With -7% growth and a 10% deficit, Italian financing needs for 2020 will be sizeable. We show that the current pace of ECB purchases is enough to cover at least 50% of 2020 funding. Adding resources from EU programs currently under discussion, financing needs may be fully covered. Market reliance will thus be limited. As the ECB will be a major financing source for Italy over the next year, the share of Italian debt held by internationals is set to fall.
The large 2020 deficit will put Italy’s public financing back in the spotlight. The updated budget in fact projects nominal GDP growth at -7% and the budget deficit at -10.4% of GDP, which would imply a deficit of EUR 173bn. Adding this massive number to the existing debt coming due, the Italian public sector would need to raise EUR 370bn (net of the debt already issued as of end-April, which amounts to EUR 180bn according to the Parliamentary Budget Office). On a monthly basis, funding needs will thus be roughly twice as much as the ones of an ordinary year (see 2021 vs 2020 redemptions in the picture below).
A natural question is thus whether Italy can benefit from the existing European COVID-19 support initiatives to finance this extraordinary amount, or whether the country will be once more at the mercy of market conditions.
ECB purchases alone will cover a very large share of Italy’s financing needs in the next two years. Modest deviations from capital key (well below the deviations observed in March and April) would be enough to cover 50-60% of 2020 financing needs.
The ECB has announced EUR 1070bn of asset purchases for the remaining part of 2020.Of those, EUR 370bn will come via the existing Asset Purchase Program (APP). The remaining EUR 750bn will be purchased through the Pandemic Emergency Purchase Programme (PEPP).
Public sector securities account for about 80% of the outstanding assets acquired by the ECB during the previous APP wave. If this ratio was maintained throughout the remaining purchases, we would see EUR 856bn of public sector purchases in 2020. If PEPP were fully sovereign (100%), we would see EUR 1.06trn of additional public sector purchases in 2020.
Based on the ECB capital key, the Italian share of purchases would be 14%. If the ECB were to follow strictly the capital key, then it would be buying between EUR 120-140bn of new Italian debt in 2020. Even in this conservative case, the ECB purchases would cover 35-42% of the financing needs for the year (net of ECB APP re-investments for 2020, which we estimate to be in the order of EUR 40bn based on data quoted by Benoît Cœuré in a 2019 speech).
Since March, the Italian share in ECB sovereign purchases has been 34%, more than twice the capital key. This share is likely to decrease over time, as Italy has been the first country hit by the pandemic, which may have resulted in the ECB frontloading its support. Still, the composition of March and April purchases suggest that the ECB approach is now de facto “need-based”, making persistent deviations from the capital key possible.
The “flexibility” the ECB stated it will apply to self-imposed limits under PEPP is in line with this interpretation – although the recent German Constitutional Court judgement on PSPP suggests that the extent and length of deviations will be subject of close scrutiny in Germany, and may lead to PEPP being challenged domestically.
Deviations from the capital key would make the financing needs even easier to meet for Italy. A 5% deviation, meaning a long-term share of 19%, would allow covering between 48% and 57% of 2020 funding needs. A 10% deviation (implying a 24% long-term share) could mean ECB purchases may cover up to 72% of 2020 funding needs. In any case, the ECB current programs are enough to ease a large share of Italian funding needs for 2020, even in absence of alternative EU-level initiatives and before market access.
On top of ECB purchases, various EU-level initiatives can contribute to alleviating financing pressure for 2020. Under SURE – the European Commission’s unemployment relief initiative – we estimate that Italy could access up to EUR 20bn, based on the requirement that the share of loans granted to the three Member States representing the largest share of loans granted shall not exceed 60% of the total available.
Another EUR 36bn would be available from the ESM new Pandemic Support credit line, although the Italian government has been reluctant to consider the option, at least until now. We do not yet know the size and structure of the EU Recovery Fund (EURF) under discussion – although EC President Von der Leyen said that “we are talking about trillion”, but we assume that Italy’s share in the EURF pot would be at least 14% (based on the share of Italy in total EU population and GDP).
In the figure below we look at four scenarios, which assume full use of SURE and vary in terms of (i) ESM use; (ii) size of EU Recovery Fund; and (iii) size of ECB Italian sovereign purchases.
The ‘worst case scenario’ assumes no recourse to the ESM, a EUR 500bn EU Recovery Fund (under delivering with respect to the expectations set by the EC President), a weight of 80% for sovereign in the ECB’s PEPP purchases with an Italian share of 14% (equal to the formal capital key). Under this scenario, Italy would be left with EUR 124 bn of funding needs to be covered on the market in 2020.
Our ‘baseline scenario’ assumes no ESM application, a EUR 1trn EU Recovery Fund and again 80% sovereign weight in PEPP purchases with 19% share for Italy (above the current share of Italy in outstanding PSPP assets, but not much). Under these conditions, the need to tap the market would be reduced to EUR 14 bn, for the rest of 2020. Adding the ESM money in the baseline scenario would allow covering all 2020 residual financing needs with the various funds available from EU initiatives.
In a very favourable scenario (‘best case’), with a EUR 1 trn recovery fund, and a weight of 80% for sovereign in the ECB’s PEPP purchases with an Italian share increased to 24%, the European resources available would exceed the remaining financing needs for 2020 even without applying for an ESM Pandemic Support credit line.
At the end of 2020, the share of Italian government debt held by central banks may increase substantially, especially vs the share held by foreign investors.
In Italy, the share of non-resident holding of government debt was 32%, as of January 2020. The central banks (ECB and Banca d’Italia) share is closer to 18%. If the ECB this year were to buy an amount close to 50-70% of the 2020 financing needs, then such share will move closer to 20-23%.
As the debt ratio is expected to increase by 15-20 p.p. this year (from 135% in 2019 to 150-155% in 2020), these numbers suggest that the ECB purchases will be enough to effectively internalise the increase in the debt ratio that is attributable to the COVID-19 shock.
If the same holds true in 2021 and 2022, the central bank share may move closer to 30% and – assuming SURE, ESM and EURF resources are drawn – another 7% of the Italian debt to GDP ratio would move from being marketable to be EU loans/grants. The consequence would likely be an erosion of the foreign-held share, assuming domestic holders shares will stay stable as they have been in the past.
Overall, while the 2020 outlook for Italian economy and public finances is unsurprisingly negative, the resources available to reduce the impact on the cost of funding are sizeable. Under plausible scenarios (as shown in Figure 4) the recourse to the market could be reduced significantly for 2020, and the fact of shifting a larger share of debt from private to public creditors (the ECB and the EU) could ease the tensions also in 2021 and going forward.
When looking at the differences between the scenario, it is clear that the size of the EU Resolution Fund is key to determine the share of funding needs left uncovered, given reasonable assumptions on the ECB action. While central bank purchases will play a major role in keeping funding costs in check, the combination of monetary policy with a bold EU fiscal initiative could be an even more powerful game changer.
Silvia MERLER – Head of Research, Algebris Policy & Research Forum
Gabriele FOA’ – Contributing Author, Portfolio Manager, Algebris Macro Credit Fund
Antonio FOCELLA – Analyst, Algebris Policy & Research ForumL'Algebris Policy & Research Forum (il "Forum") è un think tank no profit nato con lo scopo di promuovere e incoraggiare un'economia forte ed equilibrata in Europa, sulla base di un solido sistema finanziario supportato da un ambiente regolamentare e fiscale trasparente a beneficio delle società nel loro insieme. I risultati delle ricerche dei nostri esperti verranno condivisi con il pubblico, gli enti governativi e non governativi.
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