The Italian (Economic) Job

Olivér Kovács, Research Fellow, ICEG European Center

Almost two years ago, Andrew Ang and Francis A. Longstaff pointed out that the empirical evidence suggests that systemic sovereign risk has its roots in financial markets rather than in macroeconomic fundamentals.[1]

The crisis-ridden Italy, which is now facing high level of political instability as well, has been manoeuvring not so dramatically since the end of 2012 when the Prime Minister Mario Monti resigned. In other words, the perceived sovereign risk is relatively stable over time (so far). Although the yield on Italian 10-year bonds soared dramatically in the aftermath of an electoral stalemate in February 2013, and while it is true that the yield seemed to be crossing the psychological limen (5% mark); it has then gone through a significant rehabilitation and stabilisation (in March 2013, Italian bonds were yielding 4.65% which is not so far from that of German bonds).

The trajectory of sovereign debt credit risk in Q4 2012

Source: CMA Sovereign Debt Credit Risk Report Q4 2012

Even if one takes a mere glimpse into the development of real GDP growth (-2.4% of 2012) or unemployment trends (11.3% of 2012), the reluctance and the appearing calmness of financial markets in case of Italy give us a feeling of surprise. Does it mean that international investors are contemplating not just the given country’s current status of economic affairs, but taking into account the regional, what is more, the European-wide, or in case, global perspectives? (E.g. growing uncertainties over the French economy, succumb in the offshore haven, Cyprus and the growing young unemployment throughout the Iberian Peninsula and Greece). The Italian case pinpoints the importance of perceived reality created by investigating hard statistics combined with psychological factors like attitudes towards the eurozone’s third-largest economy and the world’s third-largest sovereign-debt market.

Nonetheless, Italy has to be continuously aware of the importance of the decisive implementation of long-term structural reforms and such fiscal consolidation that encapsulates the need for stimulating the aggregate demand while placing debt-to-GDP ratio on a downward trend.  

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[1] See: Ang, A. – Longstaff, F. A. (2011): Systemic Sovereign Credit Risk: Lessons from the U.S. and Europe. NBER Working Paper No. 16982

This post features the author's personal view and does not represent the view of ICEG European Center.