WORLD AUGUST 9, 2011
While the United States resolved its own (manufactured) brush with default last week, global stocks have continued to slide on the more legitimate threat posed by the sorry fiscal state of several European countries. Greece was the recipient of a major euro zone bailout at the tail end of July—but concerns over its financial stability remain. Spain and Portugal are also facing serious questions, as are Ireland and Iceland. And then there’s Italy, whose notoriously troubled government may be careening toward a default at a time when the cash-strapped continent can hardly afford the economic collapse of one of its largest member states. Will it be able to hang on?
Italian debt is roughly 120 percent of its GDP—a phenomenally high ratio that likely must be reined in for the country to stand a chance of not defaulting, particularly given its low economic growth rate. This may well prove impossible in the short run, and groups like the London-based Centre for Economics and Business Research have recently proclaimed that the country is “bound to default.” Similarly, according to a TNR report, JPMorgan has said Italy can only afford to finance itself into next month. Then, just last week, the European Central Bank purchased a variety of European bonds—not including Italian ones—in a widely questioned and not entirely successful attempt to bolster the Italian bond market. Finally, on Monday, the ECB went the extra mile and finally stepped in to buy Italian bonds, but the move did not appear to have an immediately positive effect.
Yet, in spite of the country’s grim fiscal reality, each of the Italian economic experts I contacted before the ECB’s most recent move all but ruled out the possibility of the country failing to pay its obligations. Domenico Lombardi, president of the Oxford Institute for Economic Policy and a Brookings Institute member, maintains that a default is simply not in the cards. Not only does the bulk of Italy’s debt not expire for seven years, he explained on Friday, but the ECB would not allow the country to even come “close to a default scenario.” “That would trigger a meltdown of the euro area,” he says. “It would be unthinkable that the ECB would not intervene massively and almost unconditionally.”
Still, Lombardi, who has served on the executive boards of both the IMF and World Bank and previously worked for the Bank of Italy, said Italy’s slow growth is reason for worry, and that the government and ECB had been “playing a cat and mouse game,” in which the latter would likely end up asking the government to implement its austerity measures sooner if the situation worsens. Indeed, he says, it is unlikely that Prime Minister Silvio Berlusconi’s government will make any major changes in the short-to-medium term without additional prodding. “If the situation gets worse, as I expect, the ECB will step in,” he told me before the ECB debt purchase. “Hopefully they’re not going to wait until too long.”
Harvard’s Alberto Alesina similarly does not predict a default, but his outlook is less positive than Lombardi’s. “I think Italy is too big to bail out and too big to fail,” he says, noting that the Italian debt is too large for any institutional rescue program to have an effect. Instead, a combination of “major spending cuts and structural reform” would be necessary to rescue the Italian economy, which is in for a “very, very painful period of tightening the belt,” he explained. The end result, he argues, is “Not default, but a steady decline in the country … with a heavy burden of debt that weighs on a generation.”
Duke economics professor Gianni Toniolo says that he, too, would bet against an Italian default for a number of reasons, including the country’s relatively small budget deficit. More important to Toniolo, however, are the country’s history of weathering debt crises and the international community’s reliance on Italian stability. He predicts that both international institutions and creditors like China would take serious measures to help the Italian economy before it could hurt them.
But it’s right to be pessimistic about the country’s financial future, Alesina says, largely because of Italy’s current leadership. “I don’t have any faith in Berlusconi,” he told me, predicting up to twenty years of continued decline. “If I were a foreign investor in Italy, I wouldn’t be particularly worried,” Alesina explained. “I would be much more worried as an Italian. As an Italian, we [will] be paying. Tightening our belt.”
Gabriel Debenedetti is an intern at The New Republic.