Italy is part of the solution

Italy is better positioned than the other economically troubled countries of the EU.

By ARIE MELNIK
December 19, 2011 03:18
3 minute read.
Italian Prime Minister Silvio Berlusconi

Italian Prime Minister Silvio Berlusconi 311 (R). (photo credit: REUTERS/Stefano Rellandini)

 
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There is a new government in Italy with a mandate to service the national debt by creating reforms that will induce economic growth. The problem is not as difficult as it seems because Italy is well positioned for a potential turn around. Its household debt is about 50 percent of GDP (the comparable figure in the UK is 101). The debt of Italian financial institutions is 96 percent of GDP (the comparable figure in the UK is 540). The Italian budget deficit in 2011 is -3.5 percent of GDP. In the UK it is -9 percent. Therefore, a decisive government action can make the required change.

It may sound overly optimistic to claim that Italy can save the Euro. But it defiantly has the power to reduce the dimension of the Euro crisis. Italy is still a powerful economy. Of the PIIGS countries, (Portugal, Ireland, Italy, Greece and Spain) Italy owns 57 percent of their combined sovereign debt.

The main problem is to roll over 1 trillion Euros by the end of 2015. In addition Italian banks have 1.7 trillion Euros of fixed interest debt to roll over in the period 2012-2017. If confidence in the banks remains high this debt can be renewed with a little help from the European Central Bank. If these goals can be achieved it would be a major step in the right direction.

As contagion spills from one country to another, the cost of resolution rises. So it is necessary to stop contagion and Italy can signal its ability to roll over debt via an emphasis on economic growth. On the face of it, in every credit crisis the accounting appears hopeless at the darkest hour, before dawn. If the credit crisis of Italy is solved, it will reduce the cost of resolving the debt crisis of other governments and will help to increase confidence in the financial sector. That is, Italy is such a big part of the problem now that Greece, Ireland and Portugal are minor in comparison.

Note that Italian sovereign debt is Europe's biggest bond market. In the past, Italy had three problems. First, the high level of public debt (120 percent of GDP); second, the economy did not grow for the past 10 years; third, its political system did not function well.

The first problem is given; the third problem is now solved. So resolution depends on the second problem, namely economic growth.

Closing the deficit in the Italian budget is easier than that of the UK or the US. A 3-4 percent growth in GDP in the years ahead will do it. In reviewing the situation, it should be noted that debt to GDP ratio exists not just for sovereign but also for households and the corporate sector, and on this side Italy is well positioned. It has fewer pockets of excessive debt those other countries.

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Sovereign debt is indeed high but the other components are fine. Only 24 percent of Italian households have net debt, compared to an average of 50 percent in other European countries and 16 percent of the US. Italian household debt amounts to only 17 percent of GDP compared with 150 percent for the UK. Italian households are fairly wealthy by world standards and their wealth is invested mostly in low risk assets. Only six percent of Italian households own equities. Italian households leverage is also low.


There are no housing bubbles in Italy, mortgage leverage is low. Household saving rates are close to 16 percent of GDP (only 12 percent in the UK). To this it should be added that real, non financial corporate balances are fairly solid. Corporate debt to GDP, about 80 percent, is below the UK at 120 percent and Spain at 150 percent.

The problem of the banking sector is not rooted in excessive credit creation or real estate landing. Italian bank credit to GDP is 100 percent, compared with 150 percent for the euro zone in general. The problem is that one-fifth of Italian bank assets are held in the form of sovereign debt.

These figures show that if the Italian entrepreneurial spirit can be unlocked creative growth can be restored. Even a modest growth of 3-4 percent will provide sovereign debt sustainability. Achieving this is the duty of the new government. This opportunity can work well, Let's hope that it does.

The writer is a professor of economics at the University of Haifa.

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