Italy's Public Debt Is Worse Than You Think

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Includes: ADRU, DBEU, DBEZ, DBIT, DEUR, DEZU, DRR, EEA, EPV, ERO, EUFL, EUFN, EUFX, EUO, EURL, EWI, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEE, FIEU, FLIY, FXE, GSEU, HEDJ, HEWI, HEZU, HFXE, IEUR, IEV, PTEU, RFEU, UEUR, ULE, UPV, URR, VGK
by: Desmond Lachman

Before proceeding with its budget-busting measures, the new Italian government might want to consider how large the country's public debt is. It might also want to take into account how short Italy's public debt maturity is and how exposed the country is to the whims of the global bond market.

Newly appointed Italian Prime Minister Giuseppe Conte gestures during his first session at the Senate in Rome, Italy, June 5, 2018. REUTERS/Alessandro Bianchi

Italy's public debt is officially estimated to be at around 133% of GDP, making Italy the second-most indebted country in the eurozone after Greece. However, as Carmen Reinhart has correctly pointed out, the official Italian debt numbers do not include the Bank of Italy's debtor position of more than EUR400 billion in the European Central Bank's Target 2 accounts.

If one adds the Bank of Italy's Target 2 liabilities to the Italian public debt total, the public debt to GDP ratio rises to 160%, taking that ratio to its highest level in over 100 years. Sadly, there is every reason to expect that Italy's Target 2 balance will worsen in the months ahead as the unsettled Italian political situation encourages capital flight.

Another reason to think the Italian official public debt numbers are understated is they do not take into account the likely cost of government support for the country's troubled banking system. This support could be large considering that the Italian banks' nonperforming loans amount to as much as 15% of their balance sheets, while almost a further 10% of their balance sheet is made up of Italian public bonds.

As if all of this were not bad enough, Italy's public debt suffers from the fact that at around only 7 years the average maturity of the debt is relatively short. In practical terms, the country will have to roll over more than EUR600 billion of its debt over the next three years and more than half of its debt over the next five years. This could prove to be challenging in a less favorable global liquidity environment than at present.

It is against this backdrop that one has to hope the new Italian government quickly backs off its budget-busting proposals, which would make the country's public debt even more unsustainable. Those proposals include the introduction of a guaranteed basic income and a flat income tax. Together those measures are estimated to increase Italy's budget deficit by EUR100 billion.

If the Italian government does not become fiscally more responsible soon, we should brace ourselves for another round of the European sovereign debt crisis. That in turn could have repercussions for the global economy considering that with a public debt of more than US$2.5 billion, Italy is the world's third-largest sovereign bond market.