Italy, how bad? Old Mutual’s Owainati explains
How bad is the current situation in Italy?
Abbas Owainati, economist at Old Mutual Global Investors, argued that the root of the political impasse is the fiscal position and its solution, which is more or less austerity.
“Let’s put aside for a moment that its political destiny hangs between a professional comedian and a suspect in a child prostitution case. On the surface, it looks messy,” he said.
Italy’s gross public debt of nearly €2 trillion is the third highest in the world in absolute terms, after only Japan and the US. As a proportion of GDP, at 127%, it rivals only Japan. German debt to GDP, by comparison, is 80%, while in the UK it is 89%.
Yet in 2012 Italy reported the largest primary surplus in the eurozone.
The primary balance, which measures the government’s net borrowing or lending excluding debt servicing costs, was a reported surplus of 2.5% of GDP.
“It is tempting to credit outgoing prime minister Mario Monti, who raised taxes and cut spending, and when Italy’s recent elections proved inconclusive there was an understandable fear that political paralysis could derail Italy’s budget position,” the economist said.
However, by looking back at the primary position since the formation of the euro area and beyond it becomes apparent that a structural primary surplus has existed in Italy for a long time.
Over the last two decades the Italian government has reported a primary surplus on nineteen occasions, averaging 2.7% of GDP per year. This compares to an average German primary surplus of 0.44% of GDP per year over the same period.
If we adjust the long-term debt levels to reflect the present value of the structural position, Italy’s debt to GDP could be expressed as 80% of GDP (127% – 47%) whilst Germany’s would be 70% of GDP.
All of a sudden these levels become comparable and the investment decision becomes harder to take. The decision to avoid an apparently debt-heavy nation is not as simple as it might appear.
“Wouldn’t we prefer to invest in a company with more debt that was actually profitable rather than one with lower debt but that runs at a loss?,” Owainati asked.
The conclusion, in his view, is that the key issue affecting Italy is the yield – or interest rate – it is forced to pay to induce investors to keep lending. On 10-year government bonds, as an indication, this is 3% higher than is demanded from much less profitable Germany.
“Austerity may or may not make a difference, but it is addressing the wrong problem, the structural conditions of the economy. As the long-term primary surplus suggests, at a structural level the Italian fiscal position is already sound,” said.