Italy’s debts to the European Central Bank are set to hit €500bn.
The Eurozone denotes the 19 of the 28 European Union (EU) member states that have adopted the Euro as their common currency. It was established in 1999 and its GDP as of 2016 stood at $11.8 trillion. The European Central Bank (ECB) is the central bank of the Eurozone. Their main task is to maintain price stability in the euro area and to preserve the purchasing power of the single currency.
In the 1990s, thoughtful observers understood that Italy did not belong in the eurozone. Italy could not give up its own monetary policy and currency, the lira. Between 1970 and 1999, the lira had steadily lost over 80% of its value relative to the German mark. Italy was unable to raise productivity growth against competition from China and emergent East European economies. This called for subsequent lira devaluations.
However, Italy’s top economists and finance officials were keen to join the eurozone. European Union scholars Kenneth Dyson and Kevin Featherstone say, Mario Draghi, currently president of the European Central Bank and the former director general of the Italian treasury, “believed in his soul” that the euro would enforce the discipline Italian governments needed.
Italy joined the eurozone at its inception on Jan. 1, 1999.The global crisis between 2007 and 2009, and then the 2011-2013 eurozone crisis magnified Italy’s pre-euro economic and financial fragilities. The euro’s central flaw now came to the fore: a single monetary policy could not work for the strong Germany economy and for an increasingly decrepit Italian economy.
Italy never recovered from the increase in interest rates in 2011 by the ECB. In July 2012, the ECB’s Draghi tried to heal the wounds with his dramatic promise to do “whatever it takes” to rescue eurozone countries. That led to the Outright Monetary Transactions (OMT) shield, which carried the promise that the ECB would buy unlimited quantities of a member country’s bonds. This did not have an effect on the Italian interest rates, rather combined with fiscal austerity, this led the economy in recession.
Target 2 balance, a measure of eurozone capital flows suggests that Italy’s debts to the European Central Bank are set to hit €500bn this summer.
According to ECB data, the difference between Italy’s incoming and outgoing cross-border payments (Target 2 balance) is €480bn and growing rapidly. Meanwhile, Germany’s Target 2 surplus is on track to reach €1tn.
Target 2 was set up by the ECB and eurozone national central banks to make the exchange of large payments more feasible. More than 1,700 banks use it to transact with each other. However, the resulting balances between national central banks caused controversy in Germany during the Greek debt crisis. As the effects of a possible eurozone break- up could leave the German central bank on the verge of losses.
The issue of eurozone cohesion will come to the fore again this autumn when Italy’s new government sets out its budget. In May, the coalition’s journey to power triggered a sharp market sell-off as investors recalibrated their expectations of political risk in the bloc.
Eurozone central bankers view the rise in the imbalances as a natural consequence of the €2.4tn quantitative easing (QE) programme. This led the central banks in the region to buy mostly government bonds from investors, in order to lower interest rates and increase the money supply.
Marchel Alexandrovich, a senior European economist at Jefferies, said the growing divergence in Target 2 balances had been driven by QE. The situation may have been exacerbated in recent months by overseas investors shedding their Italian holdings, he added, but it was “hard to know how much is due to worries about Italian politics”. “As long as the eurozone stays together, all of this is an accounting issue,” he said. “But these imbalances are the most obvious way in which eurozone countries’ taxpayers are exposed to break-up risk.”
Italy's anti-establishment parties who formed the government recently blamed the ECB for buying very few Italian bonds during the market turmoil that accompanied their rise to power. However, the ECB has emphasized that its bond-buying program is purely a technical tool for reaching its inflation target.
Lorenzo Fioramonti, an economist, and Five Star lawmaker, tweeted that the relative increase in German purchases still mattered, as it increased the spread between the yield on Italy’s and Germany’s bonds. However, in May the spread between Italian and French 10-year bonds doubled and this wasn’t taken into consideration.
Our assessment is that for Italy’s presence to continue in the eurozone it needs a relatively flexible monetary policy and a large euro depreciation. We feel that the details of the Italian budget this year and the successor of ECB President Mario Draghi are two significant factors that will further direct the course of this debt crisis.