Commissioner Johannes Hahn on the left, announcing a proposal to allocate €670 million to Italy following two severe earthquakes and hundreds of aftershocks in the region of Emilia-Romagna during May/June 2012. (EC Audiovisual Services).
The large size of the Italian sovereign debt, in the region of €2 trillion and its refinancing torments now the minds of all Eurozone political leaders. The same is true for capital market investors, who showed a remarkable cold-blooded attitude yesterday, after it was certain that no single political party can formulate a viable government in Rome. The euro also lost some grounds, but this was not at all an alarming development. A cheaper euro can greatly help the Italian economy. But let’s look at the political developments.
How to form a government
The centre left coalition under Pier Luigi Bersani has managed to acquire an absolute majority in the House of Representatives, but the 310 sits of the Senate are divided between the four parties in a way that nobody has an absolute majority. In the Italian political system a government has to have a majority in both Houses.
In any case the initiative is now in the hands of Bersani who needs a government partner with enough votes in the Senate, to be added to his own 121. This has to be either Silvio Berlusconi, whose centre right coalition got 117 Senate sits or Beppe Grillo’s “5 star movement” with its 54 senators. As for the outgoing Prime Minister, Mario Monti, his centre party got only 18 Senate sits, with a quite disappointing overall performance in this election. Probably it didn’t do any good to Professor’s political party the backing he got from Brussels. Berlin had the wisdom not to openly support him.
Low alarm in markets
It goes without saying that capital market fund managers have the most pressing and vested interests for a swift conclusion of negotiations over the formation of a government in Rome. It was encouraging however to see yesterday the bond market to regain confidence after some initial highs. Despite the large losses of 4.5% in the Milan stock exchange, the yield of 10 year benchmark Italian sovereign bond increased only by 31 basic units (0.31 percentage points), meaning that investors asked only for a small increase in the risk premium they demand, to continue holding such securities.
Understandably bond investors have all the reasons of the world to expect a swift solution in the Italian political stalemate, being it a grand coalition between Bersani and Berlusconi or a minor coalition between the centre left and Beppe Grillo. In either option the stakes will be very high. The first to know the news will have the prerogative in the market. Capital markets however kept their composure yesterday, but what if the new government comes out with a programme diverging widely from Monti’s austerity policies? In such a case the selloff of the Italian bonds could take large proportions. In reality markets are much more interested in the content of a possible government programme, rather than in the names undesigning it.
What if?
Returning to the introduction of this article the fact that the Italian debt has reached the region of the €2 trillion feels like a Damocles Sword above the entire Eurozone. If Italy starts looking incapable, of taking care of its own problems by itself, the Entire Eurozone will be again in peril. In such a case there will be no other solution than an intervention by the European Central Bank in the capital markets of Italy and Spain. The ECB can use its unlimited resources, in order to keep the lending interest rates for those two countries at sustainable levels. The central bank has already stated some months ago it could undertake such action. Why not now if developments reach a risky conjuncture? The volume of the Italian debt is so huge that in an emergency, there will be no other way available to refinance it, than with the freshly printed money of ECB’s.
In such an eventuality the Eurozone will face a long period of increased inflationary pressures. Such a prospect though apart from some negative effects on nominal idle wealth, will have positive repercussions on real growth, through the weakening of the euro parities. A cheaper euro however will help everybody to export more to third countries. Italy will be the first Eurozone economy to profit from such an eventuality.
If such a prospect materialises the entire atmosphere in the Eurozone will change and the euro will return to the low region of 1.25 with the dollar or maybe lower. This will be the best news for many including the Italian exporters and the tourism business. What else the Italian and all Eurozone exporters could pray for?
It’s really simple – historically the Italians/Greeks/Spanish/Portuguese gently devalued their way through life to make the numbers add up. The €uro has put screeching brakes on that overnight for them, and ever since they joined, the head of steam has been building up. Sadly there is no other fix for those individual countries except…….
The wishful thinking of “we will converge in future, so let’s pretend it has already been achieved” is politicians coblas driven by their selfish personal agendas, and it has cost those four deluded countries very dear.