Or, trying to reduce Italian solvency risk by changing the debt structure. Plus a little bit of financial repression?
FT Alphaville has just got off the phone with Luca Mezzomo, macroeconomist at Intesa Sanpaolo Group, to discuss ‘cliff risk‘ in Italian bonds.
The bonds traded over 450bps relative to Bunds for the second consecutive day this morning, sparking fears that its spread to a benchmark AAA index will also pass this mark, triggering a clearinghouse margin call. And we all remembered what happened with Ireland.
In the meantime, let’s put this potential debt spiral into context and get the caveats out the way first: Italian debt has an average maturity of around 7 years – one of the longest in the eurozone. The primary balance is eminently better than the periphery and just 44 per cent of marketable securities are held by foreigners, an investor base that is typically more sensitive to bond price moves than domestic counterparts.
But in these conditions, markets are resolutely focused on eurozone break-up risks, including the self-reinforcing risk that rising debt servicing costs will further undermine Italy’s 120 per cent debt to GDP ratio. (Investors are also worried about the other side of the ratio, Italy’s stagnant growth record.)
If the BTP-Bund spread does not drop below 250bps in the next 4 years and the 6-month T-bill pays a minimum of 60bp on 6-month Euribor until 2015, then interest spending as a proportion of GDP will come in at 6 per cent next year compared with with 5.2 per cent this year, reckons Mezzomo.
Roughly-speaking, a 1 per cent increase in market interest rates would raise interest payments as a proportion of GDP by 0.3 per cent. The government has a net €221bn bond issuance programme for the 2012 calendar year.
Against this backdrop, Italy needs fortifications – and fast. Here is a summary of Mezzomo’s thoughts:
- The demand pattern for Italian debt, as the chart below of net debt flows highlights, is shifting – with more treasury paper bought by residents and less by non residents, who turned into net sellers from 2011 Q1.
- If debt held by non-residents is not rolled over in 2012, the financing gap to be covered by residents – and dare we say it: official institutions – would be around €150- 160bn, he reckons.
What are the short-term policy options then? Last week, we covered the domestic wealth angle at €8,600bn of household wealth vs. the €1,900bn public debt mountain. Mezzomo reckons there are plenty of measures, some draconian others less, the government could take to sharply reduce net borrowing requirements by raiding domestic savings, giving the government some breathing room to implement reforms.
1. The government’s real estate assets, estimated at up to €319bn, could be used as collateral to raise funds via an SPV. Yes, this move is full of political and bureaucratic hurdles but Mezzomo reckons it’s still eminently feasible. The downside is significant too: it won’t materially impact debt ratios or multi-year borrowing requirements but could serve to lower some borrowing costs.
2. Real estate assets could be sold outright. That would reduce sharply borrowing requirements but in these skittish market conditions it would inevitably spark accusations of selling the country at bargain basement prices.
3. Households could be forced to surrender a portion of their gross wealth into callable government securities with a sub-market coupon. This would reduce borrowing requirement/costs but not ratios.
4. The most powerful measure then is a one-off wealth tax on a range of assets, a move that could reduce ratios or borrowing requirements but might eat into domestic demand.
In short — this looks a bit like “financial repression”.
So if the EU mechanism proves deficient, borrowing requirements could be sharply reduced in the very short-term. But it’s a sticky plaster option. Debt ratios need to be attacked and markets are demanding a huge fiscal adjustment.
And growth is no option: Mezzomo reckons that the country’s growth rate must rise to about 2.5-3 per cent of GDP to reduce debt ratios. Such growth levels are not unusual historically-speaking but unlikely in the coming years. Mr Bunga Bunga, are you listening?