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A rude reality interrupts Italy's holiday of denial

The cynical among us believe that nothing is true until it is officially denied, and that's why I think it will be hard – maybe impossible – for Italy to avoid a bailout of some sort.

Last week, Mario Monti, Italy's unelected Prime Minister, was asked during a panel discussion at Milan's Bocconi University whether he might tap into the new European bond-buying programs to bring down Italy's borrowing costs. "I don't think Italy needs it, nor will need it," he replied.

Where have we heard this before? Just about everywhere in Europe's zombie zone. The history of Europe sovereign bailouts is exquisitely rich in denials.

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In early 2010, Greece denied it would seek a bailout; we are not Latin America, the Greeks said. One duly came in May of that year. Then the Irish said they were not Greeks and they, too, were bailed out. Not long after, the Portuguese said they were not Irish, and, on cue, helicopters decorated with "European Union" and "International Monetary Fund" logos dropped pallets of euros into Lisbon.

Now the Spanish are saying they're not the Portuguese even though Spain has already negotiated a bank bailout that eventually may cost €100-billion ($130-billion), and is expected to negotiate bailout-lite – the purchases of its bonds by the European Stability Mechanism, Europe's new rescue fund, and the European Central Bank.

And Italy is not Spain? Indeed, it should not be. There are a lot of things to like about Italy's economy and financial position compared with Spain's. Italy's economy is bigger and more diversified. Its expected 2012 budget deficit, as a percentage of GDP, is 2.6 per cent compared to Spain's expected 6.7 per cent (the figure could be higher, because Spain has a nasty habit of blowing its deficit targets).

Italy is on the verge of running a small current account surplus and its household debt is one of Europe's lowest, while Spain's is one of the highest. It is blessed with a primary budget surplus, that is, a surplus after debt payments are stripped out.

Now the bad news. Italy is in deep recession, worse than Spain's; Italy's GDP will shrink about 2.4 per cent this year, Spain by half that. While Italy's unemployment rate, at a record high 10.8 per cent, is well less than half of Spain's 25 per cent, it is climbing relentlessly and might keep doing so as the Monti government bows before the altar of austerity. This week, through a confidence motion, the Italian parliament approved a one-percentage-point hike in the value-added tax, ostensibly to improve Italy's finances. But it might accomplish the opposite as consumers are deprived of more buying power.

Worse, the industrial sector in Italy (the euro zone's second-biggest manufacturer, after Germany) is in near free fall. In September, Italian industrial sales fell 4.2 per cent, month on month, while orders fell 4 per cent. Orders are down almost 13 per cent, year on year.

Italy's financial health, or lack thereof, matters not only because it is the euro zone's third-largest economy, but because it was the last great hope for the region's Mediterranean frontier. Greece and Portugal are falling apart and Spain seems bent on joining them on the sovereign debt scrap heap. When Mr. Monti replaced Silvio Berlusconi, the man who spent more time chasing skirts than chasing economic fixes, there was a huge sigh of relief throughout Europe. Here, finally, was a sensible, serious, honest man who would put Italy back on course. The alternative was unthinkable. There is not enough money in Europe to finance Italy, whose economy is a quarter bigger than Canada's, should it get shut out of the sovereign debt markets.

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If Italy were on the mend, it would offset some of the pessimism about the euro's future, even if Spain, Portugal and Greece were to remain in recession, or worse. But Mr. Monti is running into a brick wall in the form of Europe's biggest pile of national debt – €2-trillion, the equivalent of 125 per cent of GDP. As austerity kicks in, tax revenues will fall and Italy will have to borrow even more money to pay interest charges. Debt will rise. This is a no-win situation, especially since Italy is paying about 5 per cent on 10-year bonds, or 3.5 percentage points more than Germany.

Italy's political leadership does not inspire confidence as the economy does an imitation of the Costa Concordia. Mr. Monti's technical government will kill itself off in the spring, when democratic elections are to be held. Mr. Berlusconi's centre-right PDL party is getting destroyed, which is to be welcomed. The centre-left is uninspiring. There is no natural new leader in Italy and Italians are registering their disgust by avoiding the ballot box.

The danger is that the election produces a fragile coalition government that is incapable of preventing the collapse of a country that could take down the entire euro zone. Perhaps Mr. Monti, in his dying days in office, should do everyone a favour and trigger the bond purchase program set up by the ESM and the ECB. Doing so would tie Italy's hands, because they would demand economic reforms in exchange for the bond purchases. The next government would, in effect, have no economic or financial sovereignty, which might be a good thing for Italy.

Mr. Monti insists international financial assistance will not be needed. As the economy deteriorates and debt rises to absurd levels, he may be forced to change his stance, as so many other euro zone countries did when reality so rudely interrupted their financial fantasies.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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