EU’s aim has always been to ringfence its third- and fourth-largest economies from the problems of smaller countries.
“Risk is moving from the periphery to the other core markets, given all main routes – bail-outs or, alternatively, restructurings – lead now to the same destination: that is, Germany and France writing the cheque.”
Spain and Italy risk being sucked in
By Richard Milne, Rachel Sanderson and Miles Johnson
Protect Spain and Italy – the European Union’s aim in its messy handling of the sovereign debt crisis has always been to ringfence its third- and fourth-largest economies from the problems of smaller countries.
But this week, that policy has been thrown into serious doubt for the first time in the 18 months since Greece’s problems hit the headlines. The yields on Italy’s government debt, by far the largest bond market in Europe, on Friday hit their highest levels since October 2002.
Meanwhile, Spain’s borrowing costs have flirted with a euro-era high, which was reached only two weeks ago. Both countries are paying their highest-ever premium over Germany for their borrowing.
The latest increases were sparked when Moody’s, the US credit rating agency, downgraded Portugal by four notches to junk status on Wednesday night, amid continuing fears of a Greek default. Bank shares have been pummelled, with Italy’s UniCredit falling 20 per cent this week alone and the euro falling 2 per cent against the dollar.
“[That] has clearly shown that a severe contagion risk exists,” says Asoka Wöhrmann, chief investment officer at DWS, Germany’s biggest fund manager. “The extreme spread levels for Spain and Italy indicate the markets meltdown that a Greek default would trigger.” It would hit not just specific countries such Spain or Italy, he adds, but affect all the eurozone.
Investors across the continent acknowledge there is a growing risk that both Spain and Italy will be sucked into the crisis. But they are deeply divided over how justified it is, and whether the two merit being placed alongside Greece, Portugal and Ireland as troubled eurozone economies.
Didier St Georges, a member of the investment committee at Carmignac Gestion, a large French fund manager, says: “Fundamentally, the reaction is overdone. But markets are starting to have the upper hand and that can lead to unfair situations. You can’t ignore that as a fund manager.”
The result is that Carmignac owns no eurozone government bonds apart from Germany’s.
Neil Williams, chief economist at Hermes, the UK fund manager, is a believer in Italy, pointing to its proactive budget programme.
But he is more concerned about Spain, which he fears could be damned either way. “If it can’t pass meaningful reform – the sort that Italy managed in the mid-1990s – the bond vigilantes and rating agencies will turn the spotlight on Spain, where the private sector’s indebtedness is bigger than the economy.” But, he adds, if the authorities do attempt reform, the current youth male unemployment of 45 per cent could trigger social unrest.
In the two countries themselves, there is concern but also a belief that the latest bout of worries is unwarranted. Senior Italian officials see no reason for contagion with a budget deficit below zero and a primary deficit – that is one that excludes interest payments – of close to zero. The problems are low growth of about 1 per cent annually and a debt-to-GDP ratio of 120 per cent.
Gregorio de Felice, chief economist at Intesa Sanpaolo, says: “Italy has good fundamentals. There is no property bubble, no financial bubble, the total debt did not increase during the crisis.”
Antonio Guglielmi, senior analyst at Mediobanca, points to €10bn of rights issues in recent months among Italy’s banks, which, together with other financial institutions, hold more than half of the country’s sovereign debt.
“Italy has the same problems today as it had 12 months ago, when the market did not consider including it in the ‘Pigs’. The paradox is that Italy is facing these contagion fears even after these rights issues,” he says.
In Madrid, the mood is more nervous, despite two years of austerity measures and reforms. Concerns over a stalling economy, unknown real levels of regional debt, and a banking sector stricken by the country’s real estate collapse have provided weighty ammunition for those sceptical of the government’s claims to have “decoupled” from its rescued neighbours.
Spain has now issued more than half its planned €93.8bn of gross medium- and long-term debt for this year. Elena Salgado, the finance minister, this week described demand for Spanish debt as “extraordinary” and said Spain would have no problems financing itself. “It is not a Spanish question. It is an instability, a volatility that is effecting the debt markets in general,” she said when asked about rising interest payments for Spain.
But Miguel Angel Fernández Ordóñez, governor of the Bank of Spain, said in May that a spread between German and Spanish bonds of more than 200 basis points would be “unacceptable” in the long term, with the added costs for Spain’s corporate sector further weighing on a recovery. Yesterday the spread stood at 284bp.
For investors, this week gives what Mr Wöhrmann calls “a convincing incentive” to politicians and other parties to solve the Greek crisis. Otherwise, Mr Williams speaks for many in thinking that contagion could spread further: “Risk is moving from the periphery to the other core markets, given all main routes – bail-outs or, alternatively, restructurings – lead now to the same destination: that is, Germany and France writing the cheque.” |
