An interesting interview in Milano Finanza with Alessandro Tentori, CIO of AXA IM Italia, who takes stock of the situation of Italian debt and of the opportunity to access the ESM (MES, the European Stability Mechanism), the credit line made available by the EU of up to 2% of GDP, tied to pandemic-related expenditure.
(We would point out that the political objections to the MES are of two kinds:
the first is that it is, after all, a loan, and as such it comes with conditions, albeit softened ones;
the second is the size of the loan (EUR 37 billion, i.e. 2% of GDP), which is certainly not sufficient to meet the liquidity needs that the Covid-19 crisis has caused in Italy).
According to Tentori, financing EUR 37 billion through the MES over 10 years is an advantageous transaction for several European countries, Italy among them.
(What Tentori fails to address is the problem arising from the fact that the MES would become our preferred creditor, much to the dismay of those who have subscribed and will subscribe to Italian government bonds.
The matter is not a minor one, given that it would lead to an increase in interest rates on newly issued government bonds, with inevitable repercussions on the spread).
There also remains the open question of the conditions, set out in the Eurogroup press release of 8 May.
The financing must be used for “direct and indirect healthcare, cure and prevention-related costs due to the Covid-19 crisis”, and the surveillance of the countries requesting access to the credit line will be “commensurate with the shock”. Finally, once the emergency is over, the member states undertake to strengthen their economic and financial fundamentals, in line with the EU’s “coordination and surveillance” criteria.
Tentori rightly points out that “a loan is not a gift and as such implies a balance between costs and benefits. It is for the two parties to negotiate the terms of the loan satisfactorily”.
In theory, the sufficient condition requires that “the present value be the same for both parties”. According to the expert, “the MES credit line is a satisfactory transaction, in the sense that it strikes a balance between the cost of funding and the cost of future conditions”.
If, however, these conditions were no longer acceptable, an EU country could always “choose to issue the equivalent amount on the market, probably paying a higher coupon, in order to repay in full the debt contracted with the MES”.
And here the ECB comes into play. Tentori cites the article that Carlo Cottarelli recently published in the Financial Times, according to which “the European Central Bank will probably increase its portfolio of Italian government bonds by EUR 170 billion in 2020, i.e. 10% of the country’s GDP”.
For Tentori this is “certainly a strength in the negotiations between Rome and Brussels, since financing on the market could in any case be carried out at relatively low cost thanks to the constant support of Frankfurt”, which in fact accounts for 80% of purchases of BTPs (Italian government bonds) through the Bank of Italy. The situation is therefore different, for now, from 2011. The point is what will happen from 2021 onwards, when the ECB’s pandemic purchase programme, the PEPP, is due to end.
In the long run, Tentori recalls, the Eurosystem could come to hold 33% of the public debt of each member state. These are bonds that will remain on the Eurosystem’s balance sheet until maturity and will probably also be reinvested, “should the monetary policy strategy require it. To this must be added the contribution of the PEPP. And let us not forget the purchases linked to banking regulation (Basel III) and pension regulation (Solvency II). Although this concerns the private sector, the slice is nonetheless significant. These too are investments with a very low turnover frequency, so they remain on balance sheets practically until maturity”.
This means that, in effect, government bonds are not traded on the market, which is the surest way of eliminating the risk of sharp price swings. And therefore “the risk of euro-area government bonds has been progressively, directly and indirectly endogenised by the European authorities”, along the lines of the Japanese model.
Consequently, since the bonds are in effect “non-marketable”, that is, they are not bought and sold on the market, Tentori suggests revising Eurostat’s definition of public debt:
“in so doing, the concept of the debt/GDP ratio, which unfortunately is still often used today as an indicator of sovereign risk, would also be scaled down”.
Tentori is obviously right: it is enough to think that Japan’s debt/GDP ratio before the USD 1.1 trillion pandemic intervention stood at 230%, well above the 155% forecast for Italy after the budget measure. Yet according to the American agency Fitch, Japan has a Mid A rating, whereas Italy is today at risk of being downgraded into junk territory.
The only way out of this crisis, regardless of whether or not Italy adopts the MES, is for the ECB to keep doing its part and for finance to become once again a driver for the country.
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