Italy’s Giorgia Meloni is facing growing challenges as her latest budget raises concerns about the country’s financial stability. Economists warned that the loosened fiscal policy would lead to trouble, and it seems their predictions are coming true. Risk spreads on Italian 10-year bonds have spiked, borrowing costs have hit 5%, and debt interest is rising faster than nominal GDP. Italy’s debt ratio is already at 140% of GDP, and if bond yields continue to rise, the country could face a sovereign debt crisis.
Italy must roll over old debt and finance new debt equal to 24% of GDP over the next year, a task that no other eurozone state is facing. The country’s vulnerable position has led to Moody’s cutting Italian debt to just one notch above junk, and JP Morgan predicts that Standard & Poor’s will follow suit. Fitch has also warned of a “significant loosening” in fiscal policy, potentially leading to another downgrade.
The consequences of these downgrades would be significant, especially as Greece and Portugal are improving their credit ratings. Lower ratings would affect the collateral used by banks, particularly Italian lenders who hold a significant amount of government bonds. European banks as a whole hold €3.7 trillion of these portfolios, which are already under significant pressure. Rising yields would increase losses for these banks, potentially leading to a snowball effect.
The European Central Bank’s (ECB) collateral framework exacerbates these risks. The ECB does not accept the debt of its own country without question, leading to increased volatility in the bond market. A small downgrade in credit rating can result in higher haircuts and potentially trigger a sovereign debt crisis. This lack of a unified EU treasury or debt union puts additional pressure on individual countries, as northern creditors are unwilling to bail out southern debtors.
Italy’s economy is also struggling to find growth. Despite achieving a current account surplus and having greater private wealth per capita than Germany, Italy has experienced stagnant economic growth for a quarter of a century. The country is now back in recession, and previous measures such as the EU’s recovery fund and tax credits for home improvement have failed to provide sustained economic improvement.
Giorgia Meloni’s hard-right coalition government has also made unforced errors, including a failed tax raid on bank profits and a series of protectionist measures. These actions have raised political risk and created a negative perception of Italy’s economic policies.
Despite these challenges, Italy can likely rely on the ECB to step in and prevent a full-blown crisis. The central bank has the ability to cap yields and relax collateral rules. However, the conditions for invoking these measures are strict, and Meloni’s non-compliant budget may not meet the criteria.
Ultimately, the European Union will do what it takes to save Italy, as the collapse of the country and its exit from the eurozone would be detrimental to the entire European project. However, the ongoing tug-of-war between debtor and creditor blocs within the EU complicates the decision-making process and may lead to delayed action.
Italy’s financial future hangs in the balance as it navigates the challenges of its budget and mounting debt. The country’s stability and the actions of the ECB will be closely watched in the coming months.
More detail via Yahoo News here… ( Image via Yahoo News )