Ousting Silvio Berlusconi won’t make Italy’s fiscal mess any easier – with or without him, its debt is impossible, and Italy is headed for default.
Italy’s problems are fundamentally different than those of some other troubled countries, such as Greece. Like others, its social benefits are too generous, but substantially curbing those won’t bring its books into balance. It’s simply too late.
Italy’s budget deficit is 3.6 of GDP, less than half of the U.S. gap, but its total debt, amassed over many years, is 130 per cent. That’s an amount well above what economists consider manageable even for a country, such as the United States, that can print money, and it’s even worse for one, such as Italy, without its own currency.
Although the final act of the Berlusconi government was to craft austerity measures that will lower the deficit to less than 2 per cent of GDP, about €25-billion, it must borrow €300-billion – a massive 19 per cent of GDP – in private capital markets in 2012 to repay maturing debt. Italy is simply not growing fast enough in a Europe crippled by crises in Ireland, Greece, Spain and Portugal for private investors to take that bet.
If Italy’s nominal GDP were growing at a modest 4 per cent and the interest rates it paid on new debt were 5 per cent or less, it might manage its way out. But neither is likely. In recent days, investors have demanded record rates, well above 7 per cent, to purchase existing Italian debt.
Even at those rates, private demand is thin, and the European Central Bank has had to buy substantial amounts of Italian bonds.
Next year, the euro zone is likely not to grow in real terms, and Italian nominal growth (real growth plus inflation) is unlikely to much exceed 3 per cent and more likely to be nearer to zero. With such low nominal growth, interest rates on Italian debt much below 5 per cent would be needed to keep Rome afloat. Even at those rates, the ECB would have to take a lion’s share of Italy’s new debt issues.
The Germans won’t like such purchases, and those are not likely to happen. Even if Berlin went along, the ECB then would be compelled to monetarize significantly more of other European sovereign debt, and the inflation that followed would unravel the myth of stability and unity that justifies the euro.
Italy is too large for Germany, France and the smaller prosperous countries to rescue. Large purchases of Italian debt by France would surely result in the loss of an AAA rating it already doesn’t deserve, push up further French borrowing costs and put French finances into a negative feedback cycle. With Europe imploding, even Germany’s finances would not look quite so pristine.
The only sane option Italy really has is to earnestly implement austerity, drop the euro, remake public and private debt in the re-established lira, and let a falling value for the lira in currency markets impose a haircut on private creditors. Under that scenario, the losses investors took from devaluation would be much less than the losses they would endure in the chaos that Italy’s finances could unleash.
Peter Morici is a professor at the University of Maryland’s Robert H. Smith School of Business and a former chief economist at the U.S. International Trade Commission.