When it comes to describing Italy, one chart comes to mind: Government debt to GDP ratio, the first of the three attached data graphs.
The country’s debt to GDP ratio has been stuck above the critically important level of 90 per cent for a good part of 24 years now and -- using IMF projections out to 2017 -- will remain there. Worse, Italy’s debt/GDP ratio breached 100 per cent back in 1992 and will still be above 100 per cent in 2017, assuming the government does not engage in a wholesale dumping of state assets, as promised recently by Prime Minister Mario Monti.
However, the real Italian ‘disease’ of debt overhang is best understood not in the levels of debt attained, but in the underlying dynamics driving this debt. Take a look at Italy’s primary deficits (deficits net of interest payments of debt), the second attached chart.
As it turns out, Italy is one of the best performers in the euro zone in terms of primary surpluses. Since 1988, the country posted primary surpluses in every year except 1988-1990 and 2009-2010. It ranked fourth or better in the euro area each year between 2000 and 2011, except for 2003-2006, and will rank second or better in every year from 2012 through 2017. Measured against Germany, Italy’s primary surpluses exceeded those of the euro area’s ‘miracle economy’ in every year between 2000 and 2011 save 2008 and 2009 and will exceed them in every year from 2012 through 2017.
Instead of paying down debt and funding reductions in the excess burden of the state finances on the economy, Italy is wasting its surpluses on funding debt. The third chart shows the cost of such financing.
There are other candidates for this scenario within the euro area, namely Belgium, Ireland, Portugal, and to a lesser extent – Spain and Greece. All are struggling with debt overhang. Not all are yet capable of generating primary surpluses. All are facing euro area-imposed programs of various severity to achieve such surpluses.
And yet, as the Italian example illustrates, it is highly unlikely that attaining such a goal will lead these economies out of a debt trap.
In fact, it is the ECB and the euro area policy makers who are forcing Italy up the steep debt spiral. The latest Fiscal Monitor from the IMF clearly shows that Italy will be bearing the largest share (relative to its GDP) of the euro area exposure to various ‘firewall funds’ – the EFSF, EFSM, and ESM – around 3.5 per cent of the country’s GDP. Germany is expected to contribute 3.1 per cent and France 3 per cent.
Italian exporters – whose potential for growth is best illustrated via the country’s current account performance prior to joining the euro, when Italy generated external surpluses in excess of those generated by Germany – are currently struggling with overvalued currency. The overvaluation of the euro, sustained over almost a decade now, has led to a more than 30-per-cent loss in Italian labour force competitiveness. Meanwhile, collapsed money supply in Italy, also caused by the ECB policies, means that credit to enterprises is now running on empty.
Unfortunately for the euro, as well as for Italy, there is little hope that the ECB core policies will switch to match the needs of the countries struggling with public debt overhang. The same stands for Spain, Belgium, Portugal, Ireland, and Greece. Either the euro goes or these countries will have to exit the monetary union, or Germans, Finns and the Dutch bite the bullet and outright mutualize the debts of the euro area sovereigns.
The latter short-term fix must be followed by altering the mandate of the ECB to target not just inflation, but also growth parameters weighted to the needs of the ‘peripheral’ states and by a dramatic expansion of investment transfers from the Northern European core to the economically weakened states.
Constantin Gurdgiev is head of research with fund management firm St. Columbanus IA and a lecturer in finance at Trinity College, Dublin