Italy and Spain’s borrowing costs are at dangerous but manageable levels, and both countries must move fast to regain market confidence because the EU cannot bail them out, analysts say.
Investors are worried – Rome and Madrid have been forced to pay much higher rates on their bonds this week as Italy scrambles to form a new government and Spain sees a return of jitters before a general election on November 20.
Under intense pressure from the markets, the rate on Italian 10-year bonds – used as a reference to gauge the country’s economic health – shot up to 7.013 per cent on Tuesday, while Spain’s rose to 6.298 per cent.
While the levels are considered dangerous – because the countries risk no longer being able to borrow money on commercial markets – analysts say it is difficult to pin down at what level exactly the rates become unsustainable.
“We said 6.0 per cent, we’re now saying seven per cent. But it depends on how long it lasts,” said Jean-Francois Robin, bond strategist with Natixis bank.
Should Italian bond levels remain at seven next year, the extra cost to the country would be €7 billion – “not all that expensive” for a country which should have a primary surplus this year,” Robin said.
According to the results of a “resistance test” carried out by the Bank of Italy, the country’s colossal debt – worth around 120 per cent of gross domestic product (GDP) – would be “sustainable” even at rates of eight per cent.
In Spain, Daniel Pingarron from IG Markets brokerage house said the country “can finance itself for the moment, even if it pays a lot,” but added that a rise to seven per cent on bond rates would be a “barrier.”
Alberto Roldan, from Inverseguros brokers, said access to the markets would only become impossible “once interest rates pass seven per cent of GDP.” Italy’s stands this year at 4.8 per cent, while Spain’s is just 2.3 per cent.
“Spain can therefore hold out a bit longer,” particularly as its debt comes in at 65 per cent of GDP – almost half of Italy’s, Roldan said.
The two countries’ refinancing needs next year will be about €300 billion for Italy, and about €100 billion for Spain.
But as both suffer from anaemic growth, interest on their debt could rise, forcing them to impose harsh new budget cuts in order to meet economic targets.
This “vicious circle” can create problems in the long term.
In any case, Italy and Spain will have to act fast to regain market confidence because the European Union does not have the means to save them from a crisis.
“It is necessary to show that the country is reformed to boost growth and in Italy, Mario Monti needs to get to work,” Robin said, in reference to the technocrat appointed to lead Italy’s government through the storm.
Both Italy and Spain have the added advantage that domestic investors hold a large proportion of the debt – 58 per cent for Italy, the central bank said.
European funds pumped into Ireland, Portugal and Greece to save them from bankruptcy “cannot be used for Italy and Spain. The EU does not have the money to save them.” The idea is no more than “science fiction.” said Pingarron.
The International Monetary Fund has already doled out €44 billion worth of credit lines, but its offer to supply them to Italy was turned down, according to reports.
In order to be completely secure, Rome would need “€250 billion a year” in bailout funds which simply could not be raised, Robin said.
“The conclusion is that it would be good for the European Central Bank to keep the rate” at six per cent by buying up more debt, he said.
But that is a whole other headache as the ECB has refused to do so, arguing that it is up to politicians to manage the crisis.