Italian Bond Sale Disappoints – Debt Haircut Rumors Persist

With the announcement earlier this week that a deal to help contain the Eurozone debt crisis was in the works, attention quickly shifted from Greece to Italy. Compared to Greece, Italy’s debt situation is only marginally better with a debt to GDP ratio of 116 percent as of the end of 2010, compared to Greece’s 145 percent debt to GDP ratio.

Debt ratios aside, the greater concern is that at just over $2 trillion, Italy’s economy is more than six time larger than the Greek economy. The cash reserves required to meet Italy’s considerably greater debt could prove beyond the capabilities of the Eurozone should it be necessary to assume Italy’s debts directly.

On that front, Italy held an auction on Friday just days after the Eurozone debt deal was announced. With the euphoria of the Eurozone covenant still buoying markets, the auction was expected to follow the same trend. Unfortunately, it did not.

Italy had committed 8.5 billion euros ($11.9 billion) to the auction but only managed to find buyers for 7.93 billion euros. Worse still, the yield on benchmark ten-year notes rose to 6.06 percent. This is the highest Italy has been forced to offer on ten-year notes since the launch of the Eurozone in 1999 and suggests investor skepticism for Italy’s ability to repay its debt remains high.

During the past few weeks, Italy has been downgraded by the three leading ratings agencies. Standard and Poor’s was the first to question Italy’s ability to repay existing debt noting the government’s poor track record and its habitual over-spending. With the slowing economy, the government’s inability to manage its finances will worsen unless the government takes its commitment to balancing its budget more seriously.

With nearly $300 billion euros ($421 billion) in maturing debt due for repayment alone next year, uncertainty persists in Italy’s ability to meet its obligations. This has given rise to speculation that some form of debt revaluation similar to that arranged for Greece will also be necessary for Italy as well.

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