Her Eleftherias Kourtali
In anticipation of rising ECB interest rates, yields across the eurozone have risen sharply, bringing southern Europe’s debt sustainability back to the market, Goldman Sachs said in a report today.
However, as he points out, even if the real growth prospects for Southern Europe remain vulnerable due to the energy crisis and the war in Ukraine, the short-term “cushion” provided by increased nominal growth, persistent European budget support (Recovery Fund and (more recently, REPowerEU) and the gradual normalization of monetary policy provide the region with additional time to address its structural weaknesses.
In addition, the relatively long-term average maturity of government debt (from 7 years in Italy to 21 years in Greece) will help to smooth over the short-term impact of rising debt yields.
However, as Goldman Sachs warns, there are asymmetric risks and investors may try to “test” how exposed the region may be due to increasing yield pressures on its structural vulnerabilities, especially in Italy. To analyze this report, the US bank is updating its estimates for “yield ceilings” – the level of bond yields above which debt-to-GDP ratios are likely to follow an upward trend without significant policy changes.
He concludes that the relatively long-term average maturity of public debt in Southern Europe (from 7 years in Italy to 21 years in Greece) will help offset the short-term impact of rising debt cost returns, with GS’s debt sustainability analysis Stresses that most countries in southern Europe are still comfortably below yields that are likely to put pressure on debt ratios again. Italy is the relative exception with the current government debt pricing already approaching the estimated rate of return (2.75% for the yield on 7-year bonds). For Spain the maximum yield is set at 5.5%, for Portugal at 5.25% and for Greece at 6%.
Elections and danger
Given that timing is particularly important in terms of monetary policy changes such as those that the Eurozone is going to experience, Goldman estimates that there is a possibility of risky events in Southern Europe as the 2023 elections approach. Following the general elections in Portugal earlier this year, 2023 will most likely be the year of elections for Southern Europe, ie in Greece, Italy and Spain. In these elections there is, as he points out, the risk of policy discontinuity, which is particularly important in the region, as the region is the main recipient of the Recovery Fund. Due to the Fund’s focus on investment and reform, a strong degree of policy consistency is required over time.
While Greece is most likely to maintain the continuation of the policy, given the higher chances of the current government remaining in place and its commitment to the Recovery Fund, polls show greater uncertainty in Italy and Spain. However, due to the different attitudes towards European integration in the two political landscapes, Italy remains the country most at risk of political unrest and the prospect of the forthcoming elections could well end up being a catalyst for renewed concerns about debt sustainability.
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