Italy: the eurozone’s Achilles heel

"If you ask officials in Brussels or Berlin which country keeps them up at night, the answer is always the same," says Charlemagne in The Economist: "Italy". Almost eight times the size of Greece's economy, it is "too big either to bail or to fail". And it is drowning in debt. The government owes an eye-watering 133% of GDP. This sort of debt mountain means that governments trying to lower borrowing are essentially running up a down escalator. Even if you keep a lid on your annual overspend to avoid adding too much debt to the overall pile which Italy has in recent years the repayments necessitated by the big pile threaten to overwhelm your efforts.

Viktor Nossek of WisdomTree notes on ETFStrategy.co.uk that Italy actually managed to produce a primary budget surplus (excluding interest payments) of 1.5% in 2015, but had to pay 4% of GDP over the past three years in principal and interest payments incurred by the overall debt load. The way out of this pincer is to boost your growth rate, giving you more money to pay down your borrowings. But "this now seems elusive".

Last December's referendum on constitutional reforms that would have facilitated structural changes to boost growth produced a "No" vote. The idea was to curtail the power of the upper house, so that bills to liberalise the labour market, deregulate overprotected sectors and reduce legal red tape would have a much better chance of passing.

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Without pro-growth policies, Italy is stuck on the hard shoulder. It has barely grown since the advent of the euro; real income per head is lower than in 1999. Italy's wages and costs were relatively high, making its industry uncompetitive, and the euro ruled out alleviating the pressure by lowering interest-rates or allowing the currency to slump. Growth potential dwindled while chronic overspending and borrowing continued.

No wonder, then, that two of Italy's leading parties have called for a referendum on the country's euro membership. The next elections are due in early 2018. The current centre-left prime minister, Paolo Gentiloni, is deemed a safe pair of hands, but in a worst-case scenario a coalition of anti-establishment forces could replace him, says James Politi in the FT. One anti-euro populist party, the Five Star Movement, has edged ahead in the polls.

The single currency's credibility would be holed below the waterline if a large founding member leaves, and the knock-on effects could include a financial crisis. Meanwhile, the European Central Bank has kept Italy's long-term interest-rates low by buying its bonds, but with the general economic outlook improving in Europe, it will "taper" its bond-buying programme soon. We may, says Nossek, soon be hearing a lot more about the eurozone's Achilles heel.