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Italy Won’t Defuse Time Bomb at Heart of Euro Anytime Soon

Alessandra Migliaccio, Chiara Albanese and John Follain
·4-min read

(Bloomberg) --

Italy’s market crisis may have subsided, but the debt worries that caused it will haunt Europe for a while yet.

That’s the bleak outlook that Finance Minister Roberto Gualtieri will reveal this week when he unveils budget targets that are likely to show his ambitions to fix the region’s third-biggest economy after its coronavirus calamity remain limited for now.

Even with European Central Bank support to help keep a lid on its borrowing, and 209 billion euros ($245 billion) of European Union aid due to start flowing its way, Italy will struggle to bring its debt-to-gross domestic product ratio down. It will jump to 158% of output this year on the back of a dramatic spending increase spurred by the coronavirus outbreak, according to a Finance Ministry official who asked not to be named.

That means 2021 may mark only the beginning of a long slog to stabilize the country’s finances and start the repair work sorely needed to address chronically weak growth and low productivity. The EU’s push to change Italy’s destiny will then take up much of the coming decade, with no guarantee of success.

“In seven years time, after the financing period, you should get a lower debt-to-GDP level,” said Lorenzo Codogno, founder of LC Macro Advisers Ltd and former chief economist at the Italian Treasury. “But the problem is, will it be sustainable? Will growth be restored on a permanent basis?”

Such worrying questions are the stuff of EU nightmares. The euro remains an imperfect union of diverging economies perpetually endangered by Italy’s mammoth 2.4 trillion-euro debt load. Foreign investors hold more than 700 billion euros of that debt, underscoring how quickly market tremors in the country can reverberate around the region.

‘Very Ambitious’

Italy’s economy is forecast to shrink 9% this year and then rebound 6% in 2021, according to the ministry official.

Even that partial recovery looks “very ambitious and challenging,” said Angelo Miglietta, professor of economics and management at IULM University in Milan, noting that EU money will take time to actually stimulate the economy.

The outlook will set the framework for Italy’s 2021 budget, which must be approved by parliament by the end of the year. The cabinet will likely ratify the projections on Sunday, before the numbers are then shared with the European Commission by mid-October.

Prime Minister Giuseppe Conte’s team is working on solutions to the country’s ills and preparing a plan on how to spend the incoming EU funds. They’ve noted that, as modest as the influx of cash may be at first, growth next year would still be weaker without it.

Meanwhile, the government has already deployed 100 billion euros of stimulus to shield businesses and citizens from the crisis. A further 40 billion euros has been earmarked for 2021, according to Gualtieri.

That aid has been underpinned by support from the ECB, whose bond purchases enable Italy to service its debt load in an affordable manner, with the yield on 10-year bonds now comfortably below 1%. With its huge borrowing needs, the central bank’s help will remain crucial for the foreseeable future.

Such an outlook would be precarious enough without an ongoing pandemic, as well as the inherent instability of Italy’s political system to contend with.

While the current government coalition of the Center-left Democratic Party and the populist Five Star Movement survived recent regional elections, Conte’s year-old alliance remains quarrelsome.

The windfall from the EU risks triggering more infighting over how to divide it up, further complicating attempts to find durable solutions to the country’s long-term economic woes, all of which overshadow every Italian government with an ever-present debt burden. Since some regional aid will arrive in the form of loans, that will also add to the borrowing.

“Debt is the main problem for Italy,” said Miglietta in Milan. “Only robust growth can make the debt sustainable in the medium long term.”

(Updates with 2021 stimulus in 11th paragraph)

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