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When Milan says Basta! to Rome

 Salomons Judgement

A European procedure and an impending fine amounting to billions will not alter Italy’s way of thinking. Only a simple ‘basta!’ from the financial centres in Milan will bring the much-needed change to Rome.

Italy - with more banks than pizzerias - is a great country, but not when it comes to reforms. Low interest rates have not been used well, and there is an argument with the European Union about the party budget. In the last few weeks, journalists, customers and colleagues again asked for a vision of Italy. In an earlier column I wrote that the economic problems of the country are as ancient as the country itself, and that the new government is building castles in the air. This time I wonder when reason will return.

The weakening growth that we expect for Italy in 2019 is only a confirmation for the current government that the economy needs to be stimulated. Europe’s threatening with an excessive deficit procedure is just considered as unwanted interference. Only pressure from the financial markets can bring about a turnaround. That does not require much more than half a percent higher interest. Italian interest rates have already risen from 1.7 to 3.5% since the elections. If the interest rate rises above 4%, the solvency at the banks will be compromised. So, the interest rate should not rise too fast, but it will happen as the European Central Bank (ECB) stops its purchase programs.

Free loan from the ECB

By free loans from the (T)LTRO counter of the ECB, and the deposit in ‘safe’ government paper, 20% of all Italian debt is now held by local banks. In 2019 Frankfurt will offer less free money, while Rome will have to refinance a large amount of government debt (EUR 288 billion). Italian banks must look for an alternative for the cheap (T)LTRO loans. This pressure will also ensure that banks won’t let Italian companies roll over loans. And higher interest rates could cause problems for entrepreneurs. This situation would give a clear signal to Rome: no more party budgets, only reforms.

Recently, the Financial Times advocated the deployment of a European financial emergency fund (ESM) to alleviate the Italians’ debts. However, Rome must ask for it, which is unlikely to happen. Moreover, it will only provide temporary relief when Italian growth won’t be at a structurally higher level. Finally, Europe – rightly so – first wants to reduce risk and only then share risk.

Under the pressure of a higher Italian interest, everything becomes fluid. If financial markets put Rome to the test and Italian entrepreneurs can no longer roll over their loans, the moment comes when Milan calls Rome to tell them this situation is no longer sustainable. In my judgement that is the moment when reason prevails.

The author

Roelof Salomons

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