So far, new Italian Prime Minister Mario Monti has been able to maintain political and popular support for his 'Save Italy' economic reform program.
Is a sovereign bond yield of 7 per cent considered fatal? It's a crucial question to ask as Italy and Spain, two of the biggest victims of the debt crisis, after they sold about €22-billion worth of bonds on Thursday.
The yields were considerably lower, but the bonds were mostly short-term. Spain managed to raise about €10-billion with three-, four- and five-year issues at yields less than 4 per cent, while Italy sold 1-year bonds at 2.735 per cent, down sharply from yields of 5.95 per cent in December.
Yields on benchmark 10-year Italian bonds, however, remain close to 7 per cent. The conventional wisdom is that government financing costs become unsustainable at 7 per cent. Indeed, Greece, Ireland and Portugal begged for bailouts from the European Union and the International Monetary Fund shortly after their yields reached that level. Take Portugal. This time last year, its 10-year bond yields were 7 per cent. By March, they were 8 per cent. Two months later, Lisbon hit the bailout button.
Italy's bond yields have been 7 per cent, give or take a few basis points, on and off since the early autumn. Italy matters; it is the euro zone's third-largest economy and there is not enough firepower in Europe's bailout arsenal to save it if the country cannot finance itself. The euro zone would almost certainly break apart like a plywood dinghy in a hurricane.
But not all 7 per cent yields are created equal. That was the conclusion of a note published today by France's Société Générale. While it concedes that Italy has ample and distressing problems, it argues that it's simplistic to conclude that 7 per cent red line figure means the country has reached the point of no return.
The headline financing costs are only one part of the story. The primary surplus -- the government's income before debt-servicing charges -- is another. Here's the example used by Société Générale. Suppose a country had a debt-to-gross domestic product ratio of 100 per cent (Italy's is about 120 per cent). If the financing costs are 5 per cent, and the GDP growth rate is 4 per cent, the debt ratio would rise by 1 per cent a year. But if the same country has a primary surplus of 1 per cent, the debt level would freeze at 100 per cent.
Guess what? Italy has a primary surplus, it's growing and it's one of the highest in the euro zone. Last summer, the primary surplus was running at about 0.8 per cent of GDP. The latest figure, supplied by Istat, the national statistics agency, reported that the figure is now 1.7 per cent as austerity programs kick in. That's the good news. The bad is that Italy has slipped back into recession and it's financing costs are rising as the debt crisis rolls on. Debt, in other words, will continue to rise.
But it may not rise as much as you might think because, of course, only a small portion of Italy's financing costs are at 7 per cent. The mean (as opposed to average) duration of Italy's debt is seven years, meaning it will take seven years for the higher yields to translate into significantly higher funding costs. This means that Prime Minister Mario Monti's treasury is insulated somewhat from the full shock of the recently higher debt costs.
What Italy needs is confidence in Mr. Monti's austerity programs and reforms. Italy has a lot going for it -- a primary surplus, one of the lowest budget-deficits on the continent and, so far, political and popular support for Mr. Monti's "Save Italy" efforts; Italians are not burning down their cities in protest even if strikes and demonstrations are becoming more frequent.
What the country does not have is GDP growth and, as yet, a credible policy to shake-up Italy's hidebound, protective and sclerotic economic policies. Until it gets one, growth and employment gains will elusive or anemic.
Italy could end up paying 7 per cent yields on new bond issues for some time. But that won't necessarily ensure it's doomed to become the fourth euro zone country to sue for a bailout. Mr. Monti just has to convince bond investors to give him a little time. Pazienza -- patience -- as they say in Italy; the sun will rise tomorrow.
Eric Reguly