Greece’s never-ending sovereign debt crisis is again attracting attention. However, while markets and policy-makers fret anew over Greece possibly leaving the euro, Italy’s absence of political leadership is attracting relatively little consideration. Though the euro could survive a Greek exit, it certainly could not last in its present form were Italy to experience a financial crisis that forced it to default on public debt.
Greece’s debt crisis might become acute by the summer. A large debt repayment is due in July, which Athens will not be able to meet unless it comes to an agreement with the International Monetary Fund and European creditors. The prospects for such an agreement are clouded. The IMF has said it will only participate in a Greek bail-out if the Europeans agree to write down substantially their Greek debt claims and if the Greeks agree to additional tax and pension reform.
Ahead of Germany’s parliamentary elections, Chancellor Angela Merkel is unlikely to agree to Greek debt forgiveness. Meanwhile, with his popularity plummeting and with Greece in a deep depression, Prime Minister Alexis Tsipras is highly unlikely to agree to further painful measures.
Concurrently, Italy appears to be headed for early elections, probably in the autumn. Making such early elections more probable is the decision of Matteo Renzi, Italian prime minister between January 2014 and December 2016, to call for a leadership vote in his Democratic Party (PD). He resigned as head of the party on Sunday, signalling the start of the leadership contest. That vote runs the risk of causing a split in the PD, which might force early parliamentary elections to restore governability.
Greater attention should be paid to Rome than to Athens. Italy’s is the third largest economy in the euro area, and around 10 times the size of Greece. Italy has the world’s third largest sovereign bond market, with public debt of more than $2.5tn. Were Italy to leave the euro, it would almost certainly default on its debt, as the cost of Italian government borrowing would rise to unsustainable levels.
An Italian crisis would prove more difficult to resolve than a Greek one. Italy would require an outsized bail-out package to save it. Even an economy as robust as Germany’s would feel the strain. An Italian crisis, being largely political in nature, might not be as amenable to resolution as with Greece, where creditors simply throw money at the problem.
Stuck in a euro straitjacket that has made it difficult for Italy to redress its economic imbalances, the country’s economic performance since 2008 has been abysmal. Italian living standards today are around 10% below 10 years ago. Italy’s banking system is highly troubled and its public sector debt as a share of GDP is the second highest in the euro area. It is no surprise then that the populist and anti-euro Five Star Movement has garnered increasing support and drawn equal in the polls with the ruling PD. Almost all of Italy’s opposition parties would now like to see Italy out of the single currency.
Electioneering is under way in the Netherlands, France and Germany. Unfortunately, the world is ill-prepared the world is to deal with another and more serious European sovereign debt crisis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.