Italy’s debt reliability has played a central role in the political debate of recent years. In light of the high stock of debt, which exceeded 150% of GDP during the pandemic, the reversal of monetary policy and the gradual removal of ECB coverage (which in recent years has been the main buyer of public debt Italian), Michele Morra, Portfolio Manager Moneyfarmclarifies whether or not Italy is exposed to the risk of a new financial crisis and how the upcoming elections can influence this eventuality.
How the spread effect works
“When investors begin to have doubts about a country’s ability to repay its debt, demand for government bonds decreases and the cost of debt service increases, as the government must pay a risk premium to attract investors. on government bonds issued ”explains Morra. As regards Italy, the report reads, “this premium is generally expressed through the spread between the BTP and the Bund, or the difference between what the German state pays for its ten-year bonds and what Italy pays instead”. This financial indicator has now become the “Thermometer” of perceived risk in the Eurozone and, in particular, around Italy; “Suffice it to recall when, between 2011 and 2012, speculation on the BTP rate hit the Italian system and the spread reached over 500 basis points”, points out the Moneyfarm manager.
Italy’s role as a “special watcher”
The spread is not only linked to the fundamentals of a country, but in some cases also to the perception of reliability that it transmits, based on logic that is not always linear or easy to understand. As Morra explains, “Italy has a huge public debt that needs the support of international investors: when this support, for whatever reason, falls, the spread increases, making the service of the Italian debt even more expensive and putting the country at risk of lose the ability to finance itself. When this happens, only drastic economic policy choices or central bank intervention can bring the debt back under control. The implications are obvious, since having a large debt, in a sense, it limits the country’s sovereignty and its freedom of self-determination”.
An analysis of how the spread has moved in recent years can be useful to understand what are the factors that determine its trend. If we look at the spreads of a selection of European countries with a long-term perspective, Morra points out how they are have begun to diverge since the 2008 financial crisis and then experienced a surge in the European debt crisis of 2011 and 2012.
The spread level has since returned under control. If we look in detail at the trend of the last few years, the Moneyfarm manager points out how the difference between the spreads with the other peripheral European countries virtually zeroed at the beginning of 2018. The spread of Italy was close to those of Spain and Portugal, while only Greece, engaged in a long process of recovery from the technical default of 2012, enjoyed a higher level of spread.
What happened from 2018 onwards
Starting from the 2018 elections, the report reads, “due to the difficulty of finding a homogeneous majority in Parliament and the unclear positions of the winning parties in the elections regarding the position of Italy in Europe, interest rates have significantly increased . Since the market has always demanded a premium for the purchase of Italian debtdespite the fact that our country’s position within the Euro Area and the European Union has never actually been questioned by the various governments that have succeeded one another ”.
This trajectory, explains Morra, “clearly illustrates how the spread is not simply linked to the fundamentals of a country (deficit, debt, GDP), but in some cases also to the perception of reliability that this transmits, based on logic that is not always linear or easy to understand. Another important evidence that emerges from observing these data is the fact that when perception changes, it takes a long time to fully recover confidence. In fact, by analyzing only the macro data at the base of the spread, we note how the Italian numbers are not necessarily worse than those of the other countries of the so-called Peripheral Europe”.
If, through a simple regression, one tries to calculate the implicit spread in these data, the Moneyfarm manager points out that Italy should have a less divergent level of interest rates compared to other peripheral European nations. Aware of the limited nature of this analysis, the report reads, “however, there would seem to be an imponderable and significant factorlinked to the international perception of Italy’s role, which increases rates beyond the fundamental economic data ”.
How important is politics at the international level
According to Morra, “The issue of the country’s international perception will be central in the coming months, when the ECB will gradually reduce the purchase of government bonds and when interest rates gradually begin to rise. In this context, Italy today seems to occupy the uncomfortable seat of a country “under special observation”.
Looking to the future, the elements that could generate further distrust of the country are two according to Morra. The first is the “fragmentation and uncertainty of the political framework”: The complexity of the Italian party and political system is not always understood at the international level and the clarity of the electoral programs and coalitions will certainly be a stabilizing element.
The second are the “doubts about the country’s ability to continue on the current growth trajectory”: When we talk about“ debt sustainability ”, the emphasis is always on the rigor of public accounts and never on the ability to generate growth, while the second element is at least as important as the first. In this sense, the ability to implement effective expansionary policies will be decisive.
Regardless of the outcome of the upcoming elections, Morra points out, “Italy remains financially exposed to a potential crisis, which could be triggered by a worsening of the international economic situation. In this context, the will of the ECB to provide aid to the States most in difficulty will be crucial, perhaps by putting in place ad hoc initiatives and tools. The announcement of the ICC, which took place in July, goes in this direction, even if there remains more than a few doubts about the effectiveness of this instrument, which subordinates the intervention of the Central Bank to political conditionality (compliance with parameters, enactment of reforms ), with risks of lack of clarity and predictability “.