Italy’s economy is in free fall. So far, the ECB has been very successful in maintaining the structural stability of the euro zone. If there is no political solution to Italy’s problems, Italy will depend permanently on the support of the ECB. In the medium term, the ECB will thus become Italy’s central bank. Debt levels will then only become accounting figures. This can now be prevented by trying to help Italy back on its feet with temporary solidarity.
Europe is in the middle of the Corona crisis, and an end is not yet in sight. To prevent the economy from collapsing, the states are already taking countermeasures with huge aid and stimulus packages. While Germany has entered the crisis with well-filled coffers, Italy is hit twice as hard. Hardly any other country has been hit as hard by the corona pandemic so far, while the country already suffered from structurally weak growth and a high debt ratio of around 135%.
Despite this unfavourable starting position, Italy will be forced to increase its debt substantially again in the short term. As economic output will decline noticeably this year due to the ongoing stagnation of large parts of the economy and despite government aid measures, Italy’s debt is likely to increase significantly within a year, probably to over 150% of GDP – a new record.
If a debt level at this dizzying height had still been a cause of great concern to investors a few years ago, the chaos on the government bond markets is nowhere in sight. The ECB is primarily responsible for this. Although it is not allowed to subscribe to government bonds on the primary market (i.e. to buy bonds from governments directly upon issue) because of the ban on monetary government financing, it has been regularly active on the secondary market since the beginning of the government bond purchase programme. Not only has the ECB Governing Council decided to massively increase the bond purchase volume in the course of the crisis to a total of around EUR 1.1 trillion (!) this year, the new crisis programme PEPP also allows the central bank to deviate permanently from the country key and to buy proportionately more Italian bonds. Should there still not be enough demand for Italian paper, the ECB could both increase the PEPP volume and activate its OMT programme (Outright Monetary Transactions).
Is Italy’s soaring debt mountain not a real problem in the end? This question is likely to be asked anew, especially once the Corona crisis has subsided, as the ECB gradually reduces its emergency programmes. In fact, the problems for Italy would then be inevitable. To compensate for the falling demand for Italian paper, Rome would be forced to introduce a combination of savings and growth-enhancing measures that would convince rating agencies and investors of the country’s debt sustainability. In view of the lack of willingness to reform in recent years and the economic damage, however, the chances of this are probably not too good. In addition, there has not yet been sufficient political willingness to make transfer payments and for a temporary debt pooling on the basis of a corona fund solution in EMU. The EMU states will therefore not support Italy to the extent required.
Consequently, even after the crisis there is no realistic chance that the ECB will stop buying Italian government bonds. Otherwise there is a risk of risk premiums being overshoot, which would not only shake Europe’s largest debtor, but could also pave the way for the still strong right-wing populists in the country to return to power.
If the euro area is to be preserved and there is no political solution, Italy is permanently on the ECB’s drip. The ECB is then effectively forced to act as the central bank of Italy and other peripheral countries in order to avert damage to the euro. Aware of this, record levels of debt, similar to those already seen in Japan, suddenly lose their significance and become more like „accounting figures“ that form the opposite side of the central bank balance sheet. Italy’s debt mountain can thus no longer be viewed in isolation. Rather, it is a question of confidence in the ECB and the eurozone as a whole, which is reflected in external relations, especially in the exchange rate of the euro. As other major economies are facing similar problems, the euro has proved to be relatively robust even in the crisis. However, as long as the stability of the euro is not called into question, the ECB will not feel any pressure to reconsider its support policy for the periphery and to look for alternative solutions.