mario monti
By Eleonora Ambrosi Contributor September 16, 2012

While efforts have been made by the Italian government to solve the country’s economic woes, the threat of a debt default and its ramifications still looms.

What is the state of the Italian economy today? The prevailing opinion is that Italy’s worst period is over and there is no longer a risk of default. However, while the possibility of a collapse of the euro now seems remote, Italy is not out of the woods yet.

Among many pleasantries, Italy is well known for its remarkably high public debt, with the current debt-to-GDP ratio at about 120 percent (11.7 billion euros by the end of 2014) . Currently sunk into a stagnant economy, Italy suffers from chronically fluctuating political credibility. And the higher the rate of interest payable on the debt, the worse the situation is for public finance. In July 2011, Italy was paying a 6.3 percent interest rate on its 10-year and 5-year public debt, 6 percent on the 5-year and 5.3 percent over 2 years. These numbers are significant when considering the limited actions a state can take if it loses credibility with lenders and cannot produce income to pay off the debt.

During his speech at the Rimini Meeting, the Italian Prime Minister Mario Monti affirmed that the euro is a moral value and it would be “a tragedy” if the currency disintegrated. He stated that he saw “The light at the end of the tunnel” and that the end of the crisis “may not be so far away.” According to Monti, he had never thought that the recent policy reforms in areas such as employment, pensions, spending review, liberalization, and growth could immediately help the country grow. Instead, he said that he hoped that such reforms would speed up the reduction in interest rates.

So is Italy still more likely to default? Some considerations support this possibility.

According to investors, Italy’s chance of default in the next 2 years is around 16.5 percent; the 5-year probability jumps to 35 percent. Last June, the National Institute of Statistics reported the unemployment rate to be 11 percent in the first quarter of 2012, i.e. about 2.8 million people, over 600,000 of whom are younger than 25 years old.

The spread is high because the country is weak; it has wasted the last 20 years by avoiding any difficult decisions and dividing public resources among a few clients. Meanwhile, the country has declined with real growth close to zero, widespread youth unemployment, a labor market inconsistent with the needs of the times, and an unjust tax system with incomprehensible regulations.

Even though these recent developments are positive, they coincided with a period of relative financial calm. The structural reforms in Prime Minister Monti’s agenda involve many costs (high unemployment, lower purchasing power) that will further slow down the economy. Moreover, the Italian banks are extremely cautious when lending money; they would be cautious to lend money even if they had plenty of it. It is easy to predict what would happen in the event of a GDP contraction in the future; if the bailout money runs out, the country should either restructure its debt or plan a new bailout. In either case, what worries people more is if the Italian government decides to exit the euro zone rather than continuing austerity measures to restructure Italy’s debt.

We all might be strongly aware of the fact that in the end there is no commiseration from the market, but the time for thinking is over. If Italy defaults, the economic malaise could spread well beyond Italy’s borders, especially considering that the “Bel Paese” is the eighth-largest economy in the world.

Eleonora Ambrosi is a Junior Business Analyst at the Milan Chamber of Commerce. She graduated in International Management with a dissertation entitled: “Cross-border M&As in the Russian Oil Market: The Failed Agreement For the Exploration of the Arctic Between Tnk-Bp and Rosneft”. She also collaborates with important Italian magazines of geopolitics.

Photo courtesy of President of the European Council via Flickr.