Monti Should Seek Aid to Straitjacket Successor: Euro Credit

Prime Minister Mario Monti
For Prime Minister Mario Monti, triggering the bond buying may be the best way to prevent Italy’s borrowing costs from jeopardizing his efforts to balance the budget and trim a 1.97 trillion-euro debt. Photographer: Alessia Pierdomenico/Bloomberg

Italian Prime Minister Mario Monti should seek European aid for the same reason his Spanish peer Mariano Rajoy is resisting a rescue -- the economic straitjacket that would accompany a bailout, executives and investors say.

Italy’s 10-year yield has dropped 124 basis points since ECB President Mario Draghi first said on Aug. 2 the bank may buy bonds of cash-strapped nations, easing pressure on Monti. Still, as Monti is not running in elections due by April, he is better positioned than Rajoy to weather any political fallout from requesting support to further lower borrowing costs.

“The ECB position has prompted a relief rally but if you want to capitalize on the good mood, you have to be forward-looking, do more than what the market is expecting.” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Tapping the European rescue fund now would be a smart strategy for Italy, because committing to specific targets and reforms would help reduce the political risk after elections.”

Polls suggest Italy’s elections may lead to a hung parliament or produce a government lacking commitment to Monti’s budget policies. Even with the economy mired in a fourth recession since 2001, Italy is on track to bring its deficit within the European Union limit this year and start trimming the EU’s second-biggest debt in 2013.

Yield Difference

The difference in yield between Spanish three-year debt, the maximum maturity the ECB will target in its bond-buying program, and similar Italian bonds has widened by 21 basis points to 75 since Sept. 7, one day after Draghi’s gave details of the bond buying plan. The wider spread suggests investors perceive Italy as more creditworthy than Spain. Italian three-year debt yielded 237 basis points more than Spanish securities at the beginning of the year.

Draghi’s new bond-buying program will work in tandem with debt-purchase by the EU’s bailout funds and impose conditions on any government making a request. The ECB under its Securities Markets Program bought about 220 billion euros ($285 billion) of Greek, Irish, Portuguese, Italian and Spanish debt in 2010 and 2011 without accompanying economic sanctions.

Political Will

Italy, then run by Silvio Berlusconi, repaid that benevolence by backtracking on pledged budget reforms. Berlusconi, who resigned last year after Italy’s 10-year yields topped 7 percent, said on Sept. 17 that if he were to lead the next government, he would retract Monti’s tax on primary residences, one of the government’s key revenue-raising measures. The Democratic Party, which leads in opinion polls, led the charge to dilute Monti’s labor market overhaul.

“We might as well say right now that we are committed to these things and sign an accord that binds not only the current government and parliament but also those that come after the elections in the spring,” Giorgio Squinzi, head of employers’ lobby Confindustria said on Sept. 13.

Both Monti and Rajoy, who came to power 10 months ago after winning Spain’s biggest parliamentary majority in almost three decades, have reiterated that their countries are not currently planning to seek aid. Rajoy, who has already requested a 100 billion-euro rescue of Spain’s banks, endures higher borrowing costs than Monti, and has seen his popularity slump after imposing the deepest budget cuts in more than 30 years. The two countries making a joint bond-buying request might help buffer the political fallout.

Splitting Costs

“Spain is also at risk and a coordinated intervention with Italy would split the political costs of the initiative,” said Luigi Zingales, a finance professor at the University of Chicago’s Booth School of Business. “Second, this would prompt a relief rally by convincing investors that the anti-spread mechanism is working and, last but not least, Monti would do a favor to the next government.”

Still, triggering the bond buying would require Italy to accept possibly painful conditions that go beyond the measures already delivered by the Monti government.

“To view the bond-buying program as some form of insurance policy for Italian fiscal and structural economic reform strains credulity; It is anything but,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “It is a last resort which Italy would consider only if its debt market came under severe pressure akin to that experienced in November last year.”

Bond Gains

Italian bonds have gained more than Spanish equivalents since Draghi revealed details of his plans on Sept. 6 as investors views on the two economies began to diverge. Spain is seeking to trim its deficit this year to 6.3 percent of GDP, almost three times the Italian rate, while efforts to achieve that goal are undermined by the EU’s highest jobless rate of 25 percent, more than double that of Italy. On the debt front, Italy’s total borrowing of 120.7 percent of GDP dwarfs Spain’s at 68.5, though Italy’s debt is poised to peak this year, while Spain’s is projected to jump by more than 10 percentage points.

“Investors are finally starting to realize that Italy is in much better shape that Spain and the only reason why it was hit so hard by the economic crisis is that is has been used as a speculative vehicle by those betting against the euro,” said Mario Spreafico, who manages 1.5 billion euros as chief investment officer at Schroders Private Banking for Italy in Milan. “Even if Spain makes a request for a sovereign bailout, I don’t expect Italy to follow.”

Relative Low

Still, it was Monti who championed the plan for the EU to buy bonds, saying the EU needed to act to ensure that nations taming their finances would be rewarded with affordable funding costs. Even though the yield difference between Italy’s 10-year debt and comparable German bunds reached a six-month low of 330 basis points last week, that is still almost four times the average difference since euro notes and coins came into circulation in 2002.

For Monti, triggering the bond buying may be the best way to prevent Italy’s borrowing costs from jeopardizing his efforts to balance the budget and trim a 1.97 trillion-euro debt. With six months left in his term, a bailout would also be his political legacy.

“Monti will rather pay up in credit markets than do something which would be seen as admission of failure,” said Georg Grodzki, head of credit research at Legal & General Investment Management Ltd.

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