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Berlusconi Partying With Minor Raises Bond Risk: Euro Credit

Italian Prime Minister Silvio Berlusconi
Italian Prime Minister Silvio Berlusconi. Photographer: Georges Gobet/AFP/Getty Images

Italian Prime Minister Silvio Berlusconi faces calls for his resignation amid a sex-related scandal, driving up bond yields a month after he quelled a revolt that threatened to bring down his government.

The yield premium investors demand to hold Italian 10-year debt rather than German bunds has climbed to a one-month high of 155.7 basis points. Borrowing costs for European Union’s most- indebted countries soared this week as the EU planned rules to allow members to restructure debt. Italy may face the added risk of a change in government or political paralysis as Berlusconi battles to keep his ruling coalition intact.

Opposition leaders called for Berlusconi to step down this week amid reports in Italy’s biggest newspapers, including Corriere della Sera, that he intervened to get a 17-year-old woman, who attended a party at his private residence, released from police custody. Gianfranco Fini, a former ally who split from Berlusconi’s party in July and whose support the premier needs to stay in power, said Berlusconi should quit if it’s proven he intervened to secure the girl’s release.

“Investors should not ignore political risk given what’s going on now,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “I’m not saying Berlusconi is about to sink, but there’s a risk the market appears to be underestimating. Italy might not have the fiscal problem that Portugal or Ireland have, but you still need a strong and efficient government to push things through. And in this environment, confidence is everything.”

‘Baseless Attacks’

Berlusconi in a speech in Rome today said the reports “baseless attacks” that wouldn’t drive him from power. He called on Fini to openly declare whether he still supported the government, saying the only alternative would be early elections.

Berlusconi doesn’t deny helping the girl, saying he simply sent a friend -- his former dental hygienist who is now a regional politician for his party -- to the police station in Milan to aid the woman upon her release. In a Nov. 2 interview with “Oggi” magazine, the woman said she attended a party at Berlusconi’s Milan residence with 10 other women and was given cash and gifts by the premier. The party was in February, months before her unrelated arrest in May on suspicion of theft.

Massimo D’Alema, a former prime ministers who heads the parliamentary committee that oversees the country’s secret service, yesterday called on Berlusconi to appear before the group to discuss security issues raised by the revelations.

Economic Recovery

Berlusconi, 74, who has more than two years left in his term, said Nov. 2 that early elections would threaten the economic recovery. Italy emerged from its worst recession in 60 years last year and the economy is set to expand 1.2 percent this year after shrinking 5 percent in 2009. That contrasts with contractions forecast for Greece and Spain.

“The most negative and gravest thing for our country, which is emerging with difficulty from a profound crisis, would be to have to face an election campaign in which everyone would go after each other ferociously,” he said in a Nov. 2 speech in Milan.

In a poll for RAI state-owned television broadcast Nov. 2, 45 percent of respondents said Berlusconi should resign. Standard & Poor’s, in reaffirming Italy’s A+ credit rating the same day, said political instability was one of the biggest risks to the country’s creditworthiness going forward.

Merkel Remarks

The latest political headache for Berlusconi coincides with a renewed slump in peripheral bonds after Germany forced EU leaders to accept the notion that bond investors must share the costs of any future bailouts. German Chancellor Angela Merkel said Oct. 29 that there is “a justified desire to see that it’s not just taxpayers who are on the hook, but also private investors.”

The resulting jump in yields may have the biggest effect on Italy, which has the euro-region’s largest debt and still needs to sell more bonds than the others this year.

“Another risk factor is the new debt-crisis mechanism,” said Fabrizio Fiorini, the head of fixed income at Alletti Gestielle SGR SpA in Milan, who manages about $8 billion in assets. “Merkel is perceived as more of a threat to the Italian spread than Berlusconi.”

Italy accounts for more than a third of the 71 billion euros ($100 billion) of bonds EU governments will sell in November, HSBC Holdings Plc estimates. With the EU’s biggest debt at almost 120 percent of gross domestic product last year and the euro zone’s third-largest economy, Italy’s financing needs dwarf the other peripheral nations. Next year Italy will sell more than 225 billion euros of bonds, more than Spain, Portugal, Greece and Ireland combined, ING estimates.

Default Risk

Credit default swaps to ensure against a possible Italian default rose to 182 basis points yesterday, the highest in three weeks. That is more than similar insurance for Kazakhstan, Indonesia and the Philippines.

So far Italy has fared better than the other peripherals during the debt crisis. The economy is growing and a deficit of 5.3 percent last year is less than half that of Ireland, Greece and Spain. Italian bonds have gained 4.8 percent this year, compared with losses for Spain, Ireland, Portugal and Greece.

Berlusconi’s political travails risk prompting investors to focus on the country’s biggest fiscal weakness, its outstanding debt, said Bill Blain, strategist at Matrix Corporate Capital LLP in London.

The nominal size of Italy’s debt at about 1.8 trillion euros makes it too large to be shored up by the EU’s 750 billion-euro financial backstop set up after Greece’s near default in May. To prevent future crises, the EU is also considering ways of enforcing its existing rules on debt levels, requiring total borrowing of no more than 60 percent of GDP. Such a move would force Italy to make deficit cuts on a scale far larger than those hobbling Greece’s recovery, Blain said.

“It becomes a crisis when a majority of investors start to put the many parts of the Italian jigsaw together and realize they just don’t fit,” he said. “That’s when it may become clear that an apparently strong economy is founded on a sandpit of state debt.”

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