Italy’s debt burden was a very noteworthy concern (and still is) for the euro zone, this time last year. The reason being that Italy is one of the largest economies in the euro zone, and were the country to default on its debt, the ECB could not simply step in to the rescue. Potentially, this could be a trigger for a deep recession.
Up until recently, this threat has not been spoken about as often. However, concerns on this issue appear to be breaking the surface.
Italy versus Europe
The European Union has threatened sanctions against Italy due to its public debt being currently twice the EU limit, and still rising.
More specifically, the current populist government in Italy is highly aware that a default by the country would mark one of the biggest in history. Hence, the government is arguing that the ECB would not allow matters to get to this point – and eventually offer concessions to Italy if it meant dodging a default.
If this little game intensifies between the ECB and Italy, then the change in investor sentiment alone could be enough to do substantial damage. By just considering the premium that investors are demanding to hold on to Italian 10-year debt in comparison to the German 10-year debt, one can see a rise of 2.20 percentage points between the two. This already is an indication that investor sentiment has changed about Italy.
Regardless of if Italy does actually default or not, the increasing observation by the markets that the possibility exists could mean that it becomes increasingly difficult for Italy to continue to finance itself through taking on more debt as investors will simply be less willing to lend.
The Euro
Furthermore, the euro itself has not had the easiest time lately. Roughly, since 2018, the currency has been on a straight downward track against the U.S Dollar.
That being said, Italy is a country that has historically relied on currency devaluations to keep itself competitive – the case when the Italian lira was in circulation. Technically speaking, Italy has always relied heavily on debt to grow its economy, and what is being seen is not a particularly new incidence.
However, in spite of the weakness of the euro, Italy has no longer had the luxury of devaluing currency in order to stimulate growth. In fact, when one considers the growth in government debt versus GDP, it is easy to see that this has continued to accelerate massively after 2006.
At this point, Italy could argue that it would be to the country’s advantage to leave the euro and reintroduce its own currency as a way to pay its debts and reintroduced as a domestic currency. In fact, this speculation is already being heard by Deputy Prime Minister, Salvini.
Forward Looking
At the moment, what matters most is not whether Italy would do the unthinkable and leave the euro – rather, whether investors consider this as a significant likelihood.
Either way, the matter of Italian debt has resurfaced to the vanguard and economic growth could moderate from here should global risk appetite decline significantly as a result of Italy. If this is the case, then it is possible for markets to see further demand for risk-off assets.
This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.