Fighting Italy’s Next Crisis Means Enlisting Citizen Help

(Bloomberg) -- Italy may have weathered a financial-market storm this year, but officials are already working on a new line of defense for the next crisis.

That strategy involves enlisting citizens in the protection of the republic’s finances. The government of the euro zone’s third-biggest economy sold consumers a semi-retail bond called BTP Italia in May with record results, and now officials are marketing a first fully retail-based security for sale next week. This one is dubbed as BTP Futura.

Italy is trying to insulate itself from future turmoil over the sustainability of one of the world’s largest debt piles after investor jitters at the onset of the coronavirus crisis required the European Central Bank to step in. The sale is attempting a return to the country’s pre-euro past, when consumers who once owned almost two thirds of its borrowings provided a buffer against speculative attacks.

“The more you engage retail investors, the more you keep funding pressures ‘off market’ and the less risk there is that any surge in funding destabilizes markets,” said Giles Gale, head of European rates strategy at NatWest Markets. “More retail investment should help to reduce headline market volatility.”

Italy suffered three simultaneous crises this year, as the coronavirus emergency combined with an economic slump and market turmoil.

At its worst point, the spread between yields on the country’s 10-year bonds and Germany’s equivalent widened above 300 basis points for the first time since 2018 as a slip-up by ECB President Christine Lagarde left investors doubting her institution’s resolve in defending Italy’s euro membership until a new stimulus tool kept speculators at bay.

Italian bonds notched up their second month of gains in June, with 10-year yields trading around 1.27%, close to the lowest level since March.

The fallout from the crisis means the economy could shrink as much as 13% this year, according to Bloomberg Economics. Debt could well exceed over 150% of output as the Treasury doles out 75 billion euros ($84 billion) in stimulus packages. The government will likely need to pass a further 20 billion euros in stimulus in July to continue to support the economy, thus widening the country’s budget deficit to 11.6% of GDP, according to two people familiar with the matter.

What Bloomberg Economics Says...

“Debts will leave Italy vulnerable to almost every bump in the road. Every time growth is weaker than expected, a bank needs a bailout or a spendthrift politician makes a new promise, investors will be nervous and some will inevitably run for the exit.”

-David Powell. See his ITALY INSIGHT

Prime Minister Giuseppe Conte declared last month that “Italy is not a country where we abandon workers” and pledged to do whatever necessary to protect citizens and businesses. That probably means even more stimulus, which will need to be financed.

Overall debt is set to breach the 2.5 trillion-euro threshold later this year, according to Mazziero Research, with high refinancing needs expected in the fall.

Increasing domestic borrowing is a tactic reminiscent of Japan, which has public debt exceeding 200% yet low financing costs, partly due to the high percentage of debt owned by domestic banks, trust funds and ordinary savers.

Italian governments tried to increase retail debt before, particularly during the 2012 euro- zone crisis, when the inflation-linked BTP Italia product was created. Now officials are pushing new initiatives including BTP Futura and possible “green bonds” to cover eco-friendly investments.

Some have even floated the idea of perpetual bonds, which market regulator chief Paolo Savona defined as “typical of war periods, to which this pandemic has been compared.”

As debts pile up, it’s a good time to tap savers, with investor demand for Italian securities at record highs and borrowing costs relatively low as the ECB buys them for its rescue program. Ten-year debt sold via banks in June attracted record bidding, while the largest ever sale of retail bonds in May, a four-day auction of BTP Italia, allocated a record 22.3 billion euros.

Loyalty Premium

Since only 3.1% of Italian bonds are currently owned by citizens, compared to 62.5% in 1988, there’s a large market to be tapped, while building that up into a domestic buffer to speculation will clearly take time.

The new BTP Futura bond is touted by the Treasury as the bond “for the future of the country.” Its proceeds will be entirely used to fund measures to aid the economy, meaning those who invest will be helping Italy as they make returns for themselves. The bond’s yield will increase with time and will include a “loyalty premium” for investors who hold it until maturity, linked to Italy’s gross domestic product.

Raffaella Tenconi, chief economist at ADA Economics, told Bloomberg Television that there are good reasons to take up the offer.

“The bond pays a little bit of a premium -- it does function as an income support,” she said. “Generating an asset that yields a little bit more than inflation I think is a good idea.”

Domenico Germano, an 84 year-old pensioner, isn’t so sure. The debt sale brings back memories of a time when returns were far more attractive.

“Investing in retail bonds was an easy way to make a bit of extra profit and protect yourself against inflation,” he said of his decision to buy Italian debt in the early 1990s, when yields reached 16%, which was more of an incentive. Now, “with monetary stability, there’s less risk that your money in the bank will lose value.”

©2020 Bloomberg L.P.