30 April 2019

Il Sole 24 Ore: Italy’s debt restructuring would do enormous damage

Lorenzo Codogno and Giampaolo Galli argue that restructuring Italy’s debt "would do immense damage; it would not solve the debt problem and should, therefore, be avoided at all costs until it is still possible to do so."

[...]The key point is that most of the debt is held by residents, directly or indirectly, and less than 30% effectively belongs to foreign investors. Which means that the burden would fall on Italian households and companies, which hold the securities mainly through investment funds, pension funds and insurance policies, and for which it would essentially be a hefty tax, as such doomed to depress domestic demand. In all restructuring of the past, most of the debt was held by non-residents. In 2012, non-residents - mostly banks - held about 70% of Greek debt. As a result, the restructuring had a somewhat limited impact on domestic demand. In Italy, on the other hand, negative effects on domestic demand would also derive from the inevitable bank losses, which would lead to a fresh tightening of credit conditions. The loss of financial market assess at non-penalising conditions for larger companies would come on top of that. Even if the government decides, as it happened in Greece, to recapitalise the banks thus creating new debt with official creditors (ESM or IMF), the problems will emerge anyway. It would de facto be a wealth tax, without even the possibility of attempting a fair distribution among the citizens.

The intensity of these negative effects would obviously depend on the size of the restructuring. A small-scale restructuring (let’s say about 5% of GDP) would be useless and would generate expectations of a greater future restructuring and therefore a further loss of confidence and capital flight. A restructuring, to be effective, should thus lead to a substantial reduction of the debt and, for a country with a ratio of 132%, should be in the order of at least 50 percentage points of GDP. But a restructuring of these dimensions would have devastating effects on domestic demand, as well as on the functioning of the entire Italian and European financial system.

Restructuring does not solve the debt problem and forces Italy to do more austerity than before. This is because only a substantial primary surplus of at least 3.0-3.5% of GDP can prevent the debt from rising again. Moreover, the country would desperately need to return quickly to finance itself in financial markets. Greece implemented draconian debt cuts by more than 50% of the face value of bonds between March and December 2012: the debt-to-GDP ratio fell at the end of 2012 (from 172% in 2011 to 160%), but it rose again already above the initial level in 2013, because Greece still had a high budget deficit (13%). Then it began a ‘way of the cross’ towards a budget surplus (today at 4.5% of GDP) which is only now allowing Greece to return to growth and regain access to financial markets.

The lesson for Italy is that it is worthwhile to think about it in the first place: aim now at a budget surplus that puts the debt on a stable downward path, rather than doing it after a devastating debt restructuring.

Full article on Il Sole 24 Ore (in Italian)

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