So, has the storm passed or will the bond traders/locusts return to Italy in search of more blood and bone marrow? In the wake of three turbulent days of market trading last weekend and early this week, can Italians (and the rest of Europe) now breathe easy? For the time being, the answer seems to be yes, but this was a week when Italy got a serious fright.
One could argue that it was only ever a matter of time before Italy, the euro zone’s third-largest economy, came under attack. After all, the Italian economy can boast an unenviable set of figures seemingly purpose-designed to attract the attention of market speculation.
The Italian economy has a growth rate that hovers perilously close to zero (and has had for most of the last 20 years), which clearly undermines competitiveness. Youth unemployment is at 30 per cent, while the national debt (€1.6 trillion) represents approximately 120 per cent of GDP.
One commentator this week calculated that Italian national debt represents 25 per cent of the GDP of the entire euro zone.
On top of that, according to some estimates corruption costs Italy €70 billion per year, the price of tax evasion is believed to be close to €130 billion, while the damage done by organised crime may be as high as €150 billion.
In its 2008 SOS report, the Italian retailers’ confederation Confesercenti claimed that, with an annual turnover of €130 billion, Italy’s various mafias account for 6 per cent of GDP. Provocatively, Confesercenti claimed that organised crime was Italy’s number one business.
If some of the economic data does not look good, what about the credibility of the governing classes? Not only is embattled prime minister Silvio Berlusconi again involved in a series of court cases, but recent electoral setbacks have heightened internal tensions.
The prime minister has been squabbling with his finance minister Giulio Tremonti, telling La Repubblicanewspaper that he is "not a team player".
Add to all of that some recent negative opinions both on Italian banks and the overall Italian economy from rating agencies, Moody’s and Standard Poor’s, and you have a recipe for get-stuck-in-there speculation.
Yet, when asked about Italy, economic commentators traditionally make a series of reassuring noises. For a start, they point out that the vast majority of Italian debt is held by Italians (and their banks) and not by foreign creditors. For a second, private debt is traditionally low (no sub-prime crisis here).
Cautious Italian banks cannily avoided all the South Sea bubble investment frenzy that marked the pre-2008 worldwide crash.
In addition, unlike Greece, Italy in recent years has begun to rein in its annual deficit.
Finally, and most tellingly of all, Italy is simply too big to go to the wall. Not only is it the euro zone’s third-largest economy and therefore no one could afford to bail it out, but it is also home to the world’s third-largest, mainly internally financed, bond market.
So the storm has passed and we are now safe?
That, obviously, remains to be seen but, ironically, the ill wind that blew through Italy last weekend may have done some good.
The spectre of heavy stock market losses plus the record highs touched by Italian government bonds (the infamous “spread” compared to German bonds) did manage to send a very strong, short and sharp shock, especially through the political classes.
For a start, the opposition and government agreed to fast-track Tremonti’s four-year, €40 billion-plus austerity package through parliament, starting as of yesterday morning. And, despite obvious tensions and the involvement of Tremonti’s closest adviser, Marco Milanese, in yet another squalid scandal (one that features Bentleys, Ferraris and the payment of the rent on the minister’s central Rome apartment), Tremonti is still in the saddle.
This may not be a reason for joy among government critics but the market reality is that analysts have for sometime acknowledged that Tremonti represents the only safe pair of hands on the Italian tiller. That consideration was emphatically underlined last Tuesday. From the moment that Tremonti announced in Brussels that he was returning to Rome to “wrap up the budget”, the pressure on Italy was off and the record high bond spread receded.
That turnaround was helped by at least two other factors. Firstly, there was the Tuesday announcement from Senate speaker Renato Schifani that, with the agreement of the opposition, the budget was destined for a swift passage through parliament.
Secondly, there was the patient, behind-the-scenes guidance of state president Giorgio Napolitano who, in the apparent absence of prime minister Berlusconi, conducted a series of telephone contacts with both Tremonti and leading opposition and government figures.
And there, of course, is the very familiar rub. Where was the prime minister? As the tempest raged, he went missing, reneging on a series of planned public engagements including a visit to the boat people island of Lampedusa, a telephone phone-in at a Sunday meeting of his People Of Freedom party and the marriage of cabinet minister Renato Brunetta.
So profound was the prime minister’s Hamletian mood that he even failed to show up for one of his favourite moments of the year, last Tuesday’s pre-season get together of his AC Milan football team.
It is true that, on Tuesday afternoon, a note issued from government house pointing out how the speculative storm underlined all the more clearly the need to strengthen the current budget package. Reports suggest, however, that this note came from the pen of cabinet under-secretary Gianni Letta rather than directly from the prime minister.
Privately, the prime minister argued that the crisis had much more to do with the euro zone’s debt crisis and resultant international speculation than with any apparent government instability or incompetence.
Economic commentators, for their part, argue that, while Tremonti remains in the saddle, reservations about Berlusconi are irrelevant. The markets seem to trust Tremonti.
What matters now, though, is that the austerity package is swiftly approved and without any of the last-minute improvisations that two weeks ago saw the addition (and subsequent withdrawal) of a “Save Fininvest” measure that seemed suspiciously, purpose-designed to help the Berlusconi holding company avoid paying a €560 million fine. Only when the austerity package is through, can we breathe easy again. Any hiccups and this could be a very long, very hot Italian summer.
ITALIAN BOND SALES: RECORD INTEREST RATES PAID
ITALY RAISED nearly € 3 billion from bond sales yesterday but was forced to pay record interest rates in a make-or-break government debt auction that was seen as a key test of investor confidence in the euro zone.
The auction was seen as crucial for the zone after a turbulent week that has sucked Italy into the euro debt crisis amid concerns about its high levels of debt.
The sale came as Italy’s parliament prepares to vote on a € 40 billion austerity package to eliminate the budget deficit by 2014. Opposition parties have said they will co-operate with prime minister Silvio Berlusconi to ensure the package of cuts passes through parliament in record speed with a final vote in the lower house today. Senators voted 161 to 135 in favour of the package.
Assessing the budget, ratings agency Fitch said the government was likely to succeed in reducing the deficit as planned and, “in the absence of negative shocks”, would preserve its current sovereign credit rating.
The € 1.72 billion sale of 15-year bonds was nearly 1.5 times subscribed, indicating there was still appetite for the country’s debt, but the 5.9 per cent yield was the highest on record.
In the benchmark five-year maturity, Rome had to pay yields of 4.93 per cent – the highest in three years – versus 3.9 per cent on June 14th, a sharp increase in premiums that highlights the dangers for the euro zone’s biggest government bond market.
The € 1.25 billion five-year bond sale was nearly two times subscribed. The fact Rome had to pay high premiums to attract demand is a sign euro-zone woes are far from over.
Gavan Nolan, analyst at data provide Markit said: “The bid-to-cover ratios were relatively strong, but the yields were very high. The market seems to be focusing on the latter. The support of domestic accounts will also be crucial throughout the day. Italy’s spreads are now wider than pre-auction levels.”
Gary Jenkins, head of fixed income at Evolution Securities, said: “While it is good news that they got it done, the rising trend in yields is of some concern. Italy is not so much too big to fail as too big to bail, so it is very important that yields stabilise.”
Following the auction, yields on the benchmark 10-year Italian government bond rose 7.5 basis points to 5.64 per cent.
Italian credit default swaps rose eight basis points to 290bps, meaning the cost of insuring $10 million of debt a year for five years rose $8,000.
In the equity market, Italy’s FTSE MIB index, which had been recovering earlier in the session, fell 1.6 per cent to 18,551.44.
Italy has to refinance hundreds of billions of bonds over the next three years and higher borrowing costs or yields will put extra strains on its already sluggish economy.
– DAVID OAKLEY
