Why Mini-BOTs Loom Big for Investors in Italy Assets: QuickTake

(Bloomberg) -- Italy’s newly ascendant populist parties sent jitters across Europe’s debt markets by proposing a new class of short-dated government notes that would be created specifically to pay state arrears. The idea spooked investors who see it as akin to issuing a parallel currency that would further dent the country’s fiscal sustainability. Italian bonds pared some of the past week’s losses, with 10-year yields retracing from the highest intraday levels in more than a year, while the premium to cover a default in the nation’s debt is the stiffest since October.

1. What exactly is being proposed?

The anti-establishment Five Star Movement and the anti-immigrant League, which have agreed to rule Italy as a coalition, released a contract that includes the idea for a type of government IOU. Its name -- mini-BOT -- is a play on BOT, or Buoni Ordinari del Tesoro, a common Italian Treasury bill or short-term credit note. The two parties are considering the creation of new small-value notes (EU1 to EU500) to meet payments to suppliers and creditors that have accumulated as arrears, up to 25,000 euros each ($29,000). Like an IOU from the government, a mini-BOT would pay no interest and have no due date.

2. How would this work?

A supplier or taxpayer owed money by the government would get a certificate worth a certain amount. The notes would be state-guaranteed and accepted by the government for the payment of taxes. There’s no obligation for third parties to accept them and no guarantee they will take off as an alternative payment system. The League says that issuing 70-100 billion euros of fiscal credit-backed mini-BOTs would kickstart the economy.

3. How isn’t this a parallel currency?

The League says the notes wouldn’t be legal tender, which is an important legal distinction, since only the European Central Bank can print money in the euro zone. But mini-BOTs would be like currency in some respects. Italians could use them to buy train tickets or gasoline at state-controlled companies, for instance. Once issued, mini-BOTs could trade at a discount to their face value in euros, which would in effect result in a parallel currency -- particularly if people were to start using the new note as cash to exchange for goods and services, rather than using euros. Analysts are concerned the idea of a de facto parallel currency could weigh on the euro and that it could jeopardize Italy’s fiscal sustainability.

4. Has anything like this been tried before?

Argentina issued small-bill IOUs known as Lecops to pay civil servants in the early 2000s amid surging inflation. California temporarily used IOUs in 2009, mainly for personal income tax refunds, as it ran short of cash. Greek leaders considered issuing electronic IOUs in 2015 as they were negotiating with creditors to keep the country in the euro.

5. Would mini-BOTs be traded?

Whether they’ll be traded -- and at what discount, if they are -- isn’t clear. The League says they should trade at par, since they’d be used to settle tax payments at their full value. The League’s program says a secondary market is not needed as they can be spent and cashed in with the state or state companies.

6. Wouldn’t this add to Italy’s debt?

The League argues that the notes wouldn’t add to the debt load since they’d be used to cover existing liabilities -- money owed to taxpayers, suppliers of goods and services. The League and Five Star say in their contract that they’ll discuss whether mini-BOTs constitute debt. Analysts say the bills could be used to finance looser fiscal policies and add to Italy’s debt pile of more than 130 percent of gross domestic product. Valentin Marinov, head of G-10 currency research at Credit Agricole, said that such issuance could stoke fears about Italy trying to sidestep euro-zone public spending and borrowing restrictions.

The Reference Shelf

• The League’s campaign manifesto.
• The Five Star/League contract.
• Mini-BOTs, the Monster Under the Bed for European Investors
• Bloomberg Businessweek in 2015 explored whether a parallel currency could save Greece from drowning.

--With assistance from Lorenzo Totaro.

To contact the reporter on this story: Marco Bertacche in Milan at mbertacche@bloomberg.net

To contact the editors responsible for this story: Andrew J. Barden at barden@bloomberg.net, Jenny Paris, Laurence Arnold

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