Italian Debt Scares Global Markets

The European debt crisis has sent uncertainty and fear throughout global markets during 2011. Last week the international community watched Greece; this week, all eyes are onItaly.

On Tuesday night (US time) yields on 10 year Italian treasury bonds crossed the 7% barrier, which is seen as the threshold in which a government must seek a bailout because it can no longer pay off its welfare spending and the interest on its debt payments.

Greece,Portugal and Ireland have all needed a bailout after crossing the 7% mark in recent years.

Amy Wilson of the Daily Telegraph explains how this will affect Italy:

The yield is the interest rate on the loan, or bond, ie. how much the government has to pay to the bank, institution or country which has bought its bond and loaned it money – in the same way individuals have to pay interest on a mortgage or bank loan…

In Italy’s case, paying a 7pc interest rate to borrow new money means it becomes extremely expensive for the country to pay for its public services and service its debts.

It has been calculated that if Italy had to pay 7pc interest on all its debt – which will not happen at once because the government’s existing borrowings are already fixed at earlier agreed rates – then the country would have to pay an extra €70bn (£60bn) a year just in interest payments.

The country could find itself in the position of borrowing more money just to make its interest payments – and, like using a credit card to pay off a mortgage, that does not make it an attractive proposition to potential lenders.

On Wednesday, yield on long-term Italian treasuries soared to 7.5%, the highest rate since the Euro’s inception. Fortunately (for Rome), the European Central Bank stepped in and bought plenty of short term bonds to help the country cover its near-term obligations.

Italy sold € 5 billion in short-term debt yesterday at an average yield of 6.087%, nearly double the short-term yield from October 11th (3.57%), according to Wall Street Journal reporting 

The Italian fiscal house is tumbling down. This year the government must borrow 23% of its GDP in the bond market to pay its bills. Currently it has a €1.9 trillion in sovereign debt. That’s nearly a quarter of the continent’s total debt level.

For now, the European Central Bank has stepped in and offered vital aid to Italy. How long will that last? Is this just delaying an inevitable Italian default? The Italian government must step in and get its act together quickly, i.e. begin implementing austerity measures now, if it has any hope of attracting outside (non ECB) bond market investors.

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