Central governments’ budget deficits may be shrinking, and issuance declining but that should not be causing problems for the investors in the Italian government bond market. One of the largest government bond markets, there is ample supply around before Italian bonds become scarce. As Hugo Doyle, economist at Banca Commercial Italiana (BCI/Comit) points out, “Italy has an extremely large public debt, one that it is comparable in size to that of the US! Although budgets deficits may be shrinking, I do not think liquidity problems will be with us for a while yet.”
Doyle adds that Italian private households are material owners of their own domestic market and would not naturally be inclined to switch into another market.
Paolo Bernardelli of San Paolo IMI Asset Management is equally sure that Italy is not close to suffering from problems of poor liquidity. He explains, “The Italian market is the largest and the most active in Europe – total outstanding Italian debt amounts to more than that of France and Germany combined. It is an extraordinarily liquid market.”
There have been considerable changes in the market, many of which pre-dated the onset of EMU. Bernardelli goes on, “ Over the last decade, Italy has actually had large primary budget surpluses which has resulted in the deficit-to-GDP ratio falling from 9.2% in 1994 to 1.9% in 1999. The Government is aiming for a balance by the year 2003. In this environment, the Treasury has taken the opportunity to increase the duration and the average life of the outstanding debt: the average duration of all fixed rate paper (1 to 30 year BTP’s) is 5.5years, which is more than twice the 2.5 year figure for 1990. Short term/floating rate debt now accounts for just 35% of the total, from 65% six years ago.” The issuance of long dated, i.e. 30-year, paper has been particularly well received by investors, clamouring for US-style yield curves with which they can better construct and manage their portfolios.
Doyle adds that one of the main problems for Italy in meeting the Maastricht criteria was the enormous interest bill. “If they wanted to meet the 3% deficit target, then they just had to rationalise their debt well ahead of time in order to reduce these interest costs,” he says.
Liquidity has been further boosted by the introduction of the BTP futures contract and the electronic MTS market. The Italian domestic investors have been enthusiastic about the MTS, praising the efficient and liquid market. According to one investor, the costs of trading have fallen and transparency has also improved.
Bernardelli points out that the primary dealers on the MTS trade an average of E13bn each day. He also makes the point that foreign investors’ participation in the Italian bond market, as measured by the non-resident ownership of BTP’s and BOT’s has increased from below 1% in 1990 to 39% and 54% respectively, and must reflect the approval on the non-Italian investor to the changes.
As Doyle comments, “It is quite easy to see why the tiny markets should be suffering from wider dealing spreads post-EMU, especially with the threat of further market shrinkage as budget deficits turn into surpluses. But the Italian market has a long, long way to go before shrinking debt creates liquidity problems in Italian Treasuries.”
Most Italian investors have used EMU as an opportunity to increase diversification of risk, not in order to ‘escape’ to a more liquid or transparent market, arguing that the Italian market was efficient before the union. As for the San Paolo IMI domestic portfolios, Bernardelli explains that these have maintained their bias to the Italian market.
He goes on “We have started to diversify or domestic portfolios into other areas, but we still consider the Italian market to be the best place to invest, both for the liquidity and for the spread it offers against the other EU countries.”
Like many investors across Europe, Bernardelli and his team have been moving down the credit curve. “We now have between 10 and 20% in Euro-area corporates, with ratings between BBB and A. We do not like (non-Government) bonds with higher ratings because the spreads they offer is not worth the risks of further increases in the swap and credit spreads. We do also have some emerging market and high yield bonds too.”