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Will Italy’s new populist government cause a rerun of the Greek crisis?

Filippo Monteforte, AFP | A computer screen in Rome showing Italian debt increasing in real time, February 15 2018.

'Cut taxes while significantly increasing public spending': that is the new Italian government’s economic agenda, causing anxiety in European capitals, especially Berlin, and fear of a Greek-style crisis amongst economists.


The populist coalition of Luigio di Maio’s Five Star Movement (M5S) and Matteo Salvini’s League (formerly the Northern League), with little-known lawyer Giuseppe Conte nominated as prime minister, has caused such concern with its economic programme because of one main reason: Italian public debt stands at €2.3 billion.

If M5S and the League follow through with their policy of lowering taxes and raising public spending, the consequent rise in the Italian deficit and debt is likely to make the markets panic, according to François Ecalle, a former advisor to France’s public accounts office.

“If the creditors get scared, interest rates could rise and it could become even more expensive for Italy to service its debt,” said Ecalle, in an interview with FRANCE 24.

“Rates have already started to rise over recent days, and they could start to climb very, very steeply, like they did in 2012, at the height of the sovereign debt crisis, when Greece was on the verge of claiming bankruptcy,” Ecalle said.

The markets’ anxiety can be measured by what economists call the ‘spread’ indicator: the gap between two country’s rates. Take, for example, the difference between Italy’s rates and those of Germany, the lowest in the eurozone. The spread currently stands at 173 basis points, meaning that if Germany borrows at a 1% rate, Italy borrows at 2.73%.

So Rome’s debt costs three times more than that of Berlin. “And it can go much higher,” Ecalle warns. “In 2011, the spread exceeded 500 basis points.”

Under Germany’s thumb

The eurozone buckled but did not quite break during the 2009-2012 sovereign debt crisis. Greece was prevented from going under when the European Central Bank (ECB) started to buy vast quantities of the country’s debt, and the mere announcement of this programme was enough to calm the markets.

“When [ECB President] Mario Draghi announced that the bank would do everything in its power to save a country in trouble, it ended the crisis,” Ecalle noted.

But in order to benefit from this programme, a country needs to go through the European Stability Mechanism (ESM), which requires accepting binding conditions for cleaning up public finances. Would the new Italian government agree to submit to this?

“I’m not sure,” said Ecalle.

Nor is he sure that Germany – which, according to the ESM charter, must be consulted when countries ask for financial aid – would agree to help Italy out if it persists with what Ecalle termed “budgetary nonsense”.

“Northern European countries [the likes of Germany and the Netherlands] take the eurozone’s fiscal rules -- such as keeping budget deficits below 3% and debt-to-GDP ratios below 60% -- very seriously,” he said. “The risk is that Northern countries refuse to intervene if Rome decides not to follow the rules. The fissure between Northern and Southern Europe is growing.”

Ergo, the main risk is that the ECB could lose credibility if Germany prevents it from intervening in a crisis.

“If the markets are thinking along the same lines as me, they’ll conclude that the ESM won’t work and that there’s a new risk for the eurozone,” Ecalle commented. “That could happen with shocking speed.”

A precarious balance

Despite appearances (Italian public debt stood at 132% of the country’s GDP at the end of 2017, the second highest in the eurozone behind Greece at 179%) the country’s fiscal situation is not actually all that dangerous, according to Ecalle.

“Italy has made a lot of effort and even before the sovereign debt crisis, it had reduced its deficit quite a bit,” he said.

Consequently, Italy now has a deficit lower than that of France, at 2.3% of GDP, compared to 2.7%.

Indeed, if it were not for the cost of repaying interest on its outstanding loans, Italy would in fact have a surplus, whereas France’s deficit is structural.

“With a deficit of 2.3% and interest payments at 3.8% of GDP, Rome would actually have 1.5% to spare,” Ecalle explained.

Thus, the problem is not the deficit; it is the incoming government’s economic programme. M5S and the League have arrived at a common programme centred on ending austerity. They are not the first ones to do so: former French president François Hollande and current Greek Prime Minister Alexis Tsipras were both elected on anti-austerity platforms.

In power, they quickly U-turned.

This article was published from the original in French.

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