Monday, July 11, 2011

Italy: Too Big To Bail Out? ECB: "We're very worried about Italy"

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The European Debt Crisis is spreading from Greece to Italy


Too Big To Bail Out?

Italy is the third largest economy in the Euro Zone, behind Germany and France. The Italian economy is twice as large as the combined economies of Greece, Portugal, and Ireland, the countries already bailed out in Europe. Euro Zone Finance Ministers met to discuss the latest plan to solve the second round of debt crisis in Greece. In the meantime, contagion fears are spreading to Italy. As with Greece, Italy also has a high public debt-to-GDP ratio and a dismal forecast for economic growth. Can Italy ultimately pay its debt? Are the Italian banks potentially in trouble as they hold in their assets the Italian government debt?

Precarious State of Italy's Finances

Mohamed El-Erian, CEO of PIMCO, wrote a blog post on Sunday, July 10, 2011 and noted a credit crisis in Italy "would mark a significant extension of the regional debt crisis that Europe has repeatedly failed to come to grips with". Credit spreads and bond yields for Italian sovereign debt have spiked and stock prices for Italian banks are significantly decreasing. A senior official at the European Central Bank was quoted by Reuters as saying, "We can't go on for many more days like Friday. We're very worried about Italy." Overall, El-Erian is more confident about Italy, than Greece, Portugal, and Spain. "While the country's debt stock is high, the maturity profile is not as worrisome. Its investor base is less volatile. Adjustment fatigue is not an issue. The internal flexibility of the economy is greater. And the scope for corrective policy actions is much bigger."

Mike Riddell, a fund Manager at M&G in London, notes “As Italy or Spain or whoever’s bond prices collapse, the borrowing costs rise. As the borrowing costs rise, the interest costs steadily rise and the fiscal situation deteriorates. As peripheral sovereigns blow out, banks need to raise more and more capital to cushion themselves against the cost of future sovereign restructuring, but this bank capital will get increasingly expensive just at the time that the banks need it most.”

Italy has a debt equal to 120 percent of annual gross domestic product, one of the highest in the euro zone. The market selloff last week was sparked by tensions between Mr. Berlusconi and Mr. Tremonti. Mr. Tremonti, the country’s long-serving finance minister, has been praised for his handling of the economy during the financial crisis and, in particular, for keeping control of the budget deficit - one reason why Italy has, up to now, escaped the significant market pressures that have been brought to bear on Greece, Ireland and Portugal. His reluctance to endorse the tax cuts Mr. Berlusconi desires has put an acute strain on relations between the two men.

European Debt Crisis

Ahead of Italy in the European Debt Crisis was Ireland, Portugal, and Greece. Behind Italy is Spain. Spain could be next -  during or after the debt crisis in Italy. Greece, Ireland, and Portugal have already received bailouts and implemented fiscal austerity measures. Greece is now in the process of a second round of bailouts and austerity measures.

CNBC Guest Blog — El-Erian: Keep a Close Eye on Italy - CNBC

Italy Becoming a Bigger Priority for Euro Zone - CNBC

euro zone debt crisis: Italy, Spain Will Mean More 'Carnage': Fund Manager - CNBC


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