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Monday, 14 November 2011

The borrowing costs of European structural reforms

 

Greece and Italy changed their leaders to restore fiscal discipline. Lucas Papademos, former Governor of the Bank of Greece and Vice-President of the European Central Bank, replaced Prime Minister George A. Papandreou in the 11th of November, 2011 to implement conditions set by European leaders on the 26th of October related to 130 billion European bailout and manage a voluntary debt swap, Prime Minister of Italy Silvio Berlusconi resigned in the 12th of November, 2011 after the 45.5 billion-euro austerity package was approved in parliament and Mario Monti, former European Union Competition Commissioner, is going to form a new Italian government. So, could those changes convince the markets about mastering sovereign debt crisis?

Both new leaders are respected economists whose contributed to the development of European Union. Hence, their understanding of the Union’s benefits and current issues as well as involvement in solving domestic structural reforms required to manage sovereign debt crises could be a successful step. It seems likely that new leaders of Italy and Greece have strong relationships with the EU institutions and their authority may be accepted by domestic citizens. Consequently, it could lead to the greater European unity through smoother critical decision making and decision implementation which is necessary to keep monetary union.

It is expected that if banks accept write-down of 50% on their holdings of Greek government bonds Greece's 350- billion euro debt may be reduced by 100 billion euro and the ratio of Greek debt-to-GDP could fall from 160% to 120%. Current Italy’s debt amount of 1.9 trillion euro which is about 120 percentage of GDP.

Italy auctioned 3 billion euro five year government bonds today and that was an opportunity to check the markets’ reaction on changed leadership. However, lenders in the markets may not be particularly interested in the successors. Whenever considerations involve lending, investors take yields into account. Italy’s demand for additional funds is clear, so massive sales of currently held Italian bonds increase yields and reduce their price. Consequently, the European Central bank is induced to buy Italian government bonds in order to relieve borrowing costs.

It seems that markets will be convinced about governed sovereign debts once countries do not need to borrow at all.