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Italy's Debt Is Less Terrifying Than It Looks

Marcus Ashworth
·3-min read

(Bloomberg Opinion) -- The economic fallout for Italy from Covid-19 is going to hammer its already precarious government finances. The country’s 1.7 trillion-euro ($1.9 trillion) debt mountain is the largest in Europe, and there will no doubt be a substantial jump in its ratio of debt to gross domestic product from 135% to beyond 150%.

Nevertheless, Rome’s ability to manage its borrowings may not be affected much at all. The numbers will be bigger, yes, but it should be able to maintain the financial balancing act.

Italy has always benefited from an elevated level of household savings, with plenty of retail investors putting their money into relatively high-yielding domestic government debt; Italian banks are big holders too.

These factors alone wouldn’t be enough to prevent a repeat of the market exodus that battered Italian bonds in May 2018, when the populist coalition of the League and the Five Star Movement took power. That’s why the current Italian government is pushing so hard for a bigger European Union response, including easy terms on loans from the bloc’s rescue fund, the European Stability Mechanism.

But with the European Central Bank already doing everything it can to keep Italian borrowing costs low, the nation is capable of weathering this storm. Indeed, it still offers a more attractive yield than the rest of Europe (at least for the most liquid paper).

It helps that the fiscal restraint imposed by Brussels on Italy means the country’s budget deficit coming into this year was lower than it might have been. The country’s planned net new bond issues will still be pretty modest at below 50 billion euros.

Of course, the picture is changing rapidly with Italy’s gross debt sale total for 2020 likely to zoom from 250 billion euros to 400 billion euros, according to Imogen Bachra, a European rates strategist at NatWest Markets. But the ECB will snap up much of this through its quantitative easing programs, meaning the net requirement for sales probably won’t change much.

Italian debt made up one-third of the ECB’s asset purchases in March. And Rome could benefit from as much as 130 billion euros of additional pandemic response purchases by the euro zone’s central bank. After President Christine Lagarde’s initial miscalculation on the necessary crisis strategy, she deserves a lot of credit for turning things around.

The country’s debt balance might even improve, according to NatWest analysts, depending on how substantial the virus response package is from the EU. Including the possible help from the ESM and other bodies, and “after accounting for very significant ECB purchases, the ‘free float’ of debt that the market will have to absorb this year could be less than last year,” the analysts said.

None of this factors in the very real danger that market sentiment toward Italy could deteriorate rapidly if the coronavirus takes another ugly turn or the country’s unstable political landscape shifts adversely. The ever-increasing debt to GDP burden has to be resolved permanently at some point, and that can only come from sustained growth.

However, in the short term the monetary response has propped up Rome in its hour of need. Any signs this week that the euro zone’s finance ministers have a united response to the Covid-19 crisis might see Italy’s sovereign bonds regain their poise.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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