ITALY DEBT BURDEN: EUROZONE’S STABILITY – BY Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

October 14, 2014 | Posted by bobbysrinivasan << back to blog

According to the Mastricht Agreement, all member countries in the Eurozone are expected to keep their annual budget deficit below 3% and the total debt not to exceed 60% of the GDP. Practically, every member country violated this norm. Among the worst offenders, Italy stands out. As per the OECD, between 2007 and 2013, the Italian public sector debt rose from 103.3% to 132.6%. For this financial year, it is expected to touch 137.5% and will touch 150% by FY 15-16. The question to ask is at what point will Italy become insolvent.
Observation 1: Japan debt to GDP has already exceeded 200% as of now and it is solvent. But Japan, unlike Italy, has its own Central Bank.
The main reason for the explosion in the debt ratio has been the fall in nominal GDP – the euro value of economic output. When this falls, the debt to GDP raises. It even raises when the country does not incur any new debt.
Observation 2: The only way out of this economic quagmire is to have the nominal GDP to raise faster than debt.
Being a member of the Eurozone, it lacks policy instruments of its own. For example, it has no domestic interest rate, it can lower it to revive growth. It has no central bank to monetize debt. It has no exchange rate it could devalue.
But what Italy wants to achieve is what the Eurozone economic policy could achieve by lowering the interest rate in the euro. But the interest rate is already near zero (0.05%). There is not much that can be done here. So, the only alternative available is a major structural reform. For example, Italy needs changes in the legal system. It needs to lower the taxes down to the Eurozone average. It must also revamp the corrupt public sector. In summary, Italy needs to change the entire political system.
One possibility is the European central bank which provides ample liquidity to the Italian economy by buying Italian government bonds. It could also issue new bonds to raise funds. This is easily said than done.
Thus, in summary, Italy needs a lot of extreme and coordinated policy action to make it possible to grow the nominal GDP, service debt and ultimately, stay in the Eurozone. But, the policy adopted is neither extreme nor coordinated. Mateo Renzi, the Italian Prime Minister, has promised radical reform but not yet delivered. What is really needed is a set of policies at the Eurozone level to revive the Italian economy.
Lesson: Indefinite increase of debt in any country is only courting disaster. Indian government debt level though not crossed the 100% of GDP is a cause for concern. Mr. Jaitley has provided Rs.20 out of every Rs.100 spent towards interest payment on the previously borrowed money. Overtime, this has increased and is slowly strangulating the Indian economic growth.

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