which has a debt-to-GDP ratio of 150 percent. Italy’s €1.8 trillion ($2.5 trillion) debt, which is equal to the country’s national income, poses an unsustainable economic burden that will push Italy into the abyss if the government’s debt servicing costs keep rising.

The main measure of Italy’s borrowing cost broke above 6 percent for the first time in 14 years before easing back slightly on July 12. If the yields on its 10-year bonds reach the dreaded 7 percent threshold — the level that most economists would regard as the benchmark rate above which a euro zone country’s long-term borrowing costs become unsustainable — Italy would be on the path to default. Greece, Ireland, and Portugal all sought international assistance after their 10-year yields rose past 7 percent.

The surge in Italy’s bond yields will increase the government’s debt financing costs to about €75 billion in 2011, or almost 5 percent of GDP. That figure is expected to rise to €85 billion by 2014. Economists estimate that if the average interest rate on Italy’s debt rises to 6 percent over that period rather than the 5 percent forecast, financing costs will jump by another €35 billion. Average financing costs of 5.5 percent means Italy would need a primary surplus of at least 3 percent to stabilize debt at around 120 percent of GDP.

In a bid to calm investor anxiety and help bring down debt servicing costs, Prime Minister Silvio Berlusconi announced a four-year, €40 billion ($56 billion) austerity package to close the gap between spending and revenue. “Without balancing the budget, our debt, which is a monster that comes from our past, would devour the entire country,” Finance Minister Giulio Tremonti said.

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