This post is available in pdf format My Tuesday Column – 1 October 2018
French public debt stands at close to 100% of GDP, but is this really a cause for concern?
No – it is important not to overstate the importance of this figure. French statistics body INSEE made the news as it measured public debt at over 100% of GDP for 2017, when it included railway operator SNCF’s debt. However, this is no longer the case, with debt accounting for 99% of GDP in the second quarter of 2018.
The chart shows two phases in French public debt trends – before and after the 2008 financial crisis. The State increased its debt issues and thereby smoothed the way for macroeconomic adjustment to the crisis by spreading out the shock that hit the French economy over the longer term.
We can see that the figure then rises again after 2010, but this is not a specific feature to France. It reflects slower growth in the French economy over the longer term, and a welfare set-up that failed to change to adapt to this new trend: so soaring public debt denotes a sluggish adjustment from French institutions.
In other words, the primary role of public debt is to help spread the load at times of economic shocks, but it skyrockets when the economy is slow to adjust to new economic conditions.
Is the 100% of GDP threshold a problem or not?
The figure itself is impressive and somewhat symbolic, but it is not necessarily damaging for economic momentum per se. Japanese public debt stands at 240% of GDP, yet the country has come through the financial crisis better than others judging by per-capita GDP: the country does not seem to be in danger of default.
The real problem is that we do not know just when public debt can actually become detrimental. Rogoff and Reinhart indicated in their research that public debt begins to dent growth when it moves beyond 90% of GDP, and this rule at least partly spurred on the European Commission’s austerity policy in 2011 and 2012. However, this argument does not hold water: R&R’s calculations were wrong and there is no rule on excessive public debt. Continue reading
Here is the frightening part of the Italian budget: growth figures. In an interview Giovanni Tria said that growth forecasts for 2019 and 2020 were 1.6% and 1.7% respectively.
These are unbelievable expectations. Such numbers were attained only in period of global euphoria (2006) or of global recovery (2010). This will not be the case in 2019 or 2020. The Italian GDP growth trend is just 1.1%. That’s why budget numbers are at risks.
We cannot bet on a 2.4% budget deficit in 2019, 2020 and 2021. We must have lower growth figures in mind and probably higher expenditures. The situation is at risk in Italy In other words, the reduction of the public debt (reduction of the public debt to GDP ratio by 1% every year ) will not be achieved.
The Italian budget program, which sets out a budget deficit of 2.4% of GDP for 2019, 2020 and 2021, did not go down very well with investors. Uncertainty on Italy is making a comeback and the yield on the 10-year government bond rose sharply as shown by the chart below (as at 15.00pm CET today).
So just what are investors worried about? Continue reading
League chief eclipses senior coalition partner with anti-immigration broadside
Matteo Salvini heads the junior coalition partner in the populist government that took office in Italy on June 1. Yet the leader of the far-right League has seized control of the political agenda — eclipsing the anti-establishment Five Star Movement led by Luigi Di Maio, which won nearly twice as many votes in the March elections but is struggling to project its voice in power.
Read it here www.ft.com/content/c8de2064-7303-11e8-aa31-31da4279a601
The adjustment on the upside is not over on Italian rates. The 10 year bond’s rate is converging to 3%. The spread with the German 10-year rate is now circa 270 bp. This also reflects a safe heaven effect for German bonds.
With a rate at 3% % while the inflation is at 0.5% (in April), the real rate is way too high in Italy compared to real growth prospects. But such a level on the real rate (2.5%) would be just above the average seen since the beginning of the Euro Area (2.2%). It’s too high when the GDP trend is close to 1%. This has deterred investment and it will continue limiting the capacity to grow. We have to expect a slowdown in the economic activity in coming months. It will come from the real rate level but also from the uncertainty in the Italian economy. An austerity program that can be expected from a transition government is not good news for Italy but also for the rest of the Eurozone.
This map reflects questions about the sustainability of a government when constituents of it belong to regions and communities that are in a historical conflict. A real source of uncertainty
Judging by the Italian president Sergio Mattarella’s (justified) refusal to approve a government that would have been dominated by the League with its aversion to Europe and its institutions, the forthcoming parliamentary elections in Italy will focus on the euro and Italy’s membership of the euro area.
The worrying point here is that the Italian population is no longer in favor of the euro, as shown by the latest European Commission Eurobarometer survey (October 2017), when 40% of Italians said that the euro is a bad thing for the country as compared to 25% of the population in the euro area as a whole, and also in France. Meanwhile, only 45% of Italians think that the euro is a good thing for the country vs. 64% on average in the euro area and France. The European question played a major role in the French electoral campaign in spring 2017, but we can see that the European aspect of the Italian elections was driven by different considerations. Close to half of Italians are skeptical on the usefulness of the single European currency, and herein lies the real difference. Continue reading