The Sustainability of the Public Finances

The deterioration in global growth projections and the increase in risk aversion have prompted investors to focus much more attention on the level of public and private sector debt, at the expense of analysis of the outlook for issuers' solvency. This development has contributed to more onerous borrowing conditions for Italy, but it does not appear to take full account of the strengths of the Italian economy, such as the prudent conduct of fiscal policy in recent years, the solid financial situation of households and firms, the low level of foreign debt, the absence of imbalances* in the real-estate sector, and the soundness of the banking system.

According to the IMF, in the next two years the debt-to-GDP ratio will continue to rise in all the leading countries* except Germany and Italy (see table). In Italy, it is expected to begin decreasing in 2013 (in 2012 according to government forecasts) thanks to the substantial deficit reduction planned over the next two years. The resources needed to finance the maturing debt and the new deficit in Italy in 2012 amount to 23.5 per cent of GDP, less than in the United States (30.4 per cent) and Japan (58.6 per cent) and only slightly more than in France and Spain.

Moreover, the traditional indicators of the sustainability of the public debt paint a fairly favourable picture for Italy. For instance, the European Commission estimates that the improvement in the primary budget balance needed to stabilize the debt-to-GDP ratio is 2.3 percentage points for Italy, compared with 6.4 points for the euro area as a whole and 9.6 for the United Kingdom. A similar indicator calculated by the IMF confirms Italy's favourable position also with respect to the United States and Japan. The result for Italy reflects the pension reforms introduced beginning in the 1990s, which have significantly reduced age-related expenditure (when fully phased in they will be 1.5 percentage points of GDP higher than at present, against 3.4 points for the euro area as a whole). Similar results are obtained using an indicator recently developed by the Commission to take account of additional information concerning a country's vulnerability to macroeconomic risks.

[* Ed: their table includes Italy, Germany, France, Spain, Greece, Portugal, Ireland, United Kingdom, United States and Japan]

David Fuller's view I think most investors are overstating the risks concerning Italy's ability to manage its debt. Dissenters should at least have a look at this very detailed 62-page report from Banca D'Italia, Italy's central bank, particularly pages 13, 14 and 15.