Unless the current approach of the European Commission towards Italy’s debt problem is stimulated by a higher degree of cooperation, the re-occurrence of yet another Eurozone sovereign debt crisis seems to be inevitable.

The persistent deteriorating situation relating to Italy’s fiscal and political necessity is giving rise to additional market uncertainty and instability. Of note; rising bond yields, a decline in growth together with an eventual recession are the main drivers which are said to greatly contribute towards Italy’s weakening fiscal policy.

At present, the only factor which is preventing an additional hike in bond yields is the presumption among investors that the European Central Bank will put in place all the necessary implementations, guaranteeing Italy’s access to international markets.

Multiple attempts to rectify Italy’s situation through the simultaneous implementation of a restrictive fiscal policy together with strict structural reforms that promote growth, have both been deemed to be ineffective. While countries such as Spain, France and Germany have witnessed an economic growth of 40 per cent and 30 per cent respectively over the past two decades, Italy’s economy has only grown by 7 per cent.

Apart from the growth in debt, the continuous spending cuts which have resultantly lowered the standard of living, have radicalised the Italian electorate. This serves as a clear indication that Italy is stagnating. As it is not viable to implement any modification procedures in an environment which is filled with austerity, any reform efforts have stalled.

Although some may argue that the way forward is to loosen Italy’s deficit constraints, such procedure is regarded to only provide a short-term growth boost. Increased deficits will ultimately result into higher debt, pushing up bond yields and further increasing deficits. Similarly, the imposition of higher tax burdens on income to finance additional expenditure is also regarded to weaken growth rates and further alienate the electorate.

Taking into consideration the country’s current circumstances, a viable option would be to reduce Italy’s debt service payments. The latter would enable Italy to focus their spending on modernising its economy without further increasing the level of deficit and debt.

The practice of additional spending on infrastructure while ensuring the implantation of all the necessary reform procedures, will ultimately enhance Italy’s growth rates. Such procedure may also be regarded to be beneficial in the longer term, as it will improve Italy’s ability to service debt in the future.

As it is understandable that private investors will not voluntarily agree upon postponing the debt service payments, the European Stability Mechanism (ESM) will need to get involved in order to repurchase a portion of the high-cost debt. Once Italy will start to achieve improved and higher productivity and growth, the loan repayment granted by the ESM may commence.

According to David Folkerts-Landau, who is a chief economist at Deutsche Bank, the ability to decrease Italy’s service payments by half, or by two percentage points of the gross domestic product, would result into a rise in public expenditure of roughly €35bn per annum.

In a robust attempt to continue to rectify Italy’s situation, it would be ideal for the European Central Bank to implement its monetary powers and decrease yields back to pre-crisis levels.

As an Italian debt crisis will pose a significant threat to the Eurozone, Italy has to accept that improvements in growth is not possible without the implementation of structural reforms. Likewise, Europe should acknowledge that the solution towards Italy’s debt problem is not outright austerity. Most importantly, emphasis should be mainly focused on the dangers inherent in any financial crisis.

This article was issued by Andrew Fenech, research analyst at Calamatta Cuschieri. For more information visit, www.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.

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