Draghi’s turmoil reignites fears over Italy’s debt crisis

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1. In a major 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.

2. 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.

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3. News that the ECB was planning a tool to tackle soaring borrowing costs in the euro zone temporarily lowered it, but it rose again on Thursday when Italian Prime Minister Mario Draghi tendered his resignation.

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4. President Sergio Mattarella refused to accept Draghi’s resignation and sent the prime minister back to parliament this week.

5. What does Italy look like? Even without the political crisis, Italy is at risk because of “the size of its debt, its low growth rate and its heavy dependence on Russian gas”, Gilles Moec, chief economist of the AXA group.

6. Italy is saddled with a massive debt of more than 2.7 trillion euros ($2.7 trillion), or about 150% of GDP, the highest in the euro zone after Greece, although the debt ratio /GDP begins to decline.

seven. The country has long lagged behind other eurozone countries: between 1999 and 2019, the economy only grew by 7.9%, compared to 30.2% in Germany, 32.4% in France and 43.6% in Spain.

8. Italy’s gross domestic product increased by 6.6% in 2021, after a decline in 2020 due to the coronavirus pandemic.

9. The Bank of Italy expects GDP to grow by 3.2% in 2022, but this figure could fall below 1.0% if Russian gas supplies are cut off by the war in Ukraine.

ten. Enters into political crisis Italy has the European recovery plan to revive growth. It is the biggest beneficiary, receiving 191.5 billion euros ($193 billion) if it meets a series of reforms demanded by the EU.

11. However, Draghi’s departure would jeopardize these reforms. And with its grand coalition in disarray, chances are the country is heading for a snap election after the summer.

12. After “Super Mario” became prime minister in February 2021, the 10-year loan rate fell below 0.5%.

13. It has now risen to 3.4%.

14. “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.

15. A populist or far-right victory at the polls would weigh heavily on the spread, just as it did in 2018, when Matteo Salvini’s Anti-Immigrant League teamed up with the former anti-establishment Five Star Movement.

16. The ECB to the rescue Moec stresses that “it was the pressure on Italy that convinced the ECB to provide” a tool to limit the differences in the cost of borrowing faced by the most fragile members of the monetary club .

17. The aim is to thwart speculation and prevent the return of the debt crisis that rocked the euro zone in 2012.

18. Unicredit chief economist Erik Nielsen said the sudden rate hike in June when the ECB halted monetary support was pure speculation, “not reflecting a genuine insolvency problem”.

19. “Italy is seen as the most vulnerable country, so it’s the one we’re speculating against.”

20. But a far-right government in Italy would complicate matters: the so-called “frugal” countries of northern Europe in particular are not interested in ECB support for Eurosceptic countries.

21. Back to the crisis of 2012? Will rising interest rates derail public finances? “No, because interest rates would have to rise very sharply and sustainably for us to start seeing solvency problems,” Natixis economist Jesús Castillo told AFP.

22. Especially since Italian bonds have an average duration of more than seven years, which means that the rise in rates will not immediately affect the debt.

23. Moreover, the banks are in better shape than in 2012.

24. “Economic fundamentals remain consistent with long-term debt sustainability,” Castillo said.

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