Eurozone rocked as Italy’s technocrats lose their grip on power
Tim Wallace
5 min read
Mario Draghi Italy - Ellie Littlemore for The Telegraph
The latest twist of political fate in Italy has ignited an unusually contentious blaze at the heart of the eurozone nation.
Mario Draghi, who became Prime Minister in 2021, wanted to let Rome’s authorities build a new waste incinerator as part of a package of new spending measures. His plan was fiercely opposed by Five Star, a party founded by a comedian and an important part of the coalition which backs the technocratic Government.
On Thursday, Five Star refused to back the former president of the European Central Bank in a confidence vote in Parliament, demanding more environmentally friendly policies — as well as cash to help with the cost of living. On the other side of the coalition is Lega, a more right-wing party led by Matteo Salvini who has grumbled Draghi has slipped too far to the left.
The PM won the confidence vote, but handed in his resignation to President Sergio Mattarella after losing Five Star’s backing. Mattarella rejected Draghi’s resignation attempt on Thursday evening and asked him to address parliament to gauge the political situation.
Amid the instability, Italy faces losing a leader who is highly respected in financial markets at a critical moment — interest rates are rising and Italy needs the support of lenders to keep on financing its teetering mountain of debt.
It marks a dangerous moment for Italy and its economy, and threatens to rock the wider eurozone.
At more than 150pc of GDP, Italy’s debt is far larger than that of any other major economy in the currency area. Spain’s amounts to 118pc of its output and France is at 113pc. Germany is far less indebted with its Government borrowings equivalent to a mere 69pc of GDP.
As it stands, Italy’s debt is one-fifth higher than it was in the summer of 2012 — at 125pc of GDP — when Draghi pledged the ECB would do “whatever it takes” to support the eurozone. His unexpected but extremely valuable promise helped get the sovereign debt crisis under control.
Rome has been able to support surging debt levels thanks to rock-bottom interest rates.
While the ECB has been more cautious, borrowing costs have risen in financial markets nonetheless. For Italy in particular, that risks making its debt pile unsustainable.
The country’s 10-year borrowing costs in bond markets have already risen from 0.7pc a year ago to 1.17pc at the start of 2022, to a current 3.4pc.
During the sovereign debt crisis, economists worried that sustained bond yields of above 7pc would leave Italy on an unsustainable path, its Government unable to cut spending or raise taxes enough to keep a lid on borrowing.
Given the increase in debts over the past decade, Jack Allen-Reynolds at Capital Economics now puts that tipping point interest rate at 5pc.
Christine Lagarde, Draghi’s successor in Frankfurt, is working on a plan to raise interest rates for the eurozone as a whole but keep buying bonds at the same time. It is to reassure financial markets that the ECB is working to keep governments’ borrowing costs down and so help keep the currency zone together — much as Draghi did himself back in the debt crisis.
But that is an untested policy, and the return of political upheaval threatens to pull Italy back to the bad old days, when the Government and markets were in tension. Then, every policy received immediate judgement from financiers on whether or not it would make the country’s debts more or less sustainable.
Christian Schulz, economist at Citi, says this danger “could not resurface at a more inopportune time” than when the ECB is looking at creating this new tool.
“The tool was likely never meant to counter spread-widening due to idiosyncratic country risk,” he says, anticipating officials may limit the way it is used, demanding “tighter limits, stricter conditionality and higher pain thresholds” on bond buying.
Elwin de Groot at Rabobank says the turmoil “is not providing any support for the single currency”, as the euro has fallen to parity with the dollar for the first time in 20 years.
He suspects the political chaos could even push cautious policymakers at the ECB away from its new policy, thus undermining the central bank’s latest plan to maintain stability in the eurozone.
“One could argue that a political crisis only makes the ECB’s balancing act more complicated, as we would not be surprised if the hawks take this as evidence that any such tool is fraught with risks, such as the ECB falling hostage to politics,” he says.
That would leave Italy more exposed to rising borrowing costs at a critical moment.
Polls indicate more right-wing parties have gained support since the 2018 election, raising the prospect of a more eurosceptic coalition taking over, which Allen-Reynolds says could imperil the supply of further EU funds which the Italian state has been counting on receiving.
“Italy has already received 25pc of the funding allotted to it under Next Generation EU, but to receive the rest the Government would have to continue implementing reforms,” says Allen-Reynolds.
“They have got an inefficient public sector, IT adoption is low, the business environment is extremely difficult and the legal system is very, very sluggish. The reforms are aimed at improving all of those, so in that regard they make sense and they have made progress implementing those reforms.”
As well as delivering extra cash from Brussels, the reforms should, in the long run, help boost economic growth in a country blighted by inefficiency, debt and an ageing population.
But without Draghi, who achieved “an extremely unusual — by Italian standards — degree of unity… it is going to be much more difficult in future.”
