“Italy will not be another Greece” said former Italian Prime Minister Matteo Renzi in July 2015. Nearly four years later their sovereign debt markets show that they may be closer than ever before. Italy can borrow for five years at a rate of 1.85% and Greece can now borrow at a slightly lower rate of 1.73%.
So what is behind this, and why are the debt markets pricing equivalent credit risks for the two countries? Back in 2015, Italy could borrow for five years at 1.34% while Greek 5-year debt reached around a 20% yield at one stage. Greece was effectively still shut out of the debt markets.
Coming back to today and taking Greece first, a slow renaissance has occurred. Firstly, there has been recovery in the economy. Secondly, economic reforms have been made and the country has sustained a surplus in public finances. Finally and importantly, Greece returned to international bond issuance. Debt metrics have not really improved yet, but the deterioration has halted and as long as the economy continues to grow, like Ireland and Portugal in recent years, the credit outlook should continue to improve. Credit ratings have already started to reflect this, with all the major ratings agencies upgrading over the last year. Admittedly they remain a long way from investment grade, but things are going in the right direction.
Another factor that supports Greek debt is its scarcity, which may come as some surprise. Although the Greek government debt-to-GDP ratio remains at a very high 181%, a high proportion is funded by various bailout programmes and therefore does not need to be repaid or refinanced in the short term. Current funding needs are thus very low and are usually done to refinance more expensive loans, thus reducing debt servicing costs via issuance.
By contrast Italy, although rated investment grade, is showing some very worrying trends again. The current government is expanding the budget deficit and the ratio of budget deficit to GDP is expected to rise again this year. The ratio of total debt to GDP is rising and currently standing at a record high of over 130% GDP.
All of this debt is financed via the bond market which will have to take the strain if this problem is not tackled via greater issuance. If credit ratings deteriorate, the pool of available buyers will also decline, particularly if a sub-investment grade rating becomes likely. This is why the EU is just about to open an Excessive Deficit Procedure (EDP) for Italy. The EDP is nothing new in the EU, as even Germany has been subject to one in the early years of the Euro, and only Sweden and Estonia have escaped the procedure in recent years. Spain has just exited the procedure having entered it in 2009.
The aim of the EDP is to act as an “early warning system” for fiscal policy. It requires national governments to present plans as to how their nations will return their debt positions to that set by the Maastricht criteria i.e. a budget deficit of less than 3% of GDP and a total debt to GDP ratio of 60% over a period of time. If nation governments fail to comply, ultimately a fine of 0.2% of GDP can be levied. In practice, despite many countries being in the EDP for many years, no fine has been applied.
The current government in Italy shows very little sign of being compliant to the EU, so perhaps this will be tested in the years to come. U-turns, however, are not unprecedented. Returning to Greece, the Prime Minister Alexis Tsipras, who has presided over Greece’s return to debt markets, famously swept into power on anti-austerity rhetoric which was quickly abandoned in the face of the 2015 crises. Four years later the bond market approves, though perhaps not the population – Tsipras has recently lost heavily in the European elections and has just called a General Election.