Why Italy’s Bond Ratings May Determine Conte’s Future

Quite recently, investors believed that it was safe to hold Italian bonds. However, Fitch Ratings changed all that by downgrading the eurozone’s third-largest economy to a BBB rating, which is only one level above junk status. Bloomberg reports that this will put the country’s bonds on course to end their longest winning run in a month.

Yields on 10-year bonds leaped by 10 basis points to 1.83 percent. The yield spread over Germany widened by as much as 11 basis points to 231 basis points.

Italy’s Bond Market is Barely Staying Afloat

Furthermore, the Italian bond market is surviving thanks to support from the European Central Bank (ECB). Under its bond-buying program, the central bank has become a guaranteed purchaser of Italian debt.

In many ways this is good news for Italy. Fitch insisted that the nation was close to receiving a bigger downgrade, that was before Italy provided extra information to assuage the agency’s anxieties.

Fitch was scheduled to hold its next review on July 10, but the organization noted that Italy’s sovereign position and the coronavirus pandemic forced them to implement action outside the planned meeting.

The Current State of Italy’s Economy is Testing Conte

Italian politics can be unpredictable at the best of times, but the current state of Italy’s economy is testing the fragile unity of Italian Prime Minister Giuseppe Conte’s coalition government. Earlier this month, the Five Star Movement (M5S), who are currently in coalition with Conte’s Democratic Party, threatened to end the leftist coalition government over their resort to use the European Stability Mechanism (ESM).

Breitbart reports that M5S Senator Mario Michele Giarrusso declared his opposition to the ESM, which is an EU bailout fund that provides member states with assistance in the form of loans.

M5S leader Vito Crimi, who took over from former leader Luigi di Maio after he resigned in January, stressed that he and Conte supported the idea of coronabonds instead. Despite this, EU leaders are yet to agree that distributing debt is the answer to the eurozone’s problems, which adds further pressure on Conte. The M5S has insisted that it will pull out of the Italian Prime Minister’s coalition government if he fails to get his way on coronabonds.

Conte Under Pressure to Lower Debt

Conte’s coalition allies are also urging him to gradually ease Italy’s lockdown from May 4. With the prospect of a mass investor exodus looming too, the Italian Prime Minister is attempting to initiate an agenda of reforms and investments to increase the nation’s growth potential and lower debt.

Finance Minister Roberto Gualtieri told Bloomberg that the Italian Government will initiate a series of reforms and investments to achieve this goal. With GDP expected to plummet by 13 percent, they need to act soon.

Italy’s problems mean that the ECB may have to do more to help the troubled nation. Its bond-buying program is expected to end in the autumn if it maintains its current pace.

Conte’s Problems are Far from Over

Even if the Italian Government were able to initiate a series of reforms sooner, that does not mean Conte’s problems are over.

EU leaders are yet to agree on what their Recovery Fund will look like next May and the issue of coronabonds has not disappeared. If the Italians do not get their way on distributing debt this time, the M5S may take their threat to end Conte’s premiership seriously and withdraw from his coalition government. That is why EU leaders should demonstrate they are serious about agreeing on a Recovery Fund sufficient enough to end Italy’s political turmoil if they want to avoid this outcome.

If the M5S ends Conte’s rule, Matteo Salvini’s League may become the largest party and form a coalition with the Brothers of Italy, which could eventually spell the end of Italy’s eurozone membership.

Wednesday’s news on Italian bonds has placed substantial political pressure on Conte both outside and inside Italy. Time is running out for him to persuade his EU counterparts to support the idea of coronabonds and his coalition government is hanging by a thread because of it. With the Italian economy facing such a fragile state, action is needed sooner rather than later.