Italian Prime Minister Giorgia Meloni is relying on a familiar strategy to ensure Italy's financial stability: its own citizens. As the country experiences a welcome respite in financial markets and prepares to sell a substantial amount of bonds, Meloni and her government are increasingly leaning on consumers. Encouraging ordinary savers to invest in debt and maintaining stable public finances have become crucial elements of Italy's strategy to stay afloat. Italy, compared to its European peers, has a high debt-to-GDP ratio of around 140%, making it vulnerable to sovereign risks and increasing costs of servicing the debt.
This pursuit of domestic bond investors is a departure from the norm in European countries. Italy's issuance to retail investors outstrips that of other European nations, with significant demand expected for the upcoming bond series to be released in late February. This positive response from savers provides another boost for Meloni, who has seen Italy's risk decrease with a threat of a downgrade to junk being lifted. The yield spread between Italian bonds and German equivalents, a significant measure of euro-area risk, has touched a two-year low, reflecting the current favorable conditions.
However, Italy's vulnerability compared to its European peers remains evident, given its high debt levels and rising servicing costs. The European Central Bank estimates that around 20% of Italy's bonds will mature and need replacement within a year, a notably higher proportion compared to other major borrowers like France. Further, Italy is faced with substantial fiscal challenges, including funding the climate transition, increased defense spending, and a growing pension bill amid demographic changes.
Against this backdrop, Meloni understands the importance of capitalizing on the current favorable conditions. Italy's bond spread over German equivalents recently traded below 150 basis points, signaling an opportune moment to solidify stability. Despite not implementing radical structural reforms, the government's overall approach has been deemed satisfactory by experts, leading to "very strong" demand from savers. Charles Diebel, head of fixed income at Mediolanum International Funds, predicts that the spread will further narrow, potentially reaching around 140.
Meloni's success in leveraging Italian citizen investors relies on the lessons learned from past market fluctuations and instabilities. Finance Minister Giancarlo Giorgetti expresses contentment in having a larger percentage of debt held domestically, as domestic investors tend to offer a more stable base less likely to sell bonds during times of tension. Italian citizens have responded positively to these efforts, with data from the Bank of Italy revealing that they poured €120 billion ($130 billion) into bonds in the first 10 months of 2023.
Nonetheless, Italy's borrowing requirements remain significant. With plans to sell up to €360 billion of medium to long-term-maturity bonds in 2024, Italy leads the euro-area in its borrowing needs. As interest payments as a share of GDP have already risen by 35% in the past five years, projections indicate another 27% increase. By 2027, the associated costs could surpass the levels reached during Europe's debt crisis in 2012.
Italy's approach of turning to retail investors aligns with a broader trend in Europe. Spain and Portugal have also seen an increase in holdings of state debt among residents. Japan serves as a notable example, with its success in selling bonds to citizens sustaining low yields despite massive debt levels. Meloni's strategy harks back to the 1980s and 1990s when short-term bonds known as Buoni Ordinari del Tesoro gained popularity, making their buyers known as "BOT people."
To maintain a steady stream of investors, the current BTP Valore bond incentivizes holders who keep them until maturity with additional rewards. However, Italian citizens' holdings of bonds remain far below their historical levels, emphasizing room for growth. The appeal of high yields compared to bank savings accounts and the disappointment of low returns in previous years with ultra-low interest rates have been the primary factors driving demand. In July, the government raised over €18 billion through such a sale, setting a record.
Diluting dependence on borrowing from banks is another desirable outcome, given the disproportionate reliance on banks in Italy. This previous entanglement with the public finances contributed to the "doom loop" seen during Europe's debt crisis. The current market conditions sharply contrast with the prior turmoil. Moreover, the European Union's influx of funds into Italy's economy is projected to bolster growth in the coming year, potentially supporting the country's challenging fiscal position.
Nonetheless, Meloni's options remain limited, particularly as she navigates a fractious coalition with members committed to fulfilling fiscal promises made to voters. While attempts have been made to raise funds through the selling of public assets and the taxing of banks' extra profits, progress has been sluggish. Thus, Meloni's government finds itself heavily reliant on its citizens, not only for political support and tax revenue but also for literal investment in their policies.
In conclusion, Italy's Prime Minister Giorgia Meloni is capitalizing on favorable market conditions to secure stability, focusing on domestic investors to buy bonds and maintain stable public finances. While Italy faces vulnerabilities due to high debt levels and rising servicing costs, the current environment presents a precious opportunity. Meloni's reliance on retail investors aligns with a broader European trend, with past examples, such as Japan, showing the advantages of selling bonds to citizens. Yet, Italy's borrowing needs remain significant, requiring ongoing efforts to attract domestic investors. Despite the challenges, Meloni's government hopes to sustain economic growth and navigate fiscal promises through the support of its citizens.