The debt situation in Italy
Developments in the markets for Italian bonds and their derivatives, triggered among other things by a dispute between Silvio Berlusconi and finance minister Guilio Tremonti about an emergency budget, are raising concerns about the sustainability of Italy’s debt. On Friday 8 July, the prices of Italian government bonds started to decrease, and the spread vis-à-vis the German bond yield gradually climbed to 3.3% (18 July) from 1.85% at the start of the month. The situation improved little even after the swift approval (in three days) of an austerity package intended to save EUR 48 billion by 2014. Bond yields started to fall only in the week starting 18 July, thanks to the prospect of a potential solution to the Greek debt crisis. The insolvency of the third-largest euro area economy and the third-largest bond issuer in the world would have a negative impact on the functioning of the global economy. This box discusses to what extent the reaction of investors was justified and to what extent the economic situation in Italy resembles that in Greece.
Chart 1 (Box) Italy's public finance
Government debt stands at 120% of GDP, but Italy is capable of having primary budget surpluses
(% of GDP; source: ECB)
Italy is the second most indebted country in Europe behind Greece in relative terms, with debt of almost 120% of GDP (see Chart 1). Its debt of EUR 1.8 billion even makes it the most indebted country in Europe and represents roughly one-quarter of government debt in the euro area. Currently, Italy has no problems repaying its debt. Its long-term debt rating is A+ from S&P and AA2 from Moody’s, with a negative outlook in both cases. Historically, Italy has been able to reduce its debt both by increasing taxes and by reducing expenditures, and primarily thanks to EMU entry. Its budget had a primary surplus in the pre-crisis years (see Chart 1) and returned there in 2011 Q1. Households have a high saving rate and almost 60% of bonds are held by residents. All five Italian banks tested passed the EBA stress tests.
Chart 2 (Box) GDP growth in Italy
Economic growth has long been sluggish
(annual percentage changes; source: ECB)
Despite all these facts, future developments in Italy are raising concerns among investors. The economy is export-oriented with low domestic demand, a feature it shares with Germany. Unlike Germany, however, its exports are still oriented towards the “old”, indebted and weakly growing EU countries. Consequently, the structure of its economy combined with its ageing population does not offer good growth prospects. Chart 2 shows that economic growth has long been very sluggish. Real GDP is currently even lower than in 2000.
Chart 3 (Box) Costs and productivity of labour
Labour costs have outpaced labour productivity in recent years
(index of unit labour productivity and unit labour costs; year 2005 = 100; source: OECD)
The solution to the current crisis is to convince the markets that Italy is willing to take debt-reducing measures. However, drastic cuts may slow economic growth, which has long been low. The key task is to enhance competitiveness, which was adversely affected in the past by faster growth in labour costs than in productivity (see Chart 3). Another task is to increase the efficiency of the state (the government redistributes 51% of annual GDP), the business environment and the judicial system. Tax collection efficiency is also important – it is estimated that the government loses hundreds of billions of euros every year due to tax evasion.
Italy still has the time needed for the reforms to start working; the mean maturity of its debt was around seven years at the end of June (although 11% of the debt is supposed to be repaid this year). However, the weak government and the possible deferral of reforms due to the 2013 election are risks. The probability of further ECB rate hikes is also an unfavourable factor.
European Banking Authority