Eurozone crisis: Italy's debt pile comes under scrutiny

Silvio Berlusconi was forced to defend his economic strategy before parliament on Wednesday

Just a few months ago, international investors were fairly relaxed when they considered Italy's debt mountain - the second highest in the eurozone. Now, Prime Minister Berlusconi has been forced to defend his economic strategy before parliament, and the more excitable City economists are sending me emails declaring that "Italy is bound to default". What gives?

Forget, for a moment, the broader context of the eurozone crisis and consider only the arithmetic of Italy's debt. The scary numbers are that Italy has a debt stock of 120% of GDP, and accounts for 23% of all eurozone sovereign debt.

Because that stock of debt needs to be rolled over, Italy has to raise an equally scary amount from the bond markets on a regular basis, even though its budget deficit, at less than 4% of GDP, is among the lowest in the eurozone.

In 2012, the IMF reckons that Italy will need to raise an amount equivalent to 20% of GDP simply to refinance the debt that is coming due. That's even more than Greece, and higher than 2011, even though next year's deficit will be lower.

To translate that into hard cash, in the second half of 2011, Italy needs to raise 237bn euros (£206bn; $333bn) from the markets - and it will have to go back for another 296bn euros in 2012. The comparable figures for Spain are 150bn euros and 159bn euros.

Those are scary numbers indeed. So scary, in fact, that any normal person might wonder whether the markets have failed to spot them before.

But of course - they did notice. Investors were relaxed about the debt, even as they became anxious about Greece, Portugal and the rest, because (a) the debt was stable - the nominal cost of borrowing was lower than the nominal growth rate of the economy; and (b) Italian politics were dysfunctional, but not expensive, at least in the short term. The crisis at the top of politics may have prevented structural reforms that would raise Italy's long-term growth rate, but the technocrats made sure that the short-term debt dynamics were safe from harm.

Do these two conditions still hold? Probably. Italy still has the enormous benefit that it did not have a private debt bubble, like Spain and the rest, and high private savings limit the amount that it must borrow from international lenders. But the rest of the world has decided to make the task of managing Italy's debt a lot harder.

When it comes to stabilising the debt, the cost of borrowing has gone up just as the prospects for growth have deteriorated. That makes the arithmetic more difficult, but the debt is not yet on an explosive path.

Goldman Sachs reckons that yields need to go above 6.7% for that to happen, and remain there for a prolonged period. Morgan Stanley reckons the cut-off point is 7%, and even then, Italy could probably cope, as long as rates fell back within two years.

Growth forecast

All of these calculations assume that the various austerity measures now on the table are properly implemented - and a few more besides. For all the doubts about Mr Berlusconi, many in Italy believe that the political system still has the capacity to deliver that.

But much more important, in the short-term, will be the growth rate. For example, the Goldman Sachs estimates assume that the economy will manage to grow at 1.5% a year over the next five years - roughly the average of the last decade. That is more or less the IMF forecast, and it doesn't sound very impressive, but it's higher than the country has managed in any of the past five years.

At times like this, economists - and the folks at the European Central Bank and the European Commission - tend to wax lyrical about the need for structural reforms to "unleash the labour market" and start making up the looming productivity gap between Italy and the rest of Europe. Pension reform, privatisation... you know the list.

All of that would be good. But it's not going to double the growth rate in the next two years.

When it comes to right now, the sad fact is that Italy's future is only partly within its control.

Italy is in a stronger position than many, but like Spain, Greece, Portugal and others, it has joined the list of eurozone countries that need Europe's leaders to work out what it would take to convince investors of their commitment to the single currency - and then do it.