While attention on the Euro crisis has been focusing primarily on Greece and Cyprus, it is no mystery that Italy, alongside with Spain, constitutes the real challenge for the future of the common currency, in any direction events will be unfolding. In the relative silence of the international press, Italy’s macroeconomic situation has been showing no sign of improvement, and indeed numerous indicators portray a national economy which finds itself in a depression, rather than in a however severe recession. It is no overstatement that the Italian economy is currently collapsing.
Italy is the third largest economy of the Eurozone (after Germany and France), holds the largest public debt (over €2 trillion), which has been growing at an astonishing pace, even in more recent times and particularly as a ratio to GDP (130%), since the latter is contracting fast. How is this sustainable? Well, it is not. But for the moment, thanks to the ECB direct interventions (€102.8 billion of Italian bond purchases in 2011-12) and especially to the LTRO mechanisms, the finances of the Italian state can still be kept afloat. Italian banks have been absorbing €268 billion of liquidity issued by the ECB by means of the LTRO programme. In its essence, the mechanism is the following: because the ECB cannot lend liquidity directly to the states, except in times of absolute emergency and for the stabilisation of financial markets in the short term (as happened in 2011), it lends money to the banks, which in turn purchase government-issued bonds. Interestingly, the LTRO scheme has also become an instrument for the relatively orderly withdrawal of international investors from Italy, especially French and German, whose share of public debt has fallen from 51% to 35%, mirroring the rise of Italian banks purchasing public debt. This is an important signal, which goes in the opposite direction of an increased interdependency as would be expected from a monetary union in preparation for a political union. It is arguable that many investors are actually systematically reducing their exposure in South Europe, possibly hoping that a future breakup of the common curency will have less harmful consequences if their involvement in the financial and economy destiny of those countries is curtailed to the minimum. For Eurosceptics, it is a signal that, once all foreign investor withdraw, Italy will be left to its fate.
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