By Tyler Durden on 06/13/2012 08:05 -0400
Yesterday, Austrian finance minister Maria Fekter ruffled the unelected Italian PM’s feather by saying “forget Spain, Italy is next in the bailout line” – a statement which as expected was promptly loudly refuted, mocked, and scorned by everyone possible: the type of reaction that only the truth can possibly generate in Europe. So far so good: after all the typical European reaction to any instance of the truth is loud screams of “lies, lies” and promptly sticking your head deep in the sand. However, this time around Italy may not have the benefit of the doubt, nor the benefit of some sacrificial replacement of a prime minister: Silvio is long gone, and at this point switching one banker figurehead with another will do precisely nothing. Which is why this morning’s assessment from Bloomberg economist David Powell is spot on: “Italy would probably be forced into receiving a bailout if it were to face another two weeks like the last seven days.” But the punchline: “The bad news for Italy is the country’s stock of debt is already as large as Spain’s may become after years of fiscal turmoil. In other words, Italy already is where Spain may be heading.”
Surely Powell must be joking: has he not heard that Spain is not Uganda, and that there is “no risk” Spanish contagion will shift to Italy? Apparently not: which is actually what happens when one does the math and relies on facts instead of bluster, rhetoric and propaganda.
The seven-year sovereign yield has increased to 589 basis points from 538 basis points a week ago. That figure can be used as a proxy for the level with which the average cost of debt will eventually converge, as long as the current maturity profile is maintained, because the average age of the nation’s bonds is seven years.
The country would violate the IMF’s definition of solvency if its average cost of debt were to surpass 680 basis points. The fund defines debt as sustainable if the debt-to-GDP ratio starts to decline before the end of the forecast horizon. A rise to that level would push the ratio up to about 131 percent in 2016 and marginally higher the following year, according to Bloomberg Brief estimates. Those calculations use the projections of the IMF for growth, inflation and the primary budget deficit. If the average cost of debt were to remain at 5.89 percent – the present level of the seven-year yield – the debt-to-GDP ratio would peak in 2014 at126 percent. It would then decline to 124 percent by 2017.
The picture would deteriorate if the IMF’s economic growth forecast for this year were to prove too optimistic. It has estimated a contraction of 1.9 percent.
That looks like a best-case scenario. Output already declined 0.8 percent quarter over quarter during the first three months of the year.
The PMI data suggests the second quarter will be worse. The readings for the manufacturing sector were lower in April and May than they were at the start of the year. The figures for January, February and March came in at 46.8, 47.8 and 47.9, respectively. They were 43.8 and 44.8 for the following two months.
It gets worse…
The debt-to-GDP ratio already violates the proxy of national solvency derived from the research of Carmen Reinhart and Kenneth Rogoff. They have found sovereign debt becomes detrimental to economic growth, on average, when the ratio surpasses 90 percent.
The good news for Italy is the country has avoided a real estate bubble capable of bringing down the domestic banking system and the government has already closed the primary budget deficit. The major problem for Spain has been a recapitalization of the nation’s lenders and several years of persistent budget deficits may push the country’s debt-to-GDP ratio toward the territory of insolvency.
…And much worse.
The bad news for Italy is the country’s stock of debt is already as large as Spain’s may become after years of fiscal turmoil. In other words, Italy already is where Spain may be heading.
A sharp rise of funding costs is capable of making the size of the liabilities of Italy start to look relatively as large as thoseof Greece.
And so the temporal bogey is set at +/- 14 days, as the bond market sets its sights on the exits in preempting the Nash equilibrium defection out of Italy.
Now, we look forward to blaring denials out of Italy that all of the math above is simply idiotic and that we should trust them, because all is fine. Also: Italy is not Somalia.