The gap between Italian and German yields widened to more than 2.2 percentage points, reversing more than half of the narrowing seen since the European Central Bank’s (ECB) announced its €750bn monetary stimulus. Italy’s borrowing costs remain above their levels at the beginning of the year. Investors worry about mounting debt to fund the country’s response to the pandemic, as well as the reluctance of other eurozone countries to share the financial burden.
Higher debt-servicing costs threaten another financial crisis in the Eurozone. The proximate cause of the Eurozone crisis a decade ago was the rapid unwinding of economic imbalances and cross-border capital flows between Eurozone countries. When investors lost confidence in deficit nations and lending dried up, those countries found themselves unable to service their debts or borrow additional funds.
Although conditions are vastly different now, fears over debt sustainability have intensified since Eurozone finance ministers failed to agree on a way to pool risk across all member states. Investors are left to focus on the financial risk of each country, putting the creditworthiness of southern European nations under the question mark once again. Another Eurozone crisis could be on the cards. Financial Times’s Wolfgang Münchau already pointed out how this might be a plausible scenario due to the combination of rising debt, falling GDP, and slow growth in the Eurozone periphery.
Last week’s agreement in the Eurogroup is impressive taking into consideration the deep divisions between Eurozone member states. If a Eurozone country is in distress, it can now request a loan from the European Stability Mechanism (ESM) with limited conditionality. Unlike the previous crisis, the ECB has intervened promptly and can act as a de facto buyer of last resort for government debt. However, while available options provide for substantial liquidity, they do not address the issue of mounting debt and debt sustaintability.
The IMF forecast on Wednesday estimates government debt in the Eurozone will be propelled towards 100 per cent of GDP. Debt burdens could stifle the growth prospects of fiscally weaker states, further straining the economic cohesion of the bloc. Higher debt burdens in the Eurozone periphery would leave those countries vulnerable in the face of bondholders concerned about their solvency and constrain fiscal expansion short of what is needed to counter the crisis.