Italy’s deputy prime minister Matteo Salvini is "convinced" that Italians can help out their government, in the face of a widening yield spread between German and Italian government bonds. The authors assess the feasibility of recourse to household wealth in Italy, and estimate the relative importance of foreign debt-holders in the upcoming bond redemptions.









__________________

“The strength of Italy, that none of the friends sitting around this table today has – neither the French, nor the Spanish – is a private wealth unequalled in the world. For now, it is silent and invested in foreign bonds. I am convinced that Italians are ready to lend us a hand [1]

Matteo Salvini, October 2018

_________________

On the sidelines of the G6 meeting in Lyon, Italy’s deputy prime minister Matteo Salvini was asked about his government’s strategy, in case the spread between Italian and German government bond yields were to keep widening.

Salvini pointed to the often-celebrated level of Italian private wealth, and said he was convinced that Italians would be “ready to help”. A day later, Salvini was again on record discussing the idea of tax breaks for Italians investing in domestic government bonds. Some are arguing that the idea will be put to test next week, when the Italian Treasury is due to auction the BTP Italia – a bond that is targeted at retail investors.

To outside observers, these remarks appear to suggest that the government would not hesitate to resort to some form of financial repression in case of crisis. The rating agency Moody’s seems to share this view. In its latest rating action on Italy, Moody’s states that the decision to keep the outlook stable reflects “important credit strengths that balance the weakening fiscal prospects”, including the fact that “Italian households have high wealth levels, an important buffer against future shocks and also a potentially substantial source of funding for the government”.

Italy – unlike Greece and the other countries that came under pressure in 2010-12 – did not run large current account deficits in the run-up to the crisis, has been posting current account surpluses since 2013, and had a current account surplus of 2.8% in 2017. The counterpart of this is that recourse to foreign financing has been contained, and the Italian Net International Investment Position in 2017 was only -3.9% of GDP. This relatively stronger external position did not prevent Italy from undergoing a balance-of-payment crisis in 2011, however. And as we have previously discussed , recent balance-of-payment data point to significant outflows (almost €60 b) from Italian government securities in May and June. After a rebound in July, government bonds recorded another spate of outflows in August (€17.4 billion) – even before the start of the discussion on the controversial 2019 budget that has set Italy on a collision course with the European Commission.

But is a recourse to household wealth feasible? Can Italian households substitute for foreigners, if outflows continue? The Italian non-financial private sector has actually been decreasing its holdings of domestic government bonds in recent years, pointing to lower appetite for domestic debt. Data from the Bank of Italy’s financial account statistics show that Italian non-financial corporations held about €45 billion in government bonds at the end of 2018-Q2, down from €57 billion a year earlier. Similarly, households decreased their holdings of Italian government debt from €132 billion in 2017-Q2 to €115 billion in 2018-Q2.

An obvious question, with respect to the crisis-driven national solidarity that Salvini seems to be hinting at, pertains to size. To understand whether private wealth could serve as a buffer, we firstly need to understand what portion of outstanding Italian government securities due for redemption is held by foreigners who could suddenly decide to walk away from Italian political risk.

A geographical breakdown of redemptions is not available, but Unicredit provides a sectoral breakdown of holdings by type of security at the end of 2017 (Table 1). The breakdown shows that foreigners were relatively more present in the shorter end of the maturity distribution. Foreigners were holding 20% of CCTs (seven-year maturity), 33% of BTPs (various medium-long maturities), and 77% of BOTs (maturity up to one year).

To have a very rough idea of the relative importance of foreign holders in the upcoming redemptions, we assumed that the shares of BTPs and CCTs held by foreigners remained fairly constant since last year, and we calculated the resulting share of newly issued BOTs in non-residents’ hands. In order for the total of outstanding bonds owned abroad to be consistent with the current figures provided by the Bank of Italy, and contained in our database on sovereign bonds holdings , we estimate that approximately 58% of BOTs are owned by foreigners at present. We then apply these shares to each redemption – thus assuming that the sectoral breakdown of ownership for each redemption is the same as the aggregate[2].

Figure 1 below shows the result of this exercise. The estimated foreign share of redemptions is on average 45%, but reaches as high as 58% in some months when redemptions entirely consist of short-term BOTs (left-hand side panel). In absolute numbers, our back-of-the-envelope calculations suggest that redemptions to foreigners are worth about €121 billion between today and the end of 2019 (right-hand side panel).

This figure points to a significant need for roll-over foreign holdings, even before considering the additional €10 billion of additional deficit that is implied by the government budget plan for 2019 compared to 2018. Can Italian households be expected to come to the rescue?

The first thing to notice is that the repeatedly celebrated Italian private wealth has actually been constantly declining over the past few years. Mean household net wealth was approximately €258,000 in 2010 and €206,000 in 2016, which amounts to a decrease of more than 20% over six years (Figure 2)[3].

Total net wealth remains significant, however. Multiplying the mean net wealth by the total number of households (about 25 million in 2016, according to the Bank of Italy households survey data) we obtain a total stock of net wealth of €5,268 billion. The €121 billion-worth of redemptions that we estimate to be due to foreigners in 2019 looks very small in comparison. Even under the extreme assumption that the entire foreign share had to be rolled-over domestically and purchased by households, the total would amount to slightly less than 2.5% of total net wealth.

But are things really that simple? Most likely not. First of all, wealth taxes or similar solutions are politically toxic. There are episodes when similar calls to national unity worked: for example, Belgium during the euro crisis asked its citizens to help the government refinance its debt obligations at a rate of 4% so as to apply downward pressure to then-rising market rates, and the call was successful . Even in Italy itself, the ‘BTP italia’ – which is constructed to be appealing to retail investors – was first launched in 2012, during the country’s period of crisis. But in that case, it obviously was not an imposition. The last time that a similar solidarity effort was imposed was with the deposit levy by Giuliano Amato in 1992 – and that seems to still be a vivid memory that catalyses major opposition.

Tailored issuance and tax incentives seem to be what the current government also has in mind. But Italians are unlikely to voluntarily devolve up to 2.5% of their net wealth to fund the roll-over, if there remains uncertainty over Italian public finances and/or Italy’s membership of the euro.

What is left, therefore, is coercion. Such an approach is hardly going to be tenable from a political standpoint, for two reasons. If Italy were to find itself in a situation where households have to come to the rescue, and significantly substitute for foreign funding, this would most likely occur in the context of a crisis of important proportions: the horizon of ‘solidarity’ would hardly be limited to 2019 (as we assume here) and the size would hardly be limited to 2.5% of total net wealth – although it may not be as extreme as the 20% recently proposed by Bundesbank economist Karsten Wendorff.

Figure 3 shows that the north and centre of Italy – areas that have predominantly endorsed the League’s fiscal promises to reduce revenues and taxation – would have to contribute relatively more than the Mezzogiorno – i.e. areas that have instead predominantly endorsed the Five Star Movement’s fiscal promise to expand the welfare state – due to the relatively higher neat mean wealth in those areas.

Imposing such a solution in an environment of perfect capital mobility such as the euro area may simply be impossible: deprived of ‘voice’, Italian savers may ultimately resort to ‘exit’ towards safer bank accounts. As a matter of fact, news reports already point to increasing numbers of citizens looking into the option of moving their savings to neighbouring Switzerland.

But the option of moving money is not equally available to everyone: the relatively richer and more financially literate part of the population would likely be quicker to resort to ‘exit’, thus leaving it to the relatively poorer and less mobile savers to show solidarity. Inequality would increase, and the strains within Italian society would deepen with it.

[1] The original quote in Italian reads: “La forza dell’Italia, che nessun altro degli amici seduti al tavolo oggi ha, né i francesi, né gli spagnoli, è un risparmio privato che non ha eguali al mondo. Per il momento è silenzioso e viene investito in titoli stranieri. Io sono convinto che gli italiani siano pronti a darci una mano”

[2] This is necessarily a rough estimate. It is worth reminding that foreign holdings are diverse and they could also account for (i) central banks holdings (other than Eurosystem); (ii) indirect holdings that could ultimately be traced back to Italian owners.

[3] The 2018 wave of the household survey suggest that the decline is mostly explained by development in house prices.