In a big case of Italian deja vu, political unrest and the ECB’s rate hike have reignited fears of a debt crisis, with all eyes on borrowing costs once again.
When the European Central Bank cut monetary support in June, the spread – the closely watched spread between German and Italian 10-year interest rates – jumped to 245 points, the highest in two years.
News that the ECB was planning a tool to tackle high borrowing costs in the euro zone sent it down temporarily – but it rose again on Thursday when Italian Prime Minister Mario Draghi offered to resign.
President Sergio Mattarella refused to accept Draghi’s resignation, sending the prime minister back to address parliament this week.
What does Italy look like?
Even without the political crisis, Italy is threatened by “the size of its debt, its low growth rate and its heavy dependence on Russian gas”, Gilles Moec, chief economist of the AXA group, told AFP.
Italy is carrying a colossal debt of more than 2.7 trillion euros ($2.7 trillion), or some 150% of GDP – the highest in the eurozone after Greece – even as the debt-to-GDP ratio begins to decrease.
The country has long lagged behind other eurozone countries: between 1999 and 2019, the economy grew by only 7.9%, compared to 30.2% in Germany, 32.4% in France and 43.6% in Spain.
Italy’s gross domestic product grew by 6.6% in 2021, after a drop in 2020 due to the coronavirus pandemic.
The Bank of Italy expects GDP to grow by 3.2% in 2022, but this figure could fall to less than 1.0% if Russian gas supplies are cut off during the war in Ukraine.
Going into political crisis
Italy is counting on the European recovery plan to revive growth. It is the biggest beneficiary, set to receive 191.5 billion euros ($193 billion) if it ticks off a series of reforms demanded by the EU.
Draghi’s departure, however, would jeopardize these reforms. And with its grand coalition in disarray, the chances of the country heading for a snap election after the summer are high.
After “Super Mario” became prime minister in February 2021, the 10-year borrowing rate fell below 0.5%.
It has now climbed to 3.4%.
“If the Draghi government falls tomorrow, I can’t imagine what will happen to the spread,” said Franco Pavoncello, professor of political science at John Cabot University in Rome.
A far-right or populist victory in the polls would weigh heavily on the spread, just like in 2018, when Matteo Salvini’s Anti-Immigrant League teamed up with the former anti-establishment Five Star Movement.
The ECB to the rescue
Moec points out that “it was the pressure on Italy that convinced the ECB to introduce” a tool to limit the spreads in borrowing costs faced by the most fragile members of the currency club.
The aim is to counter speculation and prevent the return of the debt crisis that rocked the euro zone in 2012.
Unicredit chief economist Erik Nielsen said the sudden rate hike in June – when the ECB cut monetary support – was pure speculation, “without reflecting a genuine insolvency problem”.
“Italy is considered the most vulnerable country, so it is against him that we speculate.”
But a far-right government in Italy would complicate matters: the so-called “frugal” countries of northern Europe in particular are not in favor of the ECB supporting eurosceptic countries.
Back to the 2012 crisis?
Will rising interest rates derail public finances? “No, because interest rates would have to rise very sharply and sustainably for us to start observing solvency problems,” Natixis economist Jesus Castillo told AFP.
Especially since Italian bonds last on average more than seven years, which means that the rise in rates will not immediately affect the debt.
Moreover, the banks are in better shape than in 2012.
“Economic fundamentals remain consistent with long-term debt sustainability,” Castillo said.