There is a significant risk that Italy will become the euro-zone’s 6th country to receive a bailout.
Italy is the euro-zone’s third largest country and a member of the G-7. It also has the world’s third largest debt market. The debt-to-GDP ratio in Italy is over 120%. In the second Greek bailout, a goal of 120% debt-to-GDP was the target for 2020. This number was clearly derived from the situation in Italy.
Italy is still trying to hide behind Spain, but its recent efforts in the EU Summit show that Italy’s technocrat Prime Minister Mario Monti has a lot to fear.
Monti replaced the controversial Silvio Berlusconi in the fall of 2011. Monti enacted some big reforms, gained market confidence and also managed to enjoy support from political parties and the Italian public.
Yet his policies have hit the Italian economy:
- The economy contracted by 0.8% in Q1, far worse than the average euro-zone rate of 0%.
- Purchasing managers’ indicators for Italy during Q2 are pointing to fast contraction in all sectors: manufacturing, services and retail.
- Retail sales fell in the past two months, and both fell below expectations: -0.8% and -1.6%.
This is the price of austerity and the global slowdown. The Italian public is no longer supportive of Monti. Unfortunately also the markets are not supportive. The recent 10 year bond auctions both resulted in yields of over 6% – very unsustainable mixed with fast contraction and a high debt-to-GDP ratio.
Political Instability
Monti still has the backing of the Italian political parties that are in parliament, but they will not support him on further reforms. Markets need to see more pension and labor reforms in order to provide Italy some relief. This isn’t happening.
He used this lack of support to squeeze Germany to some concessions in the EU Summit. There were rumors that he threatened to resign if he wouldn’t return with any achievements.
And outside of parliament, a new force is rising: Former comedian Beppe Grillo’s 5 Start Movement is gaining traction in opinion polls after winning local elections in May. The 5 stars mostly represent anti-establishment and anti-corruption rules. Grillo personally supports an Italian exit of the euro and a default on debt.
The anti-euro sentiment is echoed by some mainstream politicians and threatens the stability of the euro-zone. This sentiment could rise if Italy opts for a bailout.
This article is part of the Forex Monthly Outlook. You can download it by joining the newsletter in the form below, which appears on any article on Forex Crunch.
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