Wednesday, 13 July 2011

Eurozone in panic: Is Italy next domino to fall?

The Eurozone is looking at several doomsday scenarios this week after Italy emerged as the latest EU state to face serious and sudden attack by international bond and security markets. After a very public spat between Prime Minister Silvio Berlusconi and his finance minister, and with the continued political uncertainty over Berlusconi's position, the markets have decided Italy may not be safe to lend to any longer.

With the paralysis in the country's government likely to prevent decisive action to confront the crisis, some are saying Italy is perhaps days away from becoming an economic failed state. And unfortunately it is not too big to fail, but it is too big for the EU to bail out.

Such extreme rhetoric may or may not be justified, depending on who you talk to. But the risk is extreme. The countries that have so far fallen victim to the debt crisis and required an EU bailout – Portugal, Ireland and Greece – are relatively tiny and their debt makes up less than 5% of overall eurozone public debt. If worse came to worse, France and Germany could afford to buy back all of their debt combined.

Italy, on the other hand, is the Eurozone's third largest economy and its debt makes up a much higher percentage of the overall eurozone amount. It would be impossible for France and Germany to buy up Italy's debt, which has now hit 120% of its GDP - second in the Eurozone only to Greece with its 143%. Spain has seen its interest rates rise over the past few days in the same way, and it is another country where the debt is so high no buy-up would be possible. If the debt crisis spreads to all five of the so-called PIIGS countries, it could spell disaster not only for the European economy but for the global economy as a whole. All eyes are on Europe now as the world waits, and the US government is reportedly getting increasingly anxious and frustrated over Europe's inaction.

The markets are demanding that Italy rapidly put in place a set of drastic austerity measures like Spain did, but getting these through the country's broken political system will be a difficult task. Silvio Berlusconi's government is in complete disarray and he is clinging to power by just one or two votes following a series of sex and corruption scandals. Italy's president made a public plea for the country's politicians to put aside their differences and vote through these austerity measures in the next few days to save the country. But it remains to be seen whether anyone will be able to hear his call above all the shouting happening in the Italian parliament at the moment.

Emergency summit this week

Add to this the news today that Ireland's credit rating has been slashed to junk status and Greece is edging toward a default and you've got real panic happening here in Brussels. The mood at the finance ministers meeting yesterday was dire. An emergency summit of Eurozone country leaders may be called in the next few days to deal with the crisis, which has the potential to spin out of control by next week.

But even if such an emergency summit is held it's unclear whether they could come to an agreement for the decisive action the markets are demanding. Northern European countries like Finland, Austria, the Netherlands and Germany (or the 'FANGS') are demanding that any second round of bailouts for the affected countries, or a possible buy-up of all of their debt, should be aided by private banks. But the European Central Bank, which administers the euro, is staunchly opposed to this. And since such involvement would likely require some kind of organised default or 'restructuring' by the affected countries, the PIIGS aren't too excited about it either.

Time is rapidly running out. While Italy and Spain are still afloat, it is still possible for the Eurozone to take extreme action to prop up the three collapsed economies and prevent contagion. But once Italy or Spain falls it will be too late – the Eurozone would not be able to bail them out or buy their debt. And who knows what might come next.

1 comment:

Captain Kid said...

There's inaction on both sides of the Atlantic (still no consensus in the Congress) and I don't see it changing anytime soon.