The EU is seeking to reform the eurozone’s bailout fund rules, known as the European Stability Mechanism, or ESM. Eurozone finance ministers have already agreed on a draft and are due to finalise it next month, but the proposals have left Rome skittish. Thus far, the country’s ruling coalition has failed to reach an agreement with the EU over the planned changes. Italy has a public debt equal to 135 percent of its GDP, and the government is concerned that this could negatively impact their post-sovereign debt crisis loan repayments.
Of specific concern are changes that would make it easier to restructure sovereign bonds in case financial crisis strikes again. Politicians from both sides assert that this move could knock down market confidence in Italy’s ability to manage their debt – as well as make debt restructuring and default more likely. Sovereign bonds would quickly lose their status as “risk-free” assets, forcing yields to quickly rise and threatening the sustainability of Italy’s debt. Domestic investors, rather than international creditors, hold most of the country’s sovereign bonds; Italian lenders hold around a sixth of the national debt, at about 400 billion euros.
The proposed reforms would essentially turn the ESM into a version of the International Monetary Fund, which would make giving support to countries in financial crises conditional on their agreement to debt restructuring – something Italy is strongly against. Right wing opposition party, the League, is especially angered by the “conditionality in the form of a macro-economic adjustment programme” that would, in some cases, force countries receiving aid to agree to outside oversight possibly involving the IMF.
This change puts the government under heavy pressure to change or block the reform altogether at the European level. In the meantime, it is working on proposals to improve the ESM. “There are strong critical points in the reform. We continue to work on it”, Raphael Raduzzi, a lawmaker for the 5-Star Movement told Reuters. Foreign Minister Luigi Di Maio called it “not feasible”.
Bank of Italy Governor Ignazio Visco said last week that introducing a debt restructuring mechanism carries a “huge risk” and could “trigger a perverse spiral of expectations of default, which may prove to be self-fulfilling”. Prominent economists, including Carlo Cottarelli, a former International Monetary Fund and Italian government official, have expressed similar concerns.
European Economic Affairs Commissioner Pierre Moscovici insists that the ESM does not pose a problem for Italy, as an automatic mechanism for restructuring debts was not present in the proposed reforms. Germany’s Finance Minister Olaf Scholz also affirmed that there was no automatic debt restructuring for struggling countries in an interview with the Italian daily La Repubblica.
Economy Minister Roberto Gualtieri, from the centre-left Democratic Party (PD) agrees with Moscovici and has described the political turmoil as “a storm in a teacup”, later asserting that “the reform of the ESM does not in any way introduce the need to preventively restructure the debt to accede to financial support”.
“Italy has not needed, does not need, and will not need ESM loans” since its debt “is sustainable and has a dynamic that is under control, also thanks to the prudent fiscal policy and supporting growth which the country is implementing”, said Gualtieri.
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Troubles with the ESM have opened up further doubts about the long-term stability of Italy’s new government, which is already beset by divisions over issues such as taxation policy, justice reform, and immigrant rights. Matteo Salvini, leader of the right-wing opposition League party –noted eurosceptic and keen supporter of strict EU budget rules – has accused Prime Minister Giuseppe Conte of “betrayal” and secretly supporting the ESM reforms, tweeting “If anyone has approved it while keeping the People in the dark, it should be remedied immediately. Otherwise it would be HIGH TREASON.”
“Approving the ESM changes would mean ruin for millions of Italians and the end of our national sovereignty”, Salvini stated last week. He hopes that this method of eurosceptic furor, with rhetoric eerily similar to his now-abandoned attack on the euro, will help unite both ardent nationalists and more moderate conservatives in his party – already polling high at 33 percent.
The Prime Minister’s office rejected the comment as “false and unfounded”, reassuring that the ESM accord has not yet been signed and that Parliament would be consulted before it was, noting the government’s veto power over approving revisions to the ESM treaty. Moreover, Conte noted the hypocritical nature of Salvini’s accusation; the draft of the contested reforms was negotiated in June, when the League was still in power .
“Today we have discovered that negotiations have been taking place for a year – there is collective delirium about the ESM that has led the leader of the opposition, the same one who took part in talks on the ESM, and has not realised that he was at the (talks) table without knowing it”, Conte jibed at Salvini. The latter responded, calling Conte a “liar” and stating that the League had “always been against the ESM reform”.
Meanwhile, Conte prefers that the ESM be reformed to align with Italy’s needs as part of a larger package of broad reforms, rather than outright veto it altogether. “We’re working on improving the accord, that’s what we’re doing at the moment. I wouldn’t raise the question of a veto”, an anonymous government official told Reuters.
In the midst of this turmoil also lies opportunity, as Italy may use ongoing talks as a way to secure the appointment of an Italian candidate to head the fund.
The Limits of Reform
Reforming the ESB is only one step the EU is making to counter slowing growth – but it isn’t enough.
During a speech given in Rome, Governor Visco noted that eurozone countries require help to reduce their public debts, saying that “some form of supranational insurance is needed” and recommending the creation of a European debt redemption fund to be financed by resources from participating countries.
Expansionary fiscal policies are also needed to raise inflation and counter economic slowdown, as well as greater eurozone economic integration that would allow the euro to act as “a single fiscal policy”. And while the European Central Bank has resumed its bond purchasing programme, known as quantitative easing, Visco stressed that state governments should be more involved.
“Acting in isolation, monetary policy can do nothing but continue along the path of ‘non-standard’ measures…This increases the risk of adverse side effects, which, in turn, need to be kept under control using instruments of an increasingly administrative nature.”