With Italy periodically setting new records for total government debt–both in real percentage of Italy’s slow-growing gross domestic product—many observers are starting to ask whether the debt is hindering growth prospects.
The conventional wisdom is that a country’s debt is not a problem as long as the economy grows faster than the debt. That would keep value as a percentage of GDP falling and it makes sense that a larger economy can afford to service a larger debt, Xinhua reported.
In the case of Italy, the debt-to-GDP ratio dropped slightly in June, but it remains on a gradual upward trend for the year as a whole. The economy is expected to grow between 0.5% and 0.7% this year, while the latest forecasts predict debt will be around 1% higher at the end of the year than it was at the end of 2014.
The country set an all-time record when its national debt reached €2.2 trillion ($2.4 trillion) in May. The figures for June showed a small drop (the overall debt remains above €2.2 trillion), but that was mostly due to lower borrowing costs. With a higher-than-usual number of bonds having come due in July, economists say new record debt levels will be set between now and the end of the year.
“There’s a debate between economists about the role of measuring debt or debt compared to GDP,” Thomas Manfredi, an economist and frequent commentator, said in an interview. “The most important indicator is obviously debt to GDP, but there are studies that show that growth is slowed when debt gets to around 100% of the GDP.”
In Italy, it’s approaching 135% of GDP, according to Eurostat. That’s second in the European Union only to Greece.
When a country’s debt gets so high, the government needs to focus on reducing its deficit and paying down debt which means it cannot afford to pay for many of the services that can help pave the way for economic growth.
“It really depends on how a country accumulated so much debt,” explained Mario Baldassarri, president of Economia Reale, a think tank. “If a debt is high because the government is making smart investments, it can be a good sign for the long-term. But that is not the case in Italy. Italy’s high debt is a problem.”
There are signals that Italy’s economy may be improving despite this. Growth expectations for this year are at least positive, in contrast to recent years when the economy contracted. Consumer confidence, industrial output, exports, home prices, automobile sales, and other indicators have all shown glimmers of hope in recent months. Matteo Renzi’s government has said that sparking economic growth is among its top priorities.
But with its massive debt, Italy is performing a delicate balancing act, economists say, and if those external factors change it would create more problems for Italy than it would for most countries.
