WHAT IS ITALY’S PROBLEM?

Q.WHY DO HIGH YIELDS ON ITALY’S DEBT MATTER?

A.A large proportion of Italian GDP is spent on debt interest. Earlier this year the European Commission forecast Italy’s budget would be in what economists call a primary surplus to the tune of 0.75 per cent of GDP. However, once interest payments are added, this falls to a deficit of four per cent. High rates mean those interest payments go up when Italy borrows more or rolls over old debts. Capital Economics estimates that the current high rates will cost Italy an extra €60bn (£51.1bn) by 2015. IMF simulations suggest that rates of over eight per cent will take Italy’s interest service costs to 20 per cent of GDP by 2015.

Q.WHAT CAN ITALY DO ABOUT ITS DEBTS?

A.Italy has a long term problem and needs more economic growth and a bigger primary surplus if it is to turn its finances around. One reason markets wanted rid of Berlusconi was because they did not believe he could deliver the necessary changes in areas like pensions and labour market reform.

Q.WILL INTEREST RATES KEEP GOING UP FOR ITALY?

A.Berlusconi says he will resign after finance reforms are passed, but analysts are sceptical that the next government will do better. Next week sees a three-year bond auction, and the government may seek outside help instead of paying seven per cent or more. If rates do keep rising, Italy will be locked out of bond markets, alongside Greece, Portugal and Ireland.

Q.WHAT HAPPENS IF ITALY CANNOT PAY ITS DEBTS?

A.Italy might call on outsiders for help. However, the ECB is constrained by treaties in how it buys government debt; the EFSF may not be big enough to help, and would be weakened in any case as Italy is meant to be a contributor to the fund; and asking the IMF for help brings a range of political problems around which countries could or would actually put more money in.