Italian Government Bonds: a 5-star fiasco?

Liseth Galvis-Corfe - 23 May 2018

The recent coalition between the Five Star movement and the League raises urgent questions about the sustainability and pricing of Italian government debt. Their proposals focus on tax cuts for companies, pension reforms and welfare spending. However, the parties have not explained the fiscal impact of the measures. There are therefore concerns over the public finances of a country that has the second highest level of debt to GDP in the Euro Area (132 per cent) and that has failed in implementing structural reforms that facilitate the reduction of the fiscal deficit.

Since the sovereign debt crisis in 2011, the proportion of debt securities held by non-residents has decreased substantially, from 47 per cent to 35 per cent between February 2011 to February 2018 (figure 1). By contrast, in the same period, the proportion of debt securities held by the Central Bank has increased from 4.2 per cent to 19 per cent. Other financial institutions and Other Monetary Financial institutions (OMFI) have also shown increases, inferring a progressive international syndication of Italian government debt.

The sovereign debt crisis reduced the interest of non-resident investors in Italian government bonds. The increase of 200 basis points (5 to 7 per cent) in the 10- year bond yield between March 2011 (beginning of the stability program by the European Commission) and November 2011 reflected concerns about the ability of Italy to repay its debt. At that time the level of debt to GDP was 116 per cent and non-resident investors feared that the country needed to borrow more money to repay its debt or even that it had to default.

In August 2011 the European Central Bank (ECB) started buying Italian government bonds to bring down borrowing costs and avoid a spread effect in other economies. As a result, its proportion of government debt held increased by 100 basis points between August 2011 and August 2012. A noticeable increase occurred in 2015 and has accelerated to the present (figure 1) this is due to the implementation of the Public-Sector Purchase Programme (PSPP) that the ECB has carried out as part of Quantitative Easing (QE). It is expected that the purchases by the ECB will run until September 2018. Without QE, a destabilization in the Italian debt market is likely.

Spreads between Italian and German 10 -year government bond yields (figure 2) have widened substantially following the agreement reached by the two populist parties. It is expected that the trend will continue as the coalition introduces the planned reforms and decides on key issues such as the use of “mini-BOT (Buoni Ordinari del Tesoro)” bonds. These are short-term government securities that act as a credit notes. They can be used as internal currency to pay government suppliers, taxes and social security. The risk of the “mini-BOT” is that the government will use it to relax fiscal policy, heaping more pressure on the already high government debt.

Figure 1

Data source: Thomson Reuters Datastream

Figure 2

Data source: Thomson Reuters Datastream

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