With the rise in sovereign interest rates in Europe, concerns about public debt in Italy are resurging. The spread between Italian bond yield and the German Bund widened markedly in February. Italy’s public debt has jumped markedly as a result of the Covid-19 crisis, an increase of around 20 points of GDP over the past two years, which brings the ratio to 150% today. Italy remains the second most indebted country in the euro zone after Greece.
Can we make a connection with the situation in Italy in 2010/2011, during the sovereign debt crisis that shook the euro zone?
The situation is different for several reasons:
First, the main factor behind the current rise in sovereign yields is not the same as it was 10 years ago. Today, bond markets are mainly reacting to rise in inflation and the expectations that the ECB will start normalizing its policy. During the 2011 crisis, the increase in Italian sovereign rates mainly reflected an increase in what can be called the "risk premium", which reflected investors' concern over a possible fragmentation of the euro area, or even a departure of Italy from the monetary union. This risk is largely ruled out today.
Then, even if the pandemic has worsened public finances, its effect will gradually recede, and it should be noted that Italy managed between 2014 and 2019 to stabilize its debt to GDP ratio. Public sector net borrowing had been gradually reduced and the country had maintained a fairly comfortable primary surplus during these years. There was therefore a tendency for the public accounts to improve, which was not the case in 2011, as the impact of the global financial crisis was still being strongly felt.
Finally, the political context in the country has changed. In 2011, the government led by Mario Monti was faced with very significant political tensions, and in particular with the emergence or strengthening of radical parties, such as the 5-star movement of Beppe Grillo or the Northern League of Matteo Salvini. Since the arrival of Mario Draghi as Prime Minister in February 2021, although tensions have persisted, the former head of the ECB has built a credible coalition and it has made encouraging progress on the structural reforms agenda necessary for the country, which has brought more confidence as to the medium and long term prospect for the country.
In summary, even if the Italian debt remains of course a major source of fragility for the country, it nevertheless seems difficult to find valid common points with the situation in which it was almost 10 years ago.
