But the fact that events were happening at the same time has also unsettled the financial markets: the interest rate differential between German and Italian government bonds, which had leveled off between 100 and 120 basis points in the summer of a year ago, shot up to 234 points at the end of last week. The spread is considered by economists to be the clinical thermometer of Italian public finances.
“What happened on Thursday was a really negative combination for Italy,” US economist Kenneth Rogoff told La Stampa newspaper. The departure of a respected and valued prime minister, coupled with a rate hike, has widened the spread – “and will affect debt development in particular”.
Italy’s debt level is currently around 150 percent of economic output. Corona has driven debt to record highs, only Greece is worse off in the euro zone.
However, Rome is of a different caliber than Athens: Italy bears around a quarter of the total debt burden in the currency area, more than 2.75 trillion euros. If the third-largest euro economy can no longer finance itself, the whole of Europe will slide into crisis. Yields on ten-year government bonds rose from 0.62 percent last summer to as much as 3.7 percent after Draghi’s resignation. “Italy has become even more vulnerable now,” says Rogoff.
New elections on September 25th
How sustainable is Italy’s debt really? What happens if interest rates continue to rise – and the country slides into recession on top of that? One thing is inevitable: a new election will take place on September 25th.
The “Brothers of Italy”, the post-fascist party of Giorgia Meloni, are ahead in the polls. The social-democratic PD, which Draghi supported to the last, comes a hair’s breadth behind.
There is already talk of a broad center alliance that will continue “in the name of Draghi”. Such an alliance is probably the only chance to prevent a right-wing government alliance.
If it is enough for Meloni in the end, there are doubts as to whether the euro critic would show a similar zeal for reform as Draghi. Italy must pass further reforms – otherwise no more money will flow from the EU recovery fund.
>> Read here: Hello Mario! Bye reforms? What will change in Italy without Draghi
The country will receive 40 billion euros per year from the Brussels corona pot until 2026. Without the funds, growth, which has already been weakened by the war in Ukraine and the energy crisis, could slow down further.
If Putin stops the gas, Italy will slip into recession
The Banca d’Italia has recently increased its expectations for the current year: the economy is expected to grow by 3.2 percent in 2022. But for the coming year, the forecast has been revised downwards: to just 1.3 percent. If Russian gas supplies were threatened to stop, Italy would slide into recession.
Yields on ten-year government bonds rose from 0.62 percent last summer to as much as 3.7 percent after Draghi’s resignation.
(Photo: Reuters)
In their annual report for 2021, the German economists calculated scenarios of an interest rate increase for several EU countries. They looked at how an increase in interest rates by one, two or three percentage points would affect interest expenditure in relation to economic output. The result: the consequences would be manageable because the countries have reduced their interest payments and borrowed more over the longer term.
If interest rates rose by three percentage points, interest payments in Italy would increase from three to 3.8 percent of gross domestic product (GDP) by 2026.
Even in the worst of scenarios, debt service would still be well below the levels seen in the euro crisis ten years ago. In 2012, Italy still had to raise five percent of GDP to service its liabilities.
In 1997, debt service even exceeded 10 percent of GDP. However, the economists assumed stable debt ratios in their report – that could look different in the event of a recession.
Italy has made good use of the low interest rates
“I don’t see any acute threat to the sustainability of Italy’s national debt,” economist Christian Kopf told Handelsblatt. Despite rising debt ratios, government debt service has fallen to a historically low level. “It will remain there for the time being, even if yields on the primary market rise, because only one eighth of the government bonds in circulation have to be replaced every year,” calculates Kopf, who heads the bond portfolio management at Union Investment.
If Italy slips into the financial crisis, the country pulls the whole of Europe with it.
(Photo: imago/Christian Ohde)
The average maturity of Italy’s government bonds is more than seven years. At the beginning of the nineties it was still between two and three years. In the recent past in particular, Italy has stocked up on longer-term bonds – and thus benefited from the low interest rate level in the euro area. Debt service has recently been reduced enormously.
In addition, Kopf is convinced that the debt ratio in relation to GDP will “probably stagnate or fall even with higher market yields and weak real growth” due to the higher inflation.
Even if the era of cheap money is now over, Italy will only need a small primary surplus in the national budget in the medium term to keep national debt in check.
Kopf does not see a major risk of contagion for the rest of the euro zone. “We don’t have a euro zone crisis, but at most a problem in Italy – and that’s homemade.”
Overall, public finances in the euro area are “significantly more robust” than they were ten years ago. The ECB should therefore not be dissuaded from adjusting the key interest rate due to the Italian national debt.
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