Euro crisis contagion worries spread to Italy

By Guy Dinmore in Rome, Nov 30, 2010

Italy’s economic fundamentals and the government’s austerity programme are capable of taking the country through the eurozone debt crisis, but market speculation coupled with political uncertainty over the future of Silvio Berlusconi’s ruling coalition have started ringing the alarm bells of contagion.

“On objective public finances criteria, Italy’s sovereign debt remains safer than, say, France’s. In addition, unlike the periphery, there is no risk to see the state suddenly snowed under with unmanageable bank liabilities,” commented Natacha Valla, a Goldman Sachs economist, following sharp rises in the cost of Italian borrowing at the Treasury’s Monday bond auction.

“But of course market dynamics are not always rational. Contagion spreading to Italy would certainly not be rational,” she added.

Although Italy’s debt-to-GDP ratio is the eurozone’s second highest after Greece, Italy has an economy set to grow by 1 per cent this year and a government deficit projected to fall to a manageable 5 per cent. Privately held debt levels are among the lowest in the eurozone, and a significant proportion of sovereign debt is in Italian not foreign hands.

Nonetheless worries are growing, compounded by uncertainty over Italy’s political stability with Mr Berlusconi, centre-right prime minister, facing a vote of confidence in his government on December 14 which he risks losing following splits within his coalition.

Franklin Allen, professor of finance at the Wharton School of the University of Pennsylvania, believes it quite likely that interest rates on Italian debt will start to rise “significantly”, although the cost of funding Italy’s 1.8 trillion euro debt remains considerably lower than three years ago.

“Given the current political issues in Italy this will be a serious problem. People are now talking about saving Spain but for sure they cannot save Italy. I think if Italian sovereign debt interest rates go up by a percent or two, the crisis will enter a new and much more serious phase and it will move very fast if this does happen,” he commented.

Andrea Romano, head of Rome’s Italia Futura think-tank, said that “rationally speaking” the eurozone crisis should put pressure on Italy’s centre-right politicians to resolve their internal differences and avoid the uncertainty of elections. “But I am not sure that the political players in Italy are rational enough,” he added.

Giorgio Napolitano, head of state, will play a crucial role should Mr Berlusconi lose his majority in parliament. Political insiders believe the president would try to bring all the centre-right parties together in a new coalition, but such a move would depend on the agreement of Mr Berlusconi who has insisted so far that he would try to force early elections if dismissed.

Despite the brewing crisis, Mr Berlusconi was the only European head of government to go to Tripoli on Monday for EU-Libyan talks, underscoring the importance he attaches to Italy’s and his own close relationship with Muammer Gaddafi, the Libyan leader.
Oliviero Roggi, professor of corporate finance at the University of Florence, believes markets have already discounted political instability in Italy. However he fears market speculation will intensify, driving up Italy’s borrowing costs.

“Like the big banks, Spain and Italy are too big too fail,” he said. “If they come under speculative attack then probably the euro is over,” he added.