May 1, 2020 / 6:02 AM / a month ago

RPT-COLUMN-How Italy's sustainability is critical for post-pandemic debt piles: Mike Dolan

(Repeats column published late on Thursday)

By Mike Dolan

LONDON, April 30 (Reuters) - As another economic crisis heaves Italy’s debt mountain back into view, the sustainability of the country’s finances has never been more salient for increasingly indebted nations everywhere.

With governments piling on debts to bridge the sudden stop in economic activity, but central banks actively keeping the cost of new borrowing down, the question of how this all pans is central to the post-pandemic world everyone’s now trying to map out.

According to International Monetary Fund projections, government net debt as a share of national output will top 100% this year in the United States, France and Belgium, and come within a whisker of it in Spain and Brazil.

Italy, Japan, Greece and Portugal have long surpassed that threshold and will rise more.

UBS’s global measure of public debt to gross domestic product is set to vault 20 percentage points this year to 101%.

But despite persistent market jitters about outlier Italy, which has for decades struggled with tight annual budgets and paltry growth due to its large debts, the sustainability question is largely in the hands of the European Central Bank.

And that’s likely the case for other countries and their central banks too

With ECB bond-buying in full flow again to fight the pandemic, markets barely flinched this week as Fitch unexpectedly cut Italy’s sovereign credit rating to the lowest investment grade rung and fretted that even stabilisation of debt at a newly forecast 156% of GDP underlined “sustainability risks”.

But many economists dismiss that there are such risks - with the key caveat that Italy remains in the euro zone.

“The debt remains perfectly sustainable, precisely because Italy is part of the euro zone,” said Unicredit’s chief economist Erik Nielsen.

While that seems obvious - even if not a cast-iron guarantee in the fractious Italian politics of recent years - Nielsen detailed how borrowing rates were often overlooked in long-term debt sustainability calculations and low ECB interest rates and bond-buying would keep Italy’s finances affordable. “Ultimately, debt sustainability is a question of cash flow,” he said, adding the best measure to use was interest obligations relative to fiscal revenue streams, not debt-to-GDP. Last year Italy spent 7.2% of fiscal revenue on interest payments, he points out, down from an average of 8% over five years and close to what Spain and Britain paid.

Nielsen argued that even if Italy’s public debt/GDP hit 167% this year and fell back to 156% by the end of 2021, as Unicredit expects, its interest-to-revenue ratio would only nudge up to less than 9% next year at current elevated funding costs.

Ten-year Italian government bond yields were last 1.82%, about 70 basis points higher than just before Italy’s March 9 lockdown though well off the 3% peak hit 10 days later.

“I have no idea why anyone would conclude that a 9% interest/revenue ratio is unaffordable, if a 7%-8% ratio is not - but I’m open to persuasion,” he concluded. He added, for context, that Italy’s ratio was far in excess of that prior to euro membership and peaked at more than 30% in 1995.

What’s more, about 17% of Italian debt interest paid just prior to this virus shock was on bonds held by the ECB - a share likely to rise due to the latest round of support. Profit made on these bonds are returned to the national Treasuries in question, so they are effectively interest-free.

Another 50% of Italy’s overall interest bill is paid to Italian creditors anyway, thus recycled in the domestic economy.


Others agree. Former IMF chief economist Olivier Blanchard said last month: “Italian debt is sustainable. But the ECB and the eurozone have to put their money where my mouth is.”

Even though the thorny issue of joint euro zone bonds appears to be off the table, the ECB appears to have both the ability and willingness to keep stepping into the breach. It’s already abandoned limits on the national share of bonds it can buy in its new pandemic-easing programmes and even dropped credit rating as a constraint to what it accepts as collateral.

As long as the ECB can manage to behave towards Italy or other euro zone countries the same way the Bank of Japan and the U.S. Federal Reserve are acting over their national debts, then relative credit concerns should be limited - aside from a premium, however small, surrounding euro zone exit or breakup.

But is there no other cost to stacking up more debts?

Tighter government spending and primary budget balances to prevent exponential debt surges is one. Possible crowding out of private borrowing another. Both potentially weigh on growth, especially for economies needing to offset aging demographics.

Harvard economist Carmen Reinhart, who along with former IMF economist Kenneth Rogoff wrote a controversial book in 2009 outlining a potential hit to national growth when debt/GDP tops 90%, said history suggests some writedowns may now be necessary.

“What experience tells us is that you have to take an out-of-the-box approach, and think seriously about writeoffs - at the household, corporate and sovereign levels,” she told Reuters this month. “We have to be open to a greater role for the restructuring of public and private debts.”

But given the number of countries now topping 100% debt/GDP ratios, Italy’s creditors may not be the only ones concerned by talk of debt writeoffs.

by Mike Dolan, Twitter: @reutersMikeD. Graphic by Ritvik Carvalho; Editing by Pravin Char

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