An Italian financial crisis poses huge threat to global economy

Από: Desmond Lachman

Judging by Italian government’s bond prices, one could be forgiven for thinking that Italy poses little threat to the global economy. After all, the Italian government can now borrow long-term from the market at 1.2 percent, or at a significantly lower rate than can the U.S. government.

However, before allowing ourselves to be lulled into a false sense of security about the Italian economy, we might want to recall Greece’s recent experience. In 2009, on the very eve of the European sovereign debt crisis, the Greek government could raise long-term funds in the market at practically the same rate as could the German government. It could do so even though the country was on the brink of an economic implosion of epic proportions and the largest sovereign debt default in the post-war period.

Strikingly, there would seem to be at least as many reasons for worrying about the Italian economy today as there were for worrying about the Greek economy back in 2009. Italy today checks practically every box for the making of a full-blown economic and political crisis within the next year or two.

For a start, since adopting the euro in 1999, the Italian economy has amply demonstrated that it is incapable of maintaining international competitiveness or generating meaningful economic growth. Worse yet, since 2008, the Italian economy has experienced a triple-dip recession that has left the country’s gross domestic product (GDP) at around 6 percent below its 2008 pre-crisis peak and its unemployment rate at over 11 percent.

Not surprisingly, years of economic recession have blown a massive hole in the Italian banking system’s balance sheet. It is estimated that Italian banks now have around 360 billion euros in nonperforming loans, which amounts to a staggering 18 percent of their loan portfolio. If that were not bad enough, the Italian banks also hold unhealthily large amounts of Italian government debt, which now totals more than 10 percent of their overall assets.

Yet another box that Italy checks for the making of an economic crisis is the very high level of its public debt. Despite years of fiscal restraint, the country’s public debt level has risen to 133 percent of GDP or to the highest level after Greece in the eurozone. With a highly sclerotic economy, it is difficult to see how Italy might bring down this ratio through economic growth. With politic limits having been reached to fiscal pain, it is also difficult to see how the country will subject itself to yet more budget austerity in a euro straitjacket. While this might not matter much at a time of ample global liquidity, there is every reason to fear that this could become a major issue for the country when global liquidity conditions begin to tighten.

Sadly, Italy also checks the political box for an economic crisis. Years of dismal economic performance has contributed to a fragmentation of Italy’s politics and to a rise of the populist Five Star Movement that is intent on taking the country out of the euro. It has to be of major concern that ahead of Italy’s forthcoming constitutional reform referendum, most likely to take place this November, the Five Star Movement is polling evenly with the ruling Democratic Party and that anti-European sentiment is rising. The last thing that a troubled Italian economy now needs is a renewed period of political uncertainty that a “no” vote in November’s referendum would almost certainly usher in.

While markets might be sanguine about the risks that Italy might pose to the global economy, there are a variety of reasons why global economic policymakers would be making a big mistake to share that complacency. Among the more important of those reasons is that Italy’s large sovereign bond market and its very large banking system make the country simply too large for the country’s European partners to save. This has to heighten the risk that an Italian economic crisis could lead to contagion to other countries in the European periphery that could lead to the eventual unraveling of the euro.

An equally important source of concern for global economic policymakers should be that Italy is very integrated in the global financial system. With a sovereign bond market that now exceeds $2.5 trillion, making it the third largest sovereign market in the world, it is inconceivable that a default on Italy’s sovereign bond market would not have major reverberations throughout the global financial system in much the same way as did the Lehman Brothers bankruptcy in 2008.

Global policymakers can of course hope that the markets are right in thinking that Italy is not headed for major economic and financial crisis that would have global ramifications. However, looking at Italy’s acute economic and political vulnerabilities, doing that would hardly seem to be a responsible way to formulate global economic policy.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

Πηγή: American Enterprise Institute