Italy: Fiscal challenges in perspective

Italy is currently facing strong support from investors . As a result, 10Y BTP-Bund is currently trading at 140-150bp, its tightest since early 2022 , despite the ECB’s QT, supported by strong risk appetite. In this special report, we look at Italian fiscal fundamentals to assess the sustainability of this market optimism over the medium run. Higher interest rates, the scheduled end to PSPP and PEPP reinvestments and the need to finance the energy and digital transition could pose a potential challenge for Italy’s fiscal position. Given its current high public debt and the outlook of a rising interest burden when compared to pre-pandemic levels, the sustainability of Italian debt is once again a topic that deserves the attention for market participants in the medium run. We take in this report an in-depth look at Italian debt dynamics by simulating the main macro-economic drivers of this debt. The outlook for potential growth remains in this context worrisome, given that demographic changes will reduce potential growth , which would need to be compensated by a rise in productivity growth. Stagnant productivity growth in the past, however, suggests that this will not be easily achieved. Our analysis of the sustainability of Italian debt over the next decade shows that maintaining a stable debt ratio will be a challenge in a context of higher interest rates. Moreover, it seems difficult to expect a significant debt reduction. This raises the question of how the next economic or financial shock can be absorbed while keeping public debt under control .