Italy may default on its debts

US, WASHINGTON (ORDO NEWS) — The world has already entered the deepest economic recession in the entire post-war period, so the last thing the world economy needs is a new crisis of Italy‘s sovereign debt.

Nevertheless, this is precisely what the decision of the Federal Constitutional Court of Germany, which cast doubt on the legality of the purchase of sovereign bonds by the European Central Bank (ECB), may lead to this, writes The National Interest.

This week, in deciding on the legality of the latest ECB quantitative easing program, German judges decided that the German government and parliament should take active steps against the ECB’s current bond purchase program.

The German constitutional court also ordered the German government to ensure that the ECB conducts a “proportionality assessment” of its latest quantitative easing program within three months. This assessment should prove that the “consequences of economic and fiscal policies” do not outweigh the objectives of its monetary policy. A German court threatened to block Germany’s participation in any such program unless the ECB provides a satisfactory assessment of its policies.

The decision of the German Constitutional Court appeared, without a doubt, at the most inopportune time for Italy (the third largest eurozone economy), which, most likely, will very soon need significant financial assistance from the ECB.

At the epicenter of the coronavirus pandemic, the Italian economy is projected to shrink by about 10% in 2020. This, in turn, will aggravate the already difficult situation of state finances of the country.

According to the International Monetary Fund, Italy’s budget deficit is likely to increase to 8.5% of GDP this year. At the same time, by the end of 2020, the ratio of public debt to the country’s GDP is likely to grow to 160%. Moreover, there is a high probability of a further increase in this ratio, since Italy will have difficulties in ensuring economic growth against the background of coronavirus.

The collapse of the Italian economy and the deterioration of its public finances mean that the Italian government will need significant funding this year. Not only will he have to finance a budget deficit close to $ 200 billion, he will need to prolong the maturity of government bonds for a total of $ 400 billion, as well as provide substantial support to his banking system, which is littered with bad loans.

Until now, investors have been prepared to finance the Italian government at fairly low interest rates. But they did this only out of confidence that, if necessary, the ECB would help Italy out by purchasing an unlimited number of its bonds on the secondary market.

The decision of the German Constitutional Court that the ECB should provide a satisfactory policy assessment within the next three months casts doubt on this assurance. If Italy finds itself under pressure from the real market in the coming months, the ECB will not want to participate in the aggressive repurchase of Italian government bonds because of fear that the German Constitutional Court will have an excuse to ban the German government from participating in future ECB bond purchase programs.

All this increases the likelihood that a full-blown crisis of Italy’s sovereign debt may begin this summer, which will almost certainly negatively affect the global financial market. Italy has the third largest sovereign bond market in the world, second only to the United States and Japan.

In the past, European politicians have sought to alleviate their economic crises. True, there has never been such a large-scale crisis as today. All hope that this time they will be more active in finding a solution to the impending crisis of Italy’s sovereign debt.


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