The debt to GDP ratio of Italy remains one of the highest in the euro area. Moreover, under current policy settings it is poised even to increase, rather than fall, over the next few years. This outlook has led the European Commission to start a debt-driven excessive deficit procedure against the country. The key issue is not so much the deficit, but the fact that public debt is not falling. Whether or not this procedure will go beyond its early stages is not clear. But it is certain that in the end, all the European authorities could do is to impose a fine of a few decimals of a percent of GDP. The real arbiter of Italian public finances thus remains the financial markets where the Italian Treasury has to sell its debt to finance both the current deficit and the roll-over of past debt coming due. In this context, the holdings structure of government debt becomes important. Knowing who are the ultimate holders of Italian public debt is crucial. A first indicationshould be the distribution of debt between domestic and foreign holders. Italy is a high savings country and some Italian policy makers like to compare their situation to that of Japan where the debt-to- GDP ratio is even higher . This huge debt burden is not perceived as a threat to financial stability because the overwhelming majority of Japanese public debt is held in Japan. But is Italy similar in this respect?
Like Japan, Italy has run a current account surplus of 2-3% of GDP for some time. This indicates an excess of domestic savings. However, an important difference is that Japan has been running a current account surplus for decades, accumulating a net foreign asset position of roughly one half of (annual) GDP, whereas the net foreign asset position of Italy, even if headed towards zero, is still negative at present. This is why only less than 7% of Japanese Government Bonds are held by foreigners. The widely repeated assertion that Italy’s debt is mainly domestic is often based on the observation that Italian households hold very large financial assets. The net wealth of Italian households is estimated to amount to about €10 trillion, of which over one half, or over €5 trillion is in financial assets, which is more than twice total public debt of around €2,250 billion. The claim that most public debt is domestic appears thus plausible at first sight. However, a closer look at the data reveals the need for two important qualifications. First of all, Italian households own very little government debt directly. All sources agree the direct holdings amount to only about €100 billion, or 5% of total public debt. The explanation is simple: a lot of debt is held by Italian financial intermediaries (banks, insurance companies, etc.) whose ultimate beneficiaries are Italian households. It would be difficult to change this pattern quickly, making it challenging for any government to suddenly try to appeal to households to buy a substantial share of the debt if other buyers were no longer interested. Another implication of the dominance of financial intermediaries is that the Italian public might read about interest rates and risk premia going up or down, but they do not immediately perceive the implications for their own financial situation. For example, the government assures the public that bank deposits and bonds are safe, but given the exposure of banks to the government it is clear that any default by the government has to lead to losses for the banks’ clients. The second observation is that the share of the debt held by Italians is somewhat lower than often assumed.