MNI INTERVIEW: Italy Debt Still Buoyed By "Whatever It Takes"

Italy’s financing costs are likely to rise as growth falls short of over-optimistic government forecasts, a former economic advisor during the prime ministership of Mario Draghi told MNI, adding that memories of the ECB’s “whatever it takes” rescue of Italian debt during the 2012 crisis had restrained selling of the country's bonds so far.

Prime Minister Giorgia Meloni’s spending plans are based on a growth forecast of 1.2% in 2024, almost "twice the 0.7% of the international consensus," said Francesco Giavazzi, who served under Draghi from 2021 to 2022 and is now an economics professor at Milan’s Bocconi University. For the moment, though, the country’s bond yields are restrained by market memories of the ECB’s promise to defend monetary union during the debt crisis a decade ago. (MNI: Italy Business Groups See Risk Of Recession)

"They lost a lot of money the last time they speculated against Italy," Giavazzi said.

The country’s fundamentals, however, continue to weaken, he said, with the government’s forecast for Italy’s debt-to-GDP ratio to remain practically flat over the next few years heavily reliant on sales of government assets.

"Sales of 1% of GDP is a lot," he said, adding that he saw more signs of the government’s being forced to take on more assets, such as by recapitalising Telecom Italia or steel company Ilva.

INCREASINGLY ISOLATED

Both of the key variables which determine Italy’s debt sustainability – the cost of debt and the rate of economic growth – are deteriorating, said Giavazzi. The government’s average cost of debt is rising as older, lower-yielding bonds mature and it is possible that Moody’s ratings agency could downgrade the country’s sovereign rating to junk, after having put its assessment on a negative outlook, he said.

Italy may also face a less supportive external environment, as Meloni’s initially harmonious relations with Brussels worsen and after political allies underperformed in elections in Poland and Spain.

The electoral results mean European Commission President Ursula von der Leyen will be less dependant on support from Rome when she seeks another term next May, Giavazzi noted.

Italy is also overplaying its hand by dragging out its ratification of a treaty to update the European Stability Mechanism, which has left it as the country not to do so, he said. While Meloni has signalled to Brussels that the treaty is likely to be ratified soon, Giavazzi noted that her junior coalition party League will vote against it and that the prime minister is unlikely to seek support from the centre-left opposition to pass the measure ahead of next May’s European elections. (See MNI INTERVIEW2: Italy’s ESM Ratification More Urgent - Buti)

ESM RATIFICATION

Rome is overestimating the weight of ESM ratification as it seeks to influence other negotiations, such as over the reform of the EU’s fiscal rules, especially with regards to countries such as Germany which would be unlikely to have recourse to the EU’s bailout fund, the former advisor said.

Italy has argued for looser fiscal rules, but Giavazzi said he saw little chance of a deal this year, with Germany’s Finance Minister Christian Lindner having little domestic political incentive to cede on his insistence that Europe’s Stability and Growth Pact retain strict borrowing limits.

An early end to the European Central Bank’s Pandemic Emergency Purchase Programme would also create additional difficulties for the Italian debt, without being enough to cause a crisis on its own, he said, adding that the ECB could also hike rates again if Middle East instability pushes up energy prices.