by Emmeran Eder, Euro on Sunday
Mith his head bowed, Italy’s Prime Minister Mario Draghi left Parliament in Rome after large parts of his governing coalition failed to express their confidence in him. Shortly thereafter he resigned.
The Italian leading index FTSE MIB acknowledged this with price losses. After all, Mario Draghi represented a head of government who followed a precise plan, exuded reliability and brought Italy back onto the European stage. He initiated important reforms, for example in the judiciary, the procedures for which take an agonizingly long time, but also in the complicated tax system and in the sluggish state administration.
The reforms are crucial for Italy to receive money from the European recovery fund set up during the Corona crisis. The country can get a total of 200 billion euros. The first tranche of 20 billion euros has already been paid out.
Draghi also reacted quickly to energy policy after the start of the Ukraine war. His government found what he was looking for in Algeria and Azerbaijan, with whom contracts for the supply of gas were concluded, which ensure that Italy can free itself from its one-sided dependence on Russia.
With Draghi’s departure, these successes are now in jeopardy. There will be new elections at the end of September. Until then, things should come to a standstill and no important new laws should be passed. The adoption of a new budget is also likely to be delayed.
A coalition of right-wing populists and right-wing extremists who are skeptical about the EU is currently ahead in the election polls. If they win in the fall, the reform agenda should be over for the time being.
This is fatal, because Italy already has enough problems. Unemployment is 8.1 percent. The country has low productivity. This is mainly due to the fact that the economy is dominated by smaller companies that are not as innovative as large companies. In addition, they often produce simpler products such as textiles or food that do not belong to the progressive industries.
The biggest problem, however, is the high national debt, which is at 150 percent of GDP. Only Greece has in the euro zone an even higher debt burden at around 180 percent of GDP. Now the agency S & P has lowered the rating outlook for Italy to “Stable” from the previous “Positive”. This threatens the country with more expensive loans. This, together with the current political instability, is fueling concerns that a new debt crisis like the one with the Greeks could break out in the EU – only this time emanating from Italy.
The yields on ten-year Italian government bonds therefore climbed to 3.6 percent for a short time, compared to 1.8 percent before the political crisis. Yields are now fluctuating between 3.2 and 3.3 percent.
New instrument of the ECB
The ECB has also recognized the problem of a new debt crisis and presented a new instrument in more detail at the last meeting, the so-called Transmission Protection Instrument (TPI). It is intended to prevent disorderly market movements in government bonds, especially speculators driving up yields in Italy, for example, so much that the economy suffers. Moreover, that would be a unified monetary policy make it more difficult, i.e. the further increase in key interest rates to combat inflation.
Actually, there are already two ways in which the ECB can combat market distortions. On the one hand, there is the PEPP. A bond purchase program that was discontinued in March 2022, but maturing government bonds may still be replaced by new purchases. If, for example, a German government bond expires, an Italian one can be purchased instead in order to reduce its yield. On average, around 20 billion euros are due each month under the PEPP. The second tool in the ECB’s toolbox is called OMT (Outright Monetary Transactions). But it has never been used. A country that resorts to it must reform in order to get credit from Brussels. These are strictly controlled and monitored by the EU. Countries want to avoid that if possible.
?Apparently the ECB’s assessment of the situation is that a third instrument is needed that stands between PEPP and OMT. “The barriers to entry are low,” said Andy Mulliner, chief strategist at wealth manager Janus Henderson Investors. These are sound budgetary management, absence of serious economic imbalances, public debt sustainability and prudent economic policies. All euro countries currently meet the conditions for using TPI. “There was a lot of leeway built in. Even Greece and Italy, with their high national debt, meet the criteria,” criticizes Daniel Hartmann, chief economist at Swiss asset manager Bantleon. In addition, the program has an unlimited volume.
Moreover, some things remain unclear. For example, when the market dislocations are so severe that TPI is applied. Or whether the decision in the Governing Council will be unanimous or only by majority decision.
Problems arise in the long run
“At first glance, that sounds good. In practice, however, it might be difficult to find the right balance when using TPI,” says Hartmann. If it is used too often, it could encourage individual countries to go into debt. “Then there is no longer any reason to make an effort. That is the dilemma in which the ECB is stuck,” said Hartmann. If the financial markets be switched off in order to suppress market distortions, there is no longer any corrective. “In the long term, this could cause enormous problems in the eurozone,” says Hartmann. Short and medium term will the ECB are trying by all means to keep the euro zone together.
Hartmann therefore sees no new debt crisis looming for the time being. The problem countries Greece and Portugal have implemented reforms and stable governments. Although Italy has a high level of debt, the economy is currently growing more than in Germany, also because of the strong tourism business. In addition, the current account balance is balanced and the problems with bad loans in Italian banks, although not resolved, have eased. In addition, the country is currently spending money due to the high grants from EU funds, which account for around two percent of GDP. In the time of the debt crisis after the financial crisis, on the other hand, massive savings were made. Finally, government crises come and go in Italy.
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