Italian Debt Adds to Fears in Euro Zone

The New York Times

By STEPHEN CASTLE

Published: July 10, 2011

LONDON — Top European officials planned to meet on Monday to wrestle with threats to the currency union as fears mounted that Italy could become a victim of the debt crisis even as discussions stalled over a second bailout for Greece. Finance ministers in the euro zone had previously scheduled two days of talks to begin on Monday afternoon in Brussels, with an emphasis on how to resolve Greece’s troubles. Over the weekend, a meeting of more senior officials was set for Monday morning.

A spokesman for Herman Van Rompuy, president of the European Council, denied that senior officials would discuss the state of Italy’s finances, which many investors consider increasingly precarious. But another official, who requested anonymity because he was not authorized to speak publicly, said Italy would probably be on the agenda.

For Italy, the cost of financing its debt rose at the end of the week, though nowhere near the levels faced by Greece. The spread between the yield on the Italian 10-year bond and the German equivalent widened on Friday to 2.36 percentage points, the most since the introduction of the euro.

Italy’s cost of borrowing for 10 years is now about 5.27 percent. Meanwhile, its blue-chip stock market index, the FTSE MIB, fell 3.5 percent.

Investors were unnerved in part by evidence of a growing divide between the Italian prime minister, Silvio Berlusconi, and the finance minister, Giulio Tremonti, who has been praised for his handling of the economy during the financial crisis and for maintaining control of the budget deficit.

The euro zone has been shaken by the fiscal troubles of Greece, Portugal and Ireland, though their economies are relatively small. The Italian economy is more than twice the size of the combined economies of those three countries. If investors were to drive Italy’s borrowing costs to unsustainable levels, it could imperil the entire European monetary union.

Even without Italy, European officials have a big task in the coming days. They have reached an impasse of sorts on whether to include the private sector in a second Greek bailout, which is considered essential to controlling the crisis that has so far been limited to the smaller economies on the Continent.

Some officials now believe that any bailout plan involving a substantial but voluntary contribution from private investors in Greek debt would be declared a selective default by the bond rating agencies Moody’s, Standard & Poor’s and Fitch. The officials’ objectives of achieving a private sector contribution that is voluntary and substantial — but which is not judged a selective default — may not be possible.

If voluntary steps would cause such an event, these officials say, then more radical options may as well be considered, including requiring banks and other private investors to take part.

Speaking on Sunday at a conference in Aix-en-Provence, France, the president of the European Central Bank, Jean-Claude Trichet, said Europe was at the “epicenter” of a debt crisis that had to be of concern to the entire developed world. He urged euro zone officials to do the “maximum” in terms of governance reforms, Bloomberg News reported. He has also been adamant about keeping debt reduction by private investors out of any bailout plan.

The special session of top European officials is to start about 8:30 a.m. Monday, when a scheduled meeting between Mr. Van Rompuy and the president of the European Commission, José Manuel Barroso, will be expanded to include Mr. Trichet; the European commissioner for economic and monetary affairs, Olli Rehn; and Jean-Claude Juncker, the finance minister for Luxembourg, who presides over meetings of the so-called Eurogroup of finance ministers from the 17 countries that use the euro as their official currency.

Vittorio Grilli, the director general of the Italian treasury, is also scheduled to attend. But Dirk De Backer, a spokesman for Mr. Van Rompuy, said Mr. Grilli would be there in his capacity as head of the euro zone’s Economic and Financial Committee and not to discuss his country’s economy.

There is absolutely no crisis meeting,” Mr. De Backer said. “This is a coordination meeting to prepare for the Eurogroup. It is not the aim or purpose to talk about Italy.” Some officials played down the meeting, pointing out that Germany, which has the biggest economy in the European Union, would not be on hand and that Mr. Van Rompuy and Mr. Barroso would not take part in the later gathering of euro zone finance ministers.

Italy has a debt equal to 120 percent of annual gross domestic product, one of the highest in the euro zone. The market sell-off last week was spurred by tensions between Mr. Berlusconi and Mr. Tremonti, the long-serving finance minister whose tough-minded deficit approach has helped keep Italy from succumbing to the problems of Europe’s peripheral economies.

Last winter, investors drove Italy’s borrowing costs higher amid concerns about its high debt, but the attack was short-lived. Fighting to keep the deficit under control, Mr. Tremonti has been reluctant to endorse some of the tax cuts that Mr. Berlusconi and other politicians desire.

Now, with few signs of economic improvement, the government is stumbling in its effort to approve a new budget that includes some austerity measures, and investors have once again turned their attention to the country.

If Mr. Berlusconi continues to foster an uncertain political environment, and if Mr. Tremonti winds up a political casualty, Italy could be swept up in the debt crisis that began in Greece.

Financial markets remain alarmed about European officials’ failure to come to grips with the crisis in Greece, which represents about 2 percent of the euro zone economy.

Despite some insistence that investors should bear some of the pain, the European Central Bank has been very skeptical about involving private sector holders of Greeks bonds in the second bailout, an aid package estimated at 85 billion euros ($121 billion).

Germany, the Netherlands and Austria remain wedded to the idea, however. A French proposal to roll over Greek debt was derailed when Standard & Poor’s said that would probably constitute a selective default. After the statement, Germany appeared to push for its original idea that investors swap the Greek bonds they hold for new debt with longer maturities.