Italian Sovereign Debt: Time to Worry or Party?

06/15/20

Italian sovereign borrowing is increasing, as the costs of dealing with a stalled economy and the pandemic build.  A recipe for disaster?  Turns out that Italian yields (and spreads with the risk free benchmark rate) are actually going down; down in the vicinity of zero. (for the WSJ's treatment of this last week, see here). And at least some Italian economist friends of mine are beginning to talk about how debt/GDP levels around 180% or maybe even 200% could be sustainable.  Aiyiyiyi. That sounds loony; given that the economic fundamentals -- thanks especially to the horror of covid-19 -- are going in the opposite direction. That said, I'm no economist and I definitely do not understand the current market patterns. As further evidence of this lunacy, Brazil was able to borrow $3.5 billion a few weeks ago at lower rates than it was having to pay before the pandemic; a pandemic to which its response has been spectacularly Trumpian. (And yes, I have economist friends of mine who insist that Brazilian debt is safe and will remain sustainable because of factors such as Fed swap lines and Trump's friendship with Bolsonaro. I'll readily admit that I don't understand the swap line theory of debt sustainability. But on that other point . . . . Really dudes? You are going to bet on Trump bailing out Bolsonaro because of their special relationship?).

Not everyone, fortunately, thinks that the markets are going to continue to adequately and fully fund this covid-19 recovery.  Below is the abstract of Tyler Zelinger's new paper on preparations Italy could make in anticipation of the need to do a debt restructuring someday soon (and he is only using them as an exemplar, since they seem to be on the precipice -- despite their current borrowing costs). If things begin to tank -- as I worry they will sooner rather than later -- papers like this that do the advance preparation that governments are refusing to do, will be invaluable. Tyler even finds a silver lining in all of this for the hypothetical Italian debt restructurer.

The abstract of the paper (just posted on ssrn) is below:

As the global economy has become more integrated and increasingly complex, the need for a system that administers government default has become more and more apparent. The body of "sovereign debt law" that has emerged to fill this need in the context of the Eurozone is an amalgamation of treaty obligations, domestic law constitutional principles, and tensions between state government and supranational government actors. Using a hypothetical Italian restructuring, this paper seeks to explore how these different bodies of law operate together to create a system that protects government function as opposed to guaranteeing creditor recovery. Further, this paper explores how an exogenous shock as the COVID-19 pandemic effects the analyses undertaken at various points in the sovereign debt legal framework.

This analysis reveals a silver lining: although Italy has suffered horrible losses as the result of the COVID-19 pandemic, the effects of the pandemic will help mitigate the legal challenges faced by Italy in the course of a local-law restructuring effort and thus smooth the path to a successful post-COVID recovery.

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