Summary and Conclusions

Italy is facing two intertwining challenges: a large government debt and an ailing banking sector associated with slow GDP growth. The high level of public debt, the still relatively high but decreasing budget deficits, structural rigidities, the precarious state of the banking

sector and the absence of growth dynamics expose the third largest economy in the euro area highly vulnerable to external and internal shocks. Due to their orders of magnitude, these challenges and their management may have implications for the financial stability of the Economic and Monetary Union in terms of systemic risks. Nevertheless, Italy is unlikely to turn a second Greece with domino effects that hit the euro area.

In spite of the significant legal constraints constituted by EU legal rules, the problems of the government debt can be managed more easily than those of the banking sector, particularly in the light of the latest short-term improvement in the overall economic situation.

The risk of an imminent general government debt crisis does not seem to be on the horizon.

Should the necessity arise in a crisis situation, in principle, the Italian Government, among other things, has the capacity to raise taxes to meet its payment obligations in spite of the opposition and the resistance of political parties and the broader society.

The task of reducing the debt ratio is primarily with the Italian Government. As a general rule, it cannot expect much help from external factors such as the softening up of the EU budgetary rules allowing larger general government deficits and the reduction of current account surpluses by other euro area member states to enable the increase of Italian exports.

EU institutions and member states could render Italy much more help in managing the refugee crisis that impose a huge burden on the country’s general government expenditures.

The refugee crisis is a common problem of all EU member states.

Primarily due to the significant negative spillover impact on GDP growth, a sudden reduction of the government debt would be much more harmful than a slow gradual reduction.

Considering the current magnitude, a substantial decrease of the public debt ratio would probably not improve much the confidence of foreign and domestic economic actors in the Italian Government. Restrained optimism is justified in the management of public debt, although negative external and internal risks are still present and not negligible. What matters more is a consistent and credible medium- or long-term strategy on the consolidation of the general government and public debt reduction.

The major challenge Italy is facing is not the general government debt, but the shaky state of its banking sector. Although the risk of a bank crisis has decreased, due to orders of magnitude, the default of large banks could put financial stability at risk not only in Italy, but in in the euro area, as well. Although the problems of Italy’s banking system have eased recently, they are far from being resolved completely. The involvement of public money in the recapitalisation of banks in order to avoid a crisis alone does not solve the deep-rooted problems of the Italian banking sector, but it may postpone its streamlining and modernisation.

A considerable part of the problems of Italy’s banking sector is associated with EU legal rules. The bank resolution system of the EU and the EMU, respectively has not been prepared for managing a problem of this size. Although it is politically difficult to implement, the completion of the banking union and the European deposit guarantee system is an important prerequisite of consolidation.

However, probably out of fear of unpredictable financial market reactions and Italy’s economic weight in the euro area, the European Commission undermined the effective legal rules to help to rescue the two troubled Venetian banks (Banco Popolare di Vicenza and Veneto Banca) thereby providing a negative precedence.

Slow GDP growth indicates that Italy’s economic and financial crisis has not come to an end yet. The dynamisation of GDP growth, too, may contribute to the improvement of the

government debt ratio and the state of the banking sector. This potential factor can be realised by continuing structural reforms and introducing new growth enhancing reform measures.

Political and constitutional reforms aiming at the strengthening of political stability and economic governance, too, are part of this issue. This can be the outbreak from the vicious circle of looming government debt and banking crisis and slow economic growth. The major limiting factor is a political one, namely the requirements of political rationality often contradict those of economic rationality. This target conflict should be reconciled somehow.

The success of the reforms will have positive political implications, as well. On the other hand, their failure may give room to anti-establishment and Eurosceptic political forces.

For a rather long time, Italy has seemed to be continuously on the brink of collapse, but it has always showed resilience and has never collapsed. Italy’s economy seems to be too big either to bail or to fall. Italy is certainly not the sick country of Europe. To prove this, the words of the Italian writer Giuseppe Tomasi di Lampedusa should be realised:

Everything has to change for nothing to really change. Hopefully, Italy is likely to muddle through with a mix of resilience and creativity.

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