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The COVID-19 crisis has led to something of a paradox: Italy’s public debt ratio has risen, but the probability of default has fallen. That’s largely because BTP yields are likely to stay far lower than seemed plausible before the pandemic, meaning that interest costs will fall. As a result, economists at Capital Economics now think Italy’s debt ratio is likely to decline over the next decade.

Key quotes

“Italy’s debt dynamics have actually improved. The most important reason for this is that, thanks to the ECB, bond yields are likely to remain far lower than seemed likely before the pandemic.”

“Italy’s debt ratio will trend down over the next decade, rather than keep rising. And lower debt interest spending will make default much less of a risk.”
“The risk to the public finances is still higher in Italy than elsewhere in the eurozone. After all, the debt ratio will remain very high and, unlike Japan for example, Italy does not control its own monetary policy.”

“There are three key downside risks to our forecast. The first is that the ECB reins in its asset purchases too quickly. The second is that there is another major economic crisis over the next few years which puts additional strain on the public finances. And the third is that a populist government brings the state’s commitment to honouring its debt into question. Nonetheless, overall risk is lower now than before the pandemic.”