Greece and Italy have made remarkable progress since the worst of the sovereign debt crisis. Both have jump-started economic growth and made significant bond sales, where previously investors had demanded large premiums for their sovereign bonds. Greece recently issued new three-month debt at a negative yield for the first time, joining a budding club of European states. Meanwhile, Italy sold dollar-denominated bonds for the first time since the start of this decade, indicating their warm return to the global financial market.
Despite this progress, both Mediterranean countries are still subject to very high levels of public debt – Greece’s stood at over 180 percent of national income at the end of 2018, while Italy’s was still nearly at 135 percent. Italy’s government hopes to keep their budget deficit at 2.2 percent this year, but is relying on extra income from fighting tax evasion, which lends to potentially unreliable economic numbers. Greece is projecting growth at optimistic rates – although higher than forecasts from the European Commission – and depends on foreign investment that appears hopeful but has not yet materialised.
Greek and Italian success has depended on the help of the European Central Bank and their increasingly expansionary monetary stances that helped push down bond yields. But their newly friendly governments are a big plus too, as were their years of austerity and painful reforms. The centre-left Democratic party in Rome replaced the far-right Eurosceptic League, which means Italy is much less confrontational than it used to be. This has assured investors that Italy will not be pulling out of the euro and will be taking their financial commitments seriously.
Similarly, the centre-right government in Greece, led by Kyriakos Mitsotakis, replaced the left-wing Syriza government led by Alexis Tsipras, and came to power on the platform of cutting taxes and boosting investment. Either way, investors are pleased.
Don’t Call it a Comeback
A major hurdle for Greece is offsetting their non-performing loans held by banks, an unfortunate legacy from the debt crisis still dragging the economy down. Their most recent innovation to cut into the total 75 billion euros of bad debt is called Hercules, named after the legendary strongman of ancient myth. The idea is to speed up selling them off by repackaging bad loans into securities with the state and guaranteeing the safest portions. For these guarantees to be activated, banks will first have to sell at least half the junior bonds issued in the securitisation.
Hercules is based on a model that worked in Italy, but the main difference is that the safest tranches of Greece’s bad debts will have a BB-rating, which is three steps into “junk rating” territory; these notes will be paid off first.
The EU has approved the scheme and the endeavour is likely to kick off before the end of the year. Hercules will mobilise 9 billion euros in state guarantees, and likely contribute about 200 million euros annually to Greece’s public budget. Even so, this massive undertaking will only address about 40 percent of Greece’s total NPL backlog, and a total of 50 billion euros worth of debt need to be slashed by 2021 in order to meet regulatory targets.
The programme has six steps. First, bad loans will be securitised in three tranches: senior, mezzanine, and junior, with the state guarantee only kicking in for the senior tranche. Following this are different timelines required to package, sell off, and pay off these tranches. Obligatory payments, like fees to servicers and guarantee fees on the senior notes, will be paid first. The order of remaining cash flow to other tranches will then be interest on the mezzanine notes, repayment in full of the senior notes, full repayment of mezzanine notes, and finally, pay-out of junior notes.
Knocking out their NPLs will help put the country’s debt even higher in demand, and investors have already proven interest in Greece’s latest bond sale. Now, even riskier assets are seen as preferable over saving cash – essentially paying to lend it money – and many are confident that trend will increase once NPLs are offloaded. To add to Greece’s victories, the Athens Stock Exchange General Index is also up roughly 36 percent, outperforming its European peers.
Still, some economists are concerned that negative yield rates mostly benefit the wealthy while punishing savers, and believe that the government can find more effective ways to stimulate growth. “Negative yields on long-dated government securities are more reflective of distorted market conditions than of stronger sovereign credit profiles”, said Fitch Ratings.
Italian Financial Renaissance
Italy’s debt has risen to 138 percent of the GDP, adding a sense of urgency to government discussion over the 2020 budget earlier this month. The country is hoping to avoid another recession via tax cuts and a boost in investments for a “green new deal”. According to the IMF, over 50 percent of Italy’s business debt is speculative and sits at a higher percentage than Spain or the UK.
Even so, Italy’s economy overall has strengthened, and foreign investors are buying up Italian debt thanks to the same down-driving yield trend that has so benefitted Greece. The new EU-friendly government is also putting investors at ease, with bond sales rising quickly since the Democratic party came into power.
“The stability brought by the new government is helping a lot”, Perotti, the chairman of Sanlorenzo SpA said in an interview. “Investors will be reassured by a more moderate, pro-European government.”
However, the new government has yet to put out policies to address Italy’s major debt and low productivity, and for some, pro-EU rhetoric only goes so far. “The new government must have found a money tree, because they seem to suggest they can cut taxes, raise spending and keep the deficit flat compared to last year, even though growth is getting worse”, said James Athey, portfolio manager at Aberdeen Asset Management. “I am still not bullish about Italy, and I am actually short.”
The IMF has revised its growth forecasts downward, predicting that Italy’s GDP will remain flat. But the country plans to sell more debt in foreign currencies, expecting demand from foreign investors to remain high. The government also seeks to lower the limit of cash payments to reduce cash-only transactions which help consumers dodge taxes, and roll out a new web-tax of 3 percent on digital companies that aims to raise 600 million euros next year. The tax will be applied to companies with annual revenues worth at least 750 million euros and digital services exceeding 5.5 million euros. Ultimately, Italy hopes this new initiative will help them avoid the deeply unpopular VAT tax, worth approximately 23 million euros.
“Profits have to be taxed where they are made”, Economy Minister Roberto Gualtieri said on Tuesday.
