Italy will face a long period of no growth, leading to the erosion of its primary budget surplus, as an interim government starts the tough task of undoing Silvio Berlusconi’s legacy, George Magnus, senior economic adviser at UBS said on Tuesday.
That primary surplus has traditionally helped allay investors concerns over the country’s high level of public debt, currently hovering around 120 percent of gross domestic product.
Mario Monti, the former European Commissioner appointed on Sunday to succeed Berlusconi, is expected to conclude talks on forming a new government on Tuesday.
With yields on Italian government debt still close to 7 percent — the level at which Portugal, Ireland and Greece had to seek bailouts as the cost of funding their debt had become unsustainable — Monti will seek to introduce credible budgetary restraint, liberalize the labor market and introduce structural reforms.
“There’s not a lot of time to do this, and the markets obviously will be extremely nervous about the sensitivity of what effectively I think an unelected government is going to try and do…bearing in mind that some of these measures are going to be extremely unpopular,” Magnus told CNBC.
Magnus pointed out that Italy is one of only three countries in the advanced world — the others being Singapore and Korea — that has a small primary surplus, meaning its budget is in surplus excluding debt interest payments.
But this surplus has been eroding for the last ten years, Magnus said. “What really has killed Italy actually is the lack of growth.”
“Bearing in mind that it looks now that the euro zone has basically entered into a new contraction…(and) that Italy won’t have any growth for a long time to come, that surplus is going to wither. That is a problem,” Magnus said.
Berlusconi’s legacy has also left Italy slumping in world rankings when it comes to operation of the rule of law, corruption and government effectiveness, Magnus said.
Although such matters were not usually taken into account in economic modeling, “these things matter enormously” for the efficiency of measures governments can implement, Magnus said.
The UBS economist said the imbalances currently witnessed in Europe, with wealthier countries bailing out those whose finances are in bad shape, were mirrored on a global scale and said the creditors had no choice but to accept they needed to step in.
“The idea that debtor countries have to bear 100 percent of the burden of adjustment is completely delusional and dangerous. What will happen is that the debtors will bring the creditors down with them,” Magnus said.
“The creditors — in this case Germany and in the wider world China — have to take some on some of the responsibility of fixing these problems. Germany will have to allow the ECB to print money and allow inflation to rise,” he said.
“The German position has to soften and if survival of the euro zone is at stake, the ECB has to be given carte blanche effectively to buy bonds and print money, Magnus said, adding however that this point of view was “hard to swallow”.
“It’s possible that out of these ashes there will emerge a stronger and more viable euro zone," Magnus said, although “that is a bit of a stretch to think about at this moment.”