The third wave of Covid worsens public finances: towards 2.750 billion in debt. But it will be even more in the hands of the EU institutions

by Carlo Cottarelli and Giulio Gottardo

The resurgence of the epidemic, with the second and third waves, has caused a worsening of economic growth prospects for 2021 compared to the government forecasts made last September, on which the budget law was based. According to the Bank of Italy, real GDP will grow by only 3.5 per cent this year, against the 6.0 per cent forecast by the government (Table 1). Recent estimates by other institutions (OECD, IMF, EU Commission) confirm growth between 3.5 and 4.1 per cent.[1]

Table 1: Public finance indicators (2019, 2020 and 2021 estimates)
	2019	2020	2021*
Nominal GDP (bn)	1791	1652	1720
Real GDP annual change (%)	0,3	-8,9	3,5
Deficit (bn)	29	157	175
Deficit (% GDP)	1,6	9,5	10,2
Public debt (bn)	2410	2569	2745
Public debt (% of GDP)	134,6	155,6	159,6
Maturing securities (bn)	334	316	364
Funding requirement (deficit + maturing securities) (bn)	363	473	539
Financing from financial markets (bn)	361	250	287
Funding from European institutions (billion)	2	223	252
of which: ECB resources (bn)	2	206	230
of which: SURE resources (mld)	0	17	11
of which: Next Gen. EU loans (bn)	0	0	11
Coverage of requirements by the financial markets	99	53	53
Coverage of needs by European institutions	1	47	47
Holders of public debt:
ECB / Bank of Italy and other European institutions (bn)	406	573	750
Financial markets (bn)	2.004	1.997	1.995
ECB / Bank of Italy and other European institutions (% GDP)	23	35	44
Financial markets (% of GDP)	112	121	116

* estimates. Source: CPI Observatory elaborations on NADEF 2020 data, PNRR, Bank of Italy and DL Sostegni.

The worsening of the crisis and closures also had a negative impact on public finances. Even if in 2020 the deficit was below expectations (157 billion and 9.5 per cent of GDP, against forecasts between 10 and 11 per cent), the prospects for 2021 have worsened. The Budget Law provided for a deficit of 123 billion (7.0 per cent of GDP). Subsequently, in January a budget variance of 32 billion was approved, now fully used by the DL Sostegni.

To this, President Draghi has announced that a further deviation will be added, which could be in the order of 20 billion.[2] Thus, the deficit in 2021 would be 175 billion (123 + 32 + 20). Furthermore, the worsening of growth from 6.0 to 3.5 per cent could further increase the deficit-to-GDP ratio due to the resulting lower incomes. On the other hand, this ratio was about 1 percentage point lower in 2020, due to higher revenues and / or lower expenses than forecast. We hypothesize that the lower deficit in 2020 could compensate for the loss of revenue due to the ongoing slowdown. With a deficit of 175 billion, the deficit-to-GDP ratio would be 10.2 percent in 2021, a slight increase compared to 2020 (Table 1). This deficit would be approximately 50 billion and 3.2 percentage points higher than the forecasts of the Update to the 2020 Economic and Financial Document (NADEF 2020, published in September).[3]

The slowdown in growth and the increase in the deficit would also affect the level of public debt. At the end of 2020, this had reached 2,569 billion, that is 155.6 per cent of GDP, the highest level since the First World War, albeit slightly lower than forecasts. The estimates of the NADEF 2020 indicated that already in 2021 the growth of the debt-to-GDP ratio would have stopped thanks to the recovery. The mix lower growth and greater deficit would instead translate into an increase in debt to almost 2750 billion, which would correspond to 159.6 per cent of GDP (Table 1 and Fig. 1).

The good news, however, is that, as in 2020, also in 2021 the resource needs of the Italian state will be covered almost half by European institutions: out of an estimate of 539 billion between maturing securities (364 billion) and deficit (175 billion). , the European institutions would cover about 252 billion, about 47 percent. Among them, the European Central Bank (ECB) would still have the lion’s share, purchasing approximately 230 billion of government bonds, of which it can be assumed that over 70 billion will be allocated to the renewal of maturing bonds and 160 to new purchases. From the European Union, 11 billion in loans at negative rates should arrive corresponding to the last two disbursements of the SURE program and another 11 billion in loans from the NGEU (Recovery Fund) program, in addition to the 14 billion non-repayable loans that will cover expenses not included in the deficit. (Table 1).[4] Furthermore, in 2021 as in 2020, the sum of new ECB purchases (160 billion) and SURE and NGEU loans (22 billion) would cover the entire deficit (175 billion).

Thanks to the support of the European institutions, in 2021 the share of public debt held by financial markets should decrease from 120.9 to 115.6 per cent of GDP, against 112.0 at the end of 2019 (Fig. 1). Consequently, despite the overall increase in debt, Italy’s exposure to the financial markets would decrease, translating, also thanks to the expansionary monetary policy, into a lower cost of debt. Consequently, at the end of 2021 approximately 27 per cent of the Italian public debt would be held by the European institutions.