Italy should halve its debt, says Thomson
Italy needs to halve its debt to remain in the Eurozone, says Stuart Thomson, chief economist at Ignis Asset Management (pictured). He says neither bulky austerity measures nor indefinite quantitative easing from the European Central Bank can help the country from its current economic impasse.
Thomson believes Italy, the third largest economy in Europe in terms of GDP, is left with a limited number of options to avert the risk of exiting EU. One is an internal devaluation of its national debt, with a 50% haircut that would bring the level of debt to GDP to the level of sustainability, set by Maastricht at 60%.
Another is a series of structural reforms designed to kick-start growth in an economy that has been on a virtually flat trend for the past decade. However, reforms will take too long to unfold and complementary austerity measures will act as a tax on real GDP growth in the next few years, resulting in a “sharp contraction”, says Thomson.
“Coupled with the ageing population this implies that the productive potential of the Italian economy is currently zero, having slowed from an average of 1.0% during the nineties to just 0.6% per annum in the noughties. Indeed, the economy is already in recession. The combination of declining activity, rising unemployment and high interest rates leaves Italy in a debt spiral with the primary budget surplus unable to compensate,” Thomson said.
In this sense, rewriting at least half of the debt burden represents the only feasible option, says Thomson. He added that the haircut of the €1.9trn of debt will need to be spread “over a series of modest devaluations that represent controlled explosions. The alternative would be for Italy to leave the single currency, but this is the nuclear option that would cause financial chaos with widespread, financial, consumer and corporate bankruptcies and consequently, while this prospect is no longer a black swan event, it is still a tail risk over the next few years.”
On a positive note, the economist noted that despite the “torrid time” the country faced over the past month, markets are showing more confidence than previously expected. After peaking to the prohibitive level of 7.56% last week, yields on ten-year bonds have moderated to more comfortable levels since Berlusconi’s departure on Friday. International investors seem to have opted for a shy confidence over panic-selling, and Monti’s focus on sustainable growth has so far convinced the Eurozone.
In addition, “over the week, Italian bonds outperformed French, Austrian and Belgium bonds as investors anticipated further sovereign downgrades to these countries, with France and Austria now likely to lose their all-important triple AAA credit rating,” Thomson said.