Italy's Renzi May Find Reality Bites in Debt Reduction Struggle

  • OECD, IMF have lower growth forecasts than government
  • Weaker economy could push debt to 134 percent of GDP next year

Prime ministers may come and go, but in Italy the public debt will probably rise. Again.

Matteo Renzi, Italy’s 40-year old premier, is relying on growth forecasts higher than most economists’ outlooks and a jump in prices to predict that Italy’s staggeringly high debt will fall for the first time since 2007.

Yet, both the Organisation for Economic Cooperation and Development and the International Monetary Fund predict 2016 growth lower than Renzi’s 1.6 percent, while recent data indicates that a measure of inflation known as the gross domestic product deflator may remain around this year’s 0.3 percent of GDP. In addition, the government has already said it will ask the European Union for more flexibility on the deficit to pay for the migrant crisis and a tax cut on first homes, a move that would put further pressure on the debt.

Bloomberg calculations show that these factors would push debt to a record 134 percent next year, well above the 131.4 percent target set by Renzi.

That would be a blow for a government whose premier and finance minister, Pier Carlo Padoan, have both said for months that 2016 will be a pivotal year for the improvement of Italy’s public finances. A failure would mirror unsuccessful attempts by former prime ministers Mario Monti and Enrico Letta, who had promised to cut debt in 2014 and 2015.

Renzi’s growth forecasts “are not consistent with the goal of a lower debt-to-GDP ratio,” said Gianluca Ziglio, executive director of fixed-income research at Sunrise Brokers LLP in London. The government would have to “significantly curb current spending or step up proceeds from privatizations and asset sales earmarking them for debt reduction, neither of which seems to be on the horizon."

Debt Burden

Italy’s debt burden is now 2.2 trillion euros ($2.5 trillion) making it the euro region’s second-largest behind Greece when measured against GDP. Sluggish growth would make the debt more difficult to service, limiting Renzi’s ability to support economic recovery.

"According to past legislation and projections of just few years ago, by now Italy’s debt GDP should have been declining to around or below 120 percent of GDP, while it is instead sailing toward 134 percent and trending higher," Ziglio said.

Ultimately, an ever-rising debt in a country that has just emerged from its longest recession since World War II might reignite concerns among investors, despite the shield provided by the European Central Bank’s bond-buying program.

"If public debt continues to rise, then Italy’s rating will almost inevitably have to be downgraded again, and I doubt whether Italy can withstand a downgrade move as easily as Japan” did when Standard & Poor’s cut its long-term credit rating earlier this month, said Marc Ostwald, a strategist at ADM Investor Services International Ltd. in London.

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