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Italy’s debt-to-GDP rose to 133% as a result of the crisis not bad fiscal policies: still, Europe needs eurobonds

by Isabella Bufacchi

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Positive signs in Italy are “unmistakable.” Governor of the Bank of Italy Ignazio Visco started his much-awaited annual speech with a positive note, as he went on describing in great detail Italy’s economic recovery and vulnerabilities.

In its traditional “Concluding Remarks” in Palazzo Koch, (Italy’s central bank headquarters are in Via Nazionale at walking-distance from the Head of State Quirinale and the Ministry of Economy and Finance), Visco indeed shed a light on Italy’s “potential to recoup the growth gap it has accumulated in the last twenty years” and gave more than a glimpse of hope on Italy’s capability to lower its high public debt, which is one of its biggest weaknesses.

“The increase of the ratio of debt to GDP, from just under 100% in 2007 to almost 133% last year is largely a consequence of the crisis,” he said, adding that with real GDP growth at the same level as the past two decades and a deflator equal to the inflation target “the debt burden would have risen only by 3%, slightly less than the increase stemming from Italy’s financial assistance to countries in difficulty.”

Visco’s message is reassuring as Banca d’Italia has a reputation on the markets of being “a reliable source:” Italy’s fiscal policy after the global financial crisis “limited the deficit,” the primary budget balance returned to surplus in 2011, net borrowing went below the threshold of 3% of GDP in 2012. And the reduction of the debt-to-GDP ratio is “appropriately indicated as a strategic objective.”

Italy does need growth to grow out of its high public debt: and Visco’s recipe for a durable recovery asks for more public investment in infrastructure and a reduction of the tax wedge on labour.

Visco did address in his speech the “problems still facing Italian banks,” which include technological challenges, regulatory changes, the large volume of non-performing loans, inadequate governance arrangements, the squeeze on profits, the need to curb high fixed-costs and to seek diversification of income. But he also gave a positive note on the pressing problem of NPLs, saying that “they are largely the legacy of the long and deep recession” and “have now reached a turning point,” given the significant decline of new bad loans in 2015.

The harshest words by the Governor were not inward looking, they were targeted to the unfinished project of the European Union. He warned on “limited risk-sharing” and “a situation of vulnerability.”

According to Visco, there is the danger not only that national and European authorities will be unable to react adequately to major shocks, but even that they will have trouble avoiding contagion triggered by circumscribed tensions.” There are no “adequate safety nets,” meaning no risk-sharing. The financial capacity of the ESM (European Stability Mechanism) is “modest,” the Banking Union is half way and there is no unified guarantee on deposits; there is no real backstop to the Single Resolution Fund; there are no common debt instruments (eurobonds) and the fiscal union looks far away from being accomplished; there is no fund to which a portion of sovereign national debts could be assigned.

“It is the euro area that is in focus of the markets’ most serious concerns,” he said.