Italy is facing a two-pronged crisis.
First there’s the fiscal crisis, heightened by waning appetite for Italian bond issues in the face of expected government issuance of up to €260bn this year. Then there’s the current incubation of future bad debt, via the government’s very own encouragement of loosened lending criteria.
On the latter, the evidence is very much tallying up. Firstly, in a speech on July 8th, the governor of the Bank of Italy Mario Draghi hinted as much when he said:
In the South of Italy, borrower risk is on average greater than in the Centre and North, but in March the rate of growth of bank loans in the South exceeded that in the other parts of the country, even though the cost of a loan was 1.7 percentage points higher on average.
Adding:
The factors that are constraining bank profitability today will become more intense, responding to the recession with the usual lags. The commitment to curbing costs must be intensified and the economies foreseen in business plans must be achieved more quickly. The banks will be decisive in determining whether the crisis we are facing is more or less long-lasting, more or less deep.
It is necessary to reconcile prudent management and capital soundness with the need not to deny financial support to firms with good potential for growth and a real ability to weather the crisis. It would be dereliction of duty if the banks and the Bank of Italy were to stray from the path of rigorous evaluation of creditworthiness. A healthy banking system is essential to growth; it safeguards the savings entrusted to banks. Last Friday, meanwhile, the head of Italy’s banking association, Corrado Faissola, warned Italian banks were putting their own commercial survival at risk by supporting government calls to help the country’s economic recovery with increasingly risky loans.
Reuters explained that state call as follows :
The government is keen to kick-start the economy with loans for small and medium-sized companies and is making this aim a requirement on banks that take up government bonds available to shore up their capital.
The motivation here for the government, of course, is Italy’s deteriorating fiscal health. Hence the incentive to approach the economic crisis from a quick-fix point of view. Which brings us back to the other prong.
Bank of New York Mellon’s Neil Mellor points out the degree of fiscal uncertainty coming Italy’s way in his Wednesday note (our emphasis):
Yesterday, the Daily Telegraph drew attention to a leaked Italian Treasury report which stated that in 2010, the country’s debt is expected to reach 120% of GDP — twice the EU’s threshold and the second largest in the world. Indeed, the government’s cash shortfalls continue to pile up: the pubic [sic] sector deficit is expected to end the year at 5.2% of GDP, according to a Reuters poll, up from a previous forecast of 4.7% just a month ago; and these deficits remind us that Italian bond yields may well have fallen this year, but the Italian Treasury still has to offer 95bp more than Bunds — some four times more than the premium which prevailed in 2007. Similarly the credit default swap on Italian 5 year debt is falling, but remains well above pre crisis levels (at c. 60bp as opposed to less than 20bp). With GDP now expected (per Reuters polls) to contract 5.2% this year compared with forecasts of ‘just’ -3.7% back in April, and with growth expected to be flat in 2010, the basis for projected improvement in these startling levels of debt is thin indeed.
His specific observation on Italian bonds is:
BNY Mellon custodial data show that net cumulative holdings of Italian bonds have been depleted steadily since the onset of last autumn’s crisis. However, it is quite noticeable that despite having enjoyed a period of respite through much of May and June, net selling rose sharply at the start of the month and levelled-off only in recent days. As it happens, this degree of stabilisation in holdings coincides with a marked fall in 10-year Italian bond yields (and their premium over Bunds) — a fall that broadly mirrors gains in bonds markets elsewhere in the world at a time of growing risk tolerance. Indeed, when investor confidence rises, doubts over fiscal frailties and credit ratings begin to ease and bond auctions (such as the one conducted in Dublin yesterday) are that much more successful. However, recent evidence rather suggests that Italy’s fiscal troubles are not going to go away that easily.
None of which bodes well for Europe and the euro, because as Mellor also points out, structural weakness in the Eurozone’s second largest debt market reduces the scope for investment opportunities for those wishing to accumulate the single currency.
As for more anecdotal evidence of the Italian state’s dire need for cash, the government is even attempting to apply a gold tax on the Bank of Italy, much to the concern of the ECB who sees the move as potentially damaging the central bank’s finances as well as its independence. As Bloomberg reported:
The ECB said the law might violate a prohibition on central banks financing their governments and it could damage the independence of the central bank by allowing an “arbitrary decrease in the Bank of Italy’s resources.”
Related links:
ECB Asks Italy to Suspend Introducing Tax on Central Bank Gold – Bloomberg
Mario Draghi: An overview of banking in Italy - BIS