Italy’s Debt Crisis Puts the European Union at a Crossroads

The Italian economic crisis is just the tip of the iceberg for the EU.

Article From Fee.org | Thursday, May 9, 2019

World Economic Forum [CC BY-SA 2.0 (https://creativecommons.org/licenses/by-sa/2.0)]

 Vijay Victor

The European Union at present is undoubtedly at a crossroads. The economies that were once reckoned strong pillars of the EU are now weakening. Economists gave several warnings on the soaring debt issues in many economies in the eurozone following the financial crisis of 2008, and the EU’s worst nightmare began with the economic crisis in Greece in 2015. Upon acceptance of a stringent set of austerity measures, bailouts were offered to Greece to make the biggest financial rescue of a bankrupt country in history.

An Economy Under Austerity Measures

However, economists believe that the bailout has not helped Greece and are considering the long-term consequences of the austerity measures on the economy.

"Greece has been a colossal failure. It is a tale of incompetence, of dogma, of needless delay and of the interests of banks being put before the needs of people. And there will be long-term consequences,” wrote Larry Elliott, economics editor of The Guardian.

Yet, there is more to be added to this debt saga. Italy is now pushing the EU to the brink of another economic crisis. The third largest economy in the eurozone is now a sinking ship, with an estimated growth rate of just 0.1 percent for 2019. The statistics show a shocking result that Italy’s GDP per capita remains stagnant at the same level as 18 years ago. The latest statistics reveal that the current debt of Italy is around 130 percent of the total GDP, which is nearly 2.6 trillion dollars—almost the same as the size of the Indian economy in nominal GDP terms. The Italian economy is ten times bigger than that of Greece’s, further exacerbating the intensity of this economic crisis.

John Higgins and Adam Hoyes, economists at Capital Economics, mentioned in a research note that "Unlike Italy's, Greece's debt-to-GDP ratio is on a downward trajectory and its debt has been restructured under far more favorable terms than Italy's. What's more, Italy's debt is much larger in absolute terms and poses a much bigger systemic risk for the euro-zone as a whole.”

Looking at the long-term growth prospects, the statistics show a shocking result that Italy’s GDP per capita remains stagnant at the same level as 18 years ago.

                                    | Source: OECD

The Italian banks are already financially weak, scuffling with refinancing their bond issues and huge debts. This has drastically reduced their capacity to lend the funds required to rejuvenate the flailing private sector, too. Loans to the private sector decreased from 679,216 million euros in January 2019 to 676,955 million euros in February 2019, marking a difference of 2,261 million euros over a period of just 30 days.

Loans to the Private Sector in Italy from 2014 to 2019

        |   Source: Trading Economics| Banca D’Italia

The economic issues in Italy have already posed major threats to the monetary targets of the European Central Bank. The crisis in Italy, if not contained, could shatter market confidence in the entire Euro area, putting the EU in big trouble.

Whom Should We Blame?

Undoubtedly, the political scenario in Italy made the crisis worse. The radical measures of the new populist government in Italy is threatening the autonomy of the Italian central bank, Banca D'Italia. The new government would like to take control of the sizeable gold reserves of the Italian central bank. “The gold is the property of the Italian people, not of anyone else,” said Matteo Salvini, the deputy prime minister and the leader of the League Party, making clear what the government is up to. This was also followed by the removal of the leader of the central bank to prevent a banking crisis in the country.

In 2018, the Italian government sought to raise its budget deficit to 2.4 percent for the next three years. However, this proposal was not acceptable to the EU. The conflicts of interest between the government and the EU became visible from there. With a common currency in use, it is impossible for the Italian central bank to think of a currency devaluation. Italian economists might also be regretting the government’s decision to switch from the lira to the euro.

During the period of the lira, even the German stocks were outperformed by the Italian stocks. Nevertheless, it is not a good choice to go back to the lira at this moment as it would cause massive losses to the investors in the whole of Europe, resulting in an unprecedented global economic crisis.

It is only a matter of time until we see what it will cost for the EU to put a stop to this rapidly spreading debt contagion.

This instability persisting in the eurozone shows the failure of employing a common fiscal and monetary policy hand-in-hand, which also calls into question the rationale of the concept of an economic union. In fact, the best performing economies are also threatened by the preposterous political and economic decisions taken by the leaders of member countries.

The Italian crisis now poses serious threats to the whole eurozone. Attempts to persuade the ambitious Italian government to stay in line with EU policies will amount to a tussle we will witness in the near future. However, the Italian economic crisis is just the tip of the iceberg. The debt issues in other European economies, including Portugal and Spain, are also serious matters of concern.

“The fundamentals in many European countries are still relatively weak. Spain is still running an excessive deficit, as is France,” said Michael Leithead, head of fixed income at EFG Asset Management. Mario Draghi, the European Central Bank president, mentioned in 2012 that the bank will do “whatever it takes” to save the euro. It is only a matter of time until we see what it will cost for the EU to put a stop to this rapidly spreading debt contagion.

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