Fiscal prudence requires attention even as Draghi’s investment plan is key to boosting growth


Italy is unlikely to reverse debt ratios on a scale to reach pre-crisis levels

The government also expects an economic boost via an additional tax package of 40 billion euros (2.4% of 2020 GDP) after the previous round of “DL Sostegni” support of 32 billion euros.

Italy’s budget deficit will widen to minimum in the short term: the government’s 2021 estimate is 11.8% of GDP – above an earlier government estimate of 7% as well as December’s forecast Scope of 9% for this year – before falling to 5.9% of GDP next year. year and to the 3% Maastricht limit by 2025. According to government projections, public debt will rise to around 160% of GDP in 2021, falling from 156% in 2020 before falling, in a scenario of “Full NGEU effect”, at 135.5% of GDP by 2032, close to the level of 134.8% before the crisis.

In our view, Italy is unlikely to reverse debt ratios on a scale to reach pre-crisis levels. The risk of a budget deficit is also on the upside, as many households and businesses may need prolonged support and growth expectations may turn out to be optimistic. While we are also of the view on the appropriateness of countercyclical government spending during the crisis, the question, during a current early recovery, will be deciding when and for which sectors public support will be withdrawn to allow markets to recover. operating again and reallocating resources more efficiently, as well as when to authorize certain insolvencies.

Fewer restrictions preventing the increase in sovereign borrowing

In view of the ongoing transitions in fiscal orthodoxy in favor of pro-growth policies, the pre-crisis checks and balances that limited the scale of spending have been relaxed as the crisis emerges. The disciplining powers of the market against high spending and government excesses are also expected to remain suppressed for an extended phase, as the ECB’s intervention implemented an implicit put option, likely holding even longer lasting signaling effects. after central bank purchases start to be canceled – restricting the market willingness to sell past borders.

Under such conditions of reduced safeguards limiting the expansion of the sovereign balance sheet, we have touch In the past, projections by the government, IMF and other forecasting bodies for a rapid and lasting decline in Italian public debt ratios from 2021 could be optimistic. Instead, we expect the Italian debt ratio to stay on a longer-term upward path – looking at the whole cycle. In this regard, general government debt could reach significantly higher levels above 160% of GDP.

Italy may not need to reduce public debt to pre-crisis levels

But, at the same time, Italy cannot need reduce public debt to pre-crisis levels.

Italy can withstand somewhat higher debt ratios at prevailing BBB + credit rating levels than it could before the crisis. This is partly explained by the extraordinary European monetary and budgetary support, but also by the improvement in the profile of Italian public debt.

The weighted average cost of outstanding debt fell from 4% in 2012 to around 2% this year. With a 10-year BTP yield of just 0.8%, this weighted average cost of outstanding debt will continue to decline. The Italian Treasury has extended the average maturity of debt to 7 years, down from 6.7 in August last year.

Even though Italy’s current debt ratio of 160% does not automatically signal a crisis as it would have been 10 years ago, there are nonetheless limits to the debt that Italy can ultimately hold within. of a monetary union in which the Italian sovereign has no independent monetary policy.

Ultimately, monetary space creates fiscal space

Ultimately, the monetary space creates fiscal space – and the fiscal space that Italy has, for example, to spend countercyclically in a future crisis even with higher debt levels – depends on the market confidence in the effectiveness of Italian government policies, which may currently be high, but also in the level of support the ECB is prepared to provide to Italy and other euro area member states and the associated constraints which the ECB itself faces in order to be able to provide such large-scale support.

At this point, we believe that even with high public debt, Italy has fiscal room for maneuver in a forthcoming crisis, in part given the ECB’s ability to ensure accommodative market conditions. But that, in itself, does not mean that governments can ignore the challenges of longer-term fiscal sustainability.

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Dennis Shen is Director of Sovereign and Public Sector Ratings at Scope Ratings GmbH. Giulia Branz, Associate Analyst at Scope Ratings, contributed to this commentary.

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