Italy is mathematically beyond point of no return, says Barclays
Moneylife Digital Team 09 November 2011

For the Italian economy, growth and austerity are not enough to offset cost of debt.

Italian Prime Minister Silvio Berlusconi has pledged to resign in the wake of a crisis in the Italian economy. But analysts from Barclays say that the economy is mathematically beyond point of return. The danger lies in the fact that high rates reinforce stability concerns, leading to higher rates leading to a deeper conviction of a self sustaining credit event and eventual default. Time has run out for the economy and policy reforms are not sufficient to break negative market dynamics. Domestic investors do not have the patience to wait for austerity and growth to work. The rate of change in negative factors is not enough to offset the slow drip of positive factors.

Barclays reasons that ECB (Eurpean Central Bank) needs to step up to the plate, print and buy bonds. At the moment, ECB is unwilling to be the lender of last resort on the scale needed. But this will be a compulsion forced by the market given massive systemic risk. Yields on bonds above 5.5% lead to an inflection point, after which only the ECB has control. Imminent bankruptcy of his country is what is forcing the hand of the prime minister to pledge to step down.

Italy’s bond yields have risen dramatically in the last month — yields on 10-year bonds have shot up from 5.6% to 6.7%. The main hope of the markets now appears to be that a technocratic government will come in to push through the kind of hard structural reforms that Italy needs. “Italy faces a liquidity crisis, not a solvency crisis” is what patriotic Italians say but it is insufficient to go forward on this simple analysis.

According to MarketWatch, Italian government debt has been relatively stable since it joined the euro, although at a very high level. Its total stock of outstanding government debt is 129% of gross domestic product today, compared with 126% back in 2000. Government spending has been fairly disciplined since it joined the euro. This year, the budget deficit is forecast to come in at only around 3.6% of GDP, which is modest by current global standards. The forecast is for a surplus by 2014. The soaring cost of Italy’s debts might derail those projections. The silver lining is in the fact that much of the north of Italy is as rich as anywhere in Europe — the North-West and North-East regions are at 126% and 124% of EU’s (European Union) average GDP per capita, for example, which makes both of them richer than France or Germany as a whole, and richer than countries we think of as fairly successful, such as Denmark.

Further, Italy has stopped growing. It has been through four recessions since it joined the euro in 1999. GDP will actually contract over the the next 10 years. This is going to make it a lot harder to pay off all the debt. It is not solvent with 1.9 trillion euros of debt outstanding.

Financial markets in Europe were closed when Berlusconi said he intended to quit, but on Wall Street shares rose after the announcement. Earlier, the interest rate on 10-year Italian bonds had edged closer to the danger level of 7% as uncertainty about Berlusconi's political future rattled investors. In Tuesday's vote to approve last year's public accounts, Berlusconi's rightwing coalition won the support of only 308 of the 630 members of the chamber. He will be hoping to persuade the president to call new elections in which Berlusconi could again play a role.

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