Italy has not been in the spotlight for some time now as attention has been directed towards China and oil. However, this does not mean that its woes have disappeared. Actually, it is quite the opposite. Eurozone’s third largest economy is in trouble and finding a solution is a matter of uttermost urgency.
The large amount of public debt is only the first of the many issues burdening the peninsula. In the last quarter of 2015, Italy reduced the level of debt to 134.6% of GDP, according to Eurostat. Although this is good news, it is still far away from the 60% threshold. Italy is ahead of only Greece, which has a public debt of 171%. This Tuesday, Istat published a report stating that unemployment remained at 11.4% in December, unchanged from previous months. Analysts are worried that the new labor legislation enacted by the PM Matteo Renzi may be ineffective, especially without a full economic recovery.
On the other hand, the banking system is overwhelmed by non-performing loans (NPLs) that have increased to as high as €200 billion, without taking into account an additional €150 billion of debt labeled as troubled. Last November, the Italian government used €3.6 billion to rescue four troubled small and midsize banks. The plan involved stripping the banks of their bad assets and putting them into one “bad bank”. At that time, the European Commission blocked this proposal, considering it illegal under European Law.
Last week, after months of negotiations, Rome reached a deal with Brussels regarding the creation of a bad bank, which will not be state owned. This means that the NPLs will not be bought using public funds. A government guarantee will be attached to the bad loans that will be sold by Italian banks. The price of the guarantee will be based on credit default swaps on issuers with similar risk profiles to these bad loans. Finance minister assured everyone that this will not burden public finances, while the European Commission will be closely monitoring the process.
Even after the government announced its guarantee plan for the NPLs, investors and market participants were not relieved. There is no clear strategy on how to proceed with the bad loans in practice and most do not see this as a permanent solution.
Meanwhile, it is not only the small banks that are in trouble. Italy’s third largest bank and also its oldest, Monte Dei Paschi di Siena, has lost more than half its value in the last three months. Last week, it announced a €200 million loss for the fourth quarter. Although it is better than the estimated €250 million loss, it is a clear example of the worrying situation of Italian banks.
At the beginning of the week, Italy’s Minister of Economy said that foreign actors must intervene and help in achieving financial stability. At the same time, Italy’s relationship with the EU has not been at an all-time high. Tensions have arisen as PM Renzi has openly attacked several EU policies regarding energy, Russia and the dominant role of Germany. He has also questioned, time and again, Italy’s role in the EU and Eurozone.
Italy may very well be on the path towards Greece’s current situation. The key to finding a solution is a strong cooperation with Brussels and a sound strategy that will solve the bad loans problem and give the financial system a breath of fresh air.