Italian crisis could ruin the euro

After 88 days of coalition talks, Italy has finally formed a new government.  Unfortunately, the new government could kick off an Italian crisis.  That’s because it’s a fragile coalition of the anti-establishment Five Star Movement and the right-wing League party.

Their only shared position seems to be an anti-European Union (EU) and anti-euro sentiment.  Indeed, the two parties nominated a noted euro-skeptic, Paolo Savona, as the economy minister.

This caused a mini-crisis as the Italian President objected to including him in the government.  The two parties grudgingly backed down but it’s only a matter of time before their anti-euro sentiment resurfaces.

This has already caused great dismay across the halls of power in the EU.  Indeed, the new Italian government has declared its intention to break the EU’s fiscal rules by raising benefits, lowering the retirement age and lowering taxes.

Economists estimate this would cost a hefty €170 billion.  To put that in perspective, that would add about 8% to Italian government’s debt-to-GDP ratio.

More importantly, it would push the debt-to-GDP level to an unsustainable 140%.  That’s well above the 120% debt-to-GDP ratio that International Monetary Fund (IMF) officials contend is sustainable.

This scares EU officials because Italy’s debt level is heading to the same level that triggered Greece’s debt crisis back in 2010.  The European Union narrowly escaped catastrophe that time by bailing out Greece.

Indeed, one of the main reasons why the richer northern European countries bailed out Greece was because they feared the economic contagion from the crisis would spread to Spain and Italy.  And they wanted to avoid that at all cost.  This time will be different and much worse because …

Italian crisis that can wipe out the euro and mortally wound the EU

The main difference between Greece and Italy is that Italy is about ten times the size of Greece.  Moreover, Italy’s debt pile is already up to a staggering €2.1 trillion.  Essentially, Italy is too big to bail out.

If the new Italian government pursues the policies it has published, investors will start fleeing in droves from its debt.  That will inevitably force interest rates on Italian debt higher and trigger a new crisis that will be ten times worse.

And we’re already seeing the early start of this Italian crisis.  The yield on 10-year Italian government bonds has shot up to by one percent to 3.13% over the last month.

That might not sound like much but a 1% rise in interest on its €2.1 trillion debt would add about €21 billion in debt expense to the Italian government fledgling finances.  That’s enough to increase Italy’s annual budget deficit by 55% to €59 billion.

In turn, this could easily trigger a mass exodus from Italian debt and send the yield on its debt soaring further.  Essentially, this creates a downward spiral similar to what happened to Greece a couple of years back.

Italy is the Eurozone’s third-largest economy.  Accordingly, any threat to its long-term fiscal health or membership to the Eurozone will create a mass panic that will make the Greek crisis look like a walk in the park.

Effectively, an Italian crisis could mortally wound the eruro and tear apart the EU.  Even if Italy avoids financial disaster, the continued rise in political and economic uncertainty is going to put pressure on the euro.

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Al Basoglu

I am a financial services professional with over a decade of experience in various roles. I've lived and worked abroad in 5 different countries while pursuing personal and professional challenges. My interests include markets, history and different cultures. I tend to weave all of my interest into my analysis and articles.