Italy, the eighth largest economy in the world, outran Greece when the prime minister threat to the stability of the 17-country single currency zone, and finance ministers met to find ways of building a firewall around the two-year-old crisis.
As Silvio Berlusconi defied huge pressure to resign, markets across Europe were hit by the fear of Italy’s possible instability.
“This is the event risk we’re all afraid of. Greece is a minnow in the grand scheme of the things,” said Stephen Lingard, director of research at Franklin Templeton, Toronto.
“If investors call into question the solvency of Italy, there’s not enough firepower in the European Union or the bailout facility to stem this crisis.”
As for Greece, it has the main problem: to have enough money to repay its debt. But for Italy liquidity has become the comprehensive question.
Investors are afraid that the country won’t be able to pay for its 1.9 trillion euro debt, which amounts to about 120 per cent of its GDP. As a result they are demanding the rise of interest rates on its bonds.
Over last 10 years Italy’s yield bonds have risen to 6.67 per cent, was announced on Monday, its highest level since the establishment of euro in 1999 – and uncomfortably close to the 7 percent-threshold that forced both Ireland and Portugal to accept bailouts.
As yields have risen, governments have to use more of their budgets mainly to paying interest costs, creating a cycle of debt.
According to Benjamin Tal, economist at CIBC World Markets Inc, “The fundamentals of Italy are not as bad as Greece. But the market is viewing its debt as pure junk in terms of risk”.
“The problem with Italy is really its budget situation. If you imposed Italian interest rates on Japan, it would go under,” he said.
In Rome, Silvio Berlusconi has defied huge pressure to resign as he struggled to hold a crumbling center-right coalition together after being forced to accept intrusive IMF surveillance of his economic reforms.
Sources said leaders of Berlusconi’s PDL party had tried to make him resign on Sunday but he was resisting.
Jean-Claude Juncker, the chairman of Eurogroup finance ministers, stopped short of calling for a national unity government in Italy, saying it wasn’t under EU/IMF protection.
After the finance ministers’ meeting, referring to a letter sent last month that set out plans for pensions reform and deregulation, he said, “What we are expecting from Italy is that Italy will implement all the measures which have been announced in Berlusconi’s letter.”
A cabinet minister claimed Italy would possibly face early elections if party rebels stripped Berlusconi of his majority in a crunch vote on public finances in parliament on Tuesday.
“If we have the majority we’ll carry on, otherwise there’ll be elections,” Gianfranco Rotondi, a minister without portfolio, said.
Lucas Papademos, European Central Bank ex-vice-president was on his way to Athens, tipped to head a transitional Greek cabinet charged with pushing a 130 billion-euro bailout plan through parliament to secure a crucial 8 billion-euro aid tranche before early general elections in February.
A Greek government spokesman said talks on finding a new prime minister were continuing in a good way, no decision had been reached. The Greek cabinet will convene on Tuesday to discuss possible developments.