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Debt Contagion Fears Spread to Italy

Stop me if you’ve heard this before, but Italian finance officials took great pains recently to state that the country is perfectly capable of dealing with the national debt on its own and that the idea of an emergency bailout is laughable.

Some may be reassured by the government’s bravado but the bond market remains unimpressed.

The spread between 10-year Italian government bonds versus the benchmark German Bunds rose to 285 points on Monday before easing slightly to 269 points. The is the widest spread for Italian debt since the adoption of the Euro and the creation of the Eurozone in 1999. The interest rate on 10-year Italian bonds rose to 5.5 percent while 10-year German debt was available at 2.81 percent.

This is an eerily familiar pattern and going by what was learned in the Irish and Greek debt crises, it is only a matter of time before Italy will be forced to turn to the European Union for emergency funding. Italy is the third largest economy after Germany and France but has the second highest debt to GDP ratio at an estimated 118 percent according to the latest information in the CIA Factbook. This makes Italy the most heavily indebted nation in the Eurozone at more than 1.7 trillion euros.

Over the next few months the Italian treasury will be forced to pay more than 70 billion euros in maturing debt – by the end of 2013, the total due for repayment will be more than 500 billion euros. Clearly, this will take more than a paltry payout of the 100 billion or so offered to Greece.

And just to make things a little more interesting, Italy is also offering up an element of political instability. The goings-on of Prime Minister Silvio Berlusconi have gained international notoriety in recent months but now it appears the Prime Minister is feuding with his Finance Minister.

Giulio Tremonti, who has served several terms as Finance Minister and is one of the few in Belusconi’s cabinet to call for fiscal restraint, is apparently on the outs with the Prime Minister. According to some reports, he is even likely to be fired. It seems that no one in the government wants to hear of “spending cuts” or “austerity” right now. As the experience in Greece has shown, these things are not very popular so it may be best to just ignore them. Besides, Germany and the rest of the EU is offering plenty of cash to preserve the integrity of the euro and save the banking system from collapse.

This is the very definition of “contagion” and there is no guarantee that the EU will rise to the bait. German banks are exposed to Greece to the tune of 33 billion euros and this was largely responsible for compelling Germany to broker a deal to ensure Greece did not default. According to Der Spiegel, German banks hold nearly four times more of Italy’s debt at nearly 125 billion euros.
While the aftermath of a default would be disastrous, the asking price to prevent it may be too high.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Scott Boyd

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