Italy's new crisis will be 'too much' for Europe to handle, Latvia's finance minister warns

  • Asked during a panel discussion in Paris Wednesday if the recent market activity could eventually impact growth, Latvian minister Dana Reizniece-Ozola was unequivocal.
  • Italy's financial situation was already a major point of concern for the 28-member EU bloc.
  • Its growth is anemic, unemployment is high at 11 percent, and its public debt is 132 percent of gross domestic product (GDP) compared to the euro zone's 87 percent.

Italy's political turmoil could hit the continent harder than the Greek financial crisis and the Brexit vote, according to the finance minister of Latvia.

A week of political turbulence in Italy saw dramatic repricing of the country's assets and has triggered fears of market contagion across the entirety of Europe.

Asked during a panel discussion in Paris Wednesday if the recent market activity could eventually impact growth, Latvian minister Dana Reizniece-Ozola was unequivocal.

"Definitely," she said. "I think we can see what an impact Brexit has already caused to the EU in general, and if Italy fails to form a government that might be still pro-European and still dedicated to the reforms and getting the country back within the fiscal stance, that might be a bigger harm to the whole of Europe."

Italy's financial situation was already a major point of concern for the 28-member EU bloc. Its growth is anemic, unemployment is high at 11 percent, and its public debt is 132 percent of gross domestic product (GDP) compared to the euro zone's 87 percent — making it the fifth-most indebted country in the world and the second in Europe, after Greece.

Speaking to CNBC's Joumanna Bercetche during the panel at the Organization for Economic Cooperation and Development (OECD), Reizniece-Ozola said, "We could handle Greece, we could and will handle Brexit ... Italy will be too much I think."

Euroskeptic politics

Ever since elections in March that saw two populist and euroskeptic parties perform well — the Five Star Movement (M5S) and the far-right wing Lega — markets have become even more worried thanks to pledges by the parties' leaders to cut taxes, increase public spending, and essentially ignore EU fiscal rules. EU officials have been calling on the parties' leaders to remain in compliance with the bloc's fiscal framework.

Lega far right party leader Matteo Salvini gestures during a press conference held at the Lega headquarter in Milan on March 5, 2018.
PIERO CRUCIATTI | AFP | Getty Images
Lega far right party leader Matteo Salvini gestures during a press conference held at the Lega headquarter in Milan on March 5, 2018.

Tensions between pro-EU establishment figures and those skeptical of the European project came to a head over the weekend after Italian President Sergio Mattarella vetoed Lega and M5S's pick for economy minister, Paolo Savona, because of his anti-euro views. The move, which prevents M5S and Lega from being able to form a coalition government, has triggered a constitutional crisis and could prompt fresh elections that could take place as early as July.

Investors fear this could usher in an even stronger victory for populist and anti-euro agendas, as a new election risks serving as a referendum on Italy's existence within the EU.

Assets on a roller coaster

The market panic on Tuesday — which saw Italian bond yields spike to their highest level in years and all major markets down, including the Dow Jones and S&P 500 — has planted fears that a financial downturn could seep through the rest of the 19-member euro zone and beyond, rupturing Europe's growth and even forcing the Federal Reserve to hold on its rate hiking plans. This week saw the euro hit its lowest point in more than six months.

Uncertainty continued to roil markets through Wednesday, although Italian stocks and bonds have been rebounding on reports that the two anti-establishment parties are renewing efforts to form a government, potentially staving off the prospect of a snap election.

Italian bonds rallied for a second day on Thursday as Italian two-year paper rose 154 basis points from Tuesday's low, marking its biggest increase in 26 years. Italian equities have meanwhile erased more than half of the losses suffered since the open of trade on Monday.

Recovery or contagion?

Still, fears loom over potential contagion, which refers to the spread of market disturbances from one region to others and is normally associated with a financial meltdown. The spread of an Italian financial and debt crisis to other countries could cripple their ability to repay government debt without third-party help.

The closest example of this would be Greece, whose debt crisis over the past several years brought chaos onto Europe and still remains a major problem for the continent today, although European safeguards largely prevented contagion.

"Several big countries are already demonstrating they are not in the game," the Latvian minister told CNBC on Thursday. She described this as a burden politically and emotionally as well as financially for the rest of the euro community.

"We see how difficult it is for Greece to take the common agreements on their rescue program, to pursuing the necessary reforms. I'm not so sure that the other member states would be eager now to invest more in some of the countries that probably have not obeyed the strict rules of the game."

Asked if Italy's crisis could spell the end of the euro, Reizniece-Ozola replied, "I wouldn't think so still, because the rest of the countries, in general, we do appreciate having the common currency." But, she added, it could still "trigger" a move in that direction.

Latvia adopted the shared European currency in 2014 and in 2017 saw robust growth of 4.5 percent, aided by EU funds like the European Social Fund, and European Regional Development Fund and the Cohesion Fund. The Baltic country of just under 2 million joined the OECD as its 35th member state in 2016 and has been praised for its fiscal and structural reforms.

While the market panic seems to corroborate Reizniece-Ozola's views earlier in the week, many analysts see the risk of contagion as small, and the risk of a euro departure even smaller. Former IMF Chief Economist Olivier Blanchard told CNBC this week that he believed Europe would be OK, but he was "very worried about Italy."