Bloomberg News

Italy May Need More From Draghi as Debt Load Mounts: Euro Credit

August 21, 2014

Italy’s best hope may again be the bond market’s favorite Italian: Mario Draghi.

The nation’s mounting debt, coupled with a shrinking economy, is close to unsustainable, Ashoka Mody, a former deputy director at the International Monetary Fund, said yesterday in a telephone interview from New Delhi.

“Unless there is an extraordinary fiscal effort or a growth recovery, the Italian debt must be regarded with a reasonable probability to be unsustainable today,” said Mody, now a visiting professor in international economic policy at the Woodrow Wilson School, Princeton University.

Mody said Italian Prime Minister Matteo Renzi should call on the European Central Bank, led by Draghi, to orchestrate a coordinated depreciation of the euro and buttress exports from Italy and other European countries. The Italian economy, the third-biggest in the euro region, slid back into recession in the second quarter, and the nation has the second-biggest biggest debt load in the region.

Without a currency depreciation, Renzi should “start consulting smart sovereign debt attorneys to ensure orderly restructuring of its debt,” said Mody, who joined the IMF in 2001 and was the fund’s mission chief in Ireland. “Delays in debt restructuring are known to be costly and therefore early and pre-emptive action is always wise.”

Roberto Basso, a spokesman for Italy’s finance minister, declined to comment on Mody’s remarks.

Euro Weakens

Renzi may be getting lucky already. The euro has fallen about 5.2 percent from this year’s high of $1.3993 in May. European investors facing record-low interest rates are sending the most money overseas in six years, an ECB report showed this week. That has helped push the euro to an almost one-year low versus the dollar, and is supportive of further “downside,” according to Goldman Sachs Group Inc. (GS:US)

Pressure remains on Draghi to do more, after the euro region’s economic growth ground to a halt.

“I’m convinced that more can be done and I’m also convinced that the ECB is getting ready to do more, given the dismal inflation figures that we recently got,” Italian Finance Minister Pier Carlo Padoan said in a BBC Radio interview aired on Aug. 17. He also said the government will have to revise down its growth forecast for 2014.

Shrinking Italy

Italy’s economy shrank 0.2 percent in the second quarter after contracting 0.1 percent in the previous three months. Gross Domestic Product fell in all but one of the last 12 quarters.

The nation’s debt ratio will rise this year to 134.9 percent of GDP from 132.6 percent in 2013, according to the government’s economic and financial plan passed in April. Debt is projected to fall to 125.1 percent of GDP by 2017.

“Had the ECB implemented a quantitative easing program, Italy might have avoided the worst of a credit crunch that barred its economic recovery and may harm its public finances,” said Luca Noto, who helps oversee 14 billion euros at Anima Sgr SpA in Milan.

At this point, investors are not worried about Italy’s ability to handle its debts. On Aug. 12, at the last auction before the summer break, borrowing costs on one-year bills dropped to a record low, underpinned by Draghi’s 2012 pledge to do “whatever it takes” to defend the euro.

No Question

The Treasury in Rome returns to the market next week with sales of zero-coupon bonds, six-month bills and five- and 10-year bonds.

“Restructuring is not an issue as investors don’t question Italy’s ability to repay its debt,” said Noto. Still, “since the end of June a series of negative data and the lack of clear direction and speed in Renzi’s economic agenda have been slowly eroding investors’ confidence in the government’s ability to pass pro-growth measures,” he said.

Some JPMorgan Asset Management funds moved out of 10-year Italian securities into Spanish debt, while Credit Agricole SA (ACA) and ING Groep NV (INGA) recommended trades to take advantage of stronger economic growth in Spain.

Ten-year Italian yields were at 2.60 percent yesterday, and the rate on Spanish bonds was at 2.40 percent.

“Italy’s recession will have negative effects on fiscal policy and on the overall political climate, both at the domestic and European level,” Moody’s Investors Service said in an Aug. 11 report.

“Because the government budget assumes real GDP growth of 0.8 percent this year, the contraction of the economy threatens the government’s fiscal strength,” the rating company said.

On Aug. 7, Draghi took aim at his own country, saying it could only blame itself for the unexpected recession, and the government needed to speed up reforms.

“I agree completely with Draghi,” Renzi told the La7 television channel the same day. “If it’s a dig, I’m having a dig too. What the ECB president said is sacrosanct: we need to put Italy back in order to make it more competitive.”

To contact the reporter on this story: Lorenzo Totaro in Rome at ltotaro@bloomberg.net

To contact the editors responsible for this story: Rodney Jefferson at r.jefferson@bloomberg.net Kevin Costelloe, Dara Doyle


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