The Italian job

April 18, 2012

As we exclusively reported last night, Italy will delay by a year its plan to balance the budget in 2013. That Rome is no longer aiming for a zero budget deficit next year is very different from Spain which has upped its 2012 deficit goal to 5.3 percent of GDP, way above the 3 percent EU limit (though it is aiming for that in 2013).

Italy’s move also makes eminent economic sense to find a little fiscal leeway given it is already in a recession that is likely to deepen. Initial market action suggests investors buy into the sense of it rather than viewing it as the wrong direction of travel.

The drive to find $400 billion or more of new crisis-fighting funds for the IMF seems to be slowly falling into place. The euro zone is good for about half of it. Japan, Sweden and Denmark committed a total of $77 billion between them yesterday and it is hoped that the British and others, most notably China, will also come to the table. Germany says the deal must be done at the IMF spring meeting at the end of the week. That is not a certainty.

After some steep stock falls, markets have calmed. Bund futures and European stocks are pretty much flat. One of the most profound questions right now is whether markets are seriously spooked by Spain or are merely booking profits and allowing a routine correction to happen after a stellar first quarter – particularly for stock markets – before delving back in again.

Spain remains front and centre for the markets. Today, its government embarks on another crucial quest – to persuade/cajole/force its autonomous regions to come up with the cuts, including in painful areas like health and education, to meet stiff deficit targets this year and next.

Confidence in Spain has evaporated since Rajoy ripped up an agreed deficit target for 2012 without consulting his partners. One way of clawing it back could be a framework that would guarantee the autonomous regions would agree to tough debt-cutting measures. Last year’s ballooning of the deficit beyond forecast was in large part down to the regions’ spending.

Spain’s other big headache is the health of its banks, still trying to get out from under colossal property market bad debts after that bubble burst. Late yesterday, the central bank approved all 135 Spanish banks’ plans to boost capital by around 54 billion euros in total (most independent experts say far more will eventually be needed) but said some may struggle. We get the latest bad loans data for Spanish banks later.

Despite the jump in Spanish borrowing costs, there are strong reasons for caution about imminent disaster. The government cannily used ECB-created benign market conditions in the first part of the year to shift nearly half its annual debt issuance needs already and the banks – which look like they will need recapitalization at some point – are well funded for now having also loaded up on the European Central Bank’s three-year liquidity splurge.

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