During the heyday of the sovereign debt crisis, speculation over whether Greece would abandon the euro was rife. In the end, Greece defaulted and its economy shrank by one-quarter, but it did not leave the euro. Ever since, there has been concern that Italy’s elevated debt burden might lead to its own debt crisis, and a possible ‘Italexit’.
Fathom’s proprietary indicators suggest that investors continue to see a high risk of default in Greece and a significant risk of both default, and euro exit, in Italy. However, drawing close comparisons between the two countries purely based upon the magnitude of their debt may be misleading for several key reasons.
First, Greece is currently running an overall budget surplus in excess of 0.5% of GDP while Italy’s budget remains in deficit ― despite this, Fathom’s proprietary probability of default indicators show that investors remain more bearish on Greek debt and judge the Hellenic Republic to be more than twice as likely to default.
Indeed, investors tend to remain cautious when lending to countries that have previously defaulted. According to another of Fathom’s proprietary indicators (the Sovereign Fragility Index), this effect could be contributing as much as 1.6 percentage points to Greek government borrowing costs ― at the time of writing, the benchmark ten-year Greek government bond yield is 1.0 percentage points above its Italian counterpart.
Second, comparisons between Italy’s current fiscal problems and those of Greece in 2010 are unhelpful — during the crisis, Greece was running a double-digit budget deficit while Italy’s present budget is only dragged into deficit by interest payments; though an elevated debt-to-GDP ratio does make it vulnerable to swings in market sentiment, it is far from certain that Italy is on the path to default.
Third, while the current level of Fathom’s probability of default indicator for Italy is comparable to Greece’s indicator in late-2009, this should not be viewed as a signal of an imminent crisis since the latter was set against a backdrop of what Eurostat described as “unreliability of data” that flattered the Greek fiscal position.
Fourth, investors in 2019 seem to view Italy’s likelihoods of default and euro exit as moving together, much as they did with Greece in 2010, however the latter showed that default is not a guaranteed precursor for an exit; though Greece did come close then, Fathom’s proprietary indicators show that investors now see less chance of Greece abandoning the euro than Italy.
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