x Abu Dhabi, UAEMonday 22 January 2018

Last act of Europe's tragedy has role for the Middle East

Europe's debt crisis is looking more and more like an Italian opera – and few of them have happy endings.

For the past several years, Italy under Prime Minister Silvio Berlusconi resembled a political comic opera, with a larger-than-life character of ravenous appetites and tragic hubris. But the recent "political death" of Mr Berlusconi represents only the end of Act One. Two more acts remain, and this drama could turn from comedy to tragedy quickly.

The source of the potential tragedy is Italy's heavy debt, which stands at 118.4 per cent of its GDP - the second highest in Europe after Greece's - amid an environment of low growth, high borrowing costs, and euro zone economic troubles. Italy's debt, though large, could be managed in a different environment, a different time. But the storm that is shaking Europe is no ordinary one.

It should be remembered that the Greek default roiled the euro zone, affected global markets, and spawned intense debates about the future of the euro across the continent. Ultimately, it also produced a bailout programme that has kept Greece afloat, though battered and shaken with a populace whipsawed by daily news of rising bond yields, downgrades, bank defaults and European Union squabbling.

But Italy is not Greece. Its economy is more than eight times the size of its fellow Mediterranean state. It is the seventh largest economy in the world, and the third largest in Europe. Thus, its debts are exponentially larger too.

To put it in perspective, you would have to take the combined debts of Portugal, Ireland, and Greece - other highly indebted euro zone countries - and multiply them by three. Simply put, the fate of Italy matters much more deeply to the world economy and the euro zone than the fate of Greece does.

As for the Middle East, the European Union states as a bloc represent the largest trading partner for several major regional countries. Total GCC-EU trade amounts to some 80 billion euros (Dh390 billion). Total EU trade with countries of the southern Mediterranean, which includes Egypt, Algeria, Syria, Jordan, Morocco, the Palestinian Authority, Turkey, Israel, Lebanon, Libya and Tunisia, stands at some 225 billion euros - or 10 per cent of all EU trade.

For many North African Arab countries, Europe's slowdown has been bad for business: fewer tourists, less demand for imports, less trade. An Italy implosion that shatters the euro zone would be disastrous to countries like Morocco and Tunisia, which are highly dependent on trade with Europe, and a blow to the entire southern Mediterranean.

It would also have heavy repercussions in the United States, China, Japan and other major markets. And herein lies the potential tragedy of Italy's economic crisis: Italy is a heavyweight global economy whose fate is linked to one of the three heavyweight economic zones of the world, the EU.

We sometimes overuse the cliché about our interlinked and globalised world. But there is no escaping the cliché here. Italy's crisis does not belong to Italy alone.

The fall of Mr Berlusconi cheered markets. The entry of a new, more sober prime minister, the technocrat Mario Monti, was greeted with early relief by markets - the equivalent of an operatic garden party full of promise but with hints of foreboding. That dark cloud above the party was Italy's debt.

Bond yields in Italy entered dangerous territory last week, edging above 7 per cent. This is the red zone territory that forced bailouts for Greece, Ireland, and Portugal. And the contagion is spreading. Just last week, Standard and Poor's cut Belgium's credit rating, the new conservative government in Spain has hinted that it will need outside financial support, and even more fiscally healthy countries like Austria, Finland and France have seen their borrowing costs shoot up.

Here, if this were an opera, is where Italian Prime Minister Mario Monti, played by a lead tenor, might enter, wring his hands and croon about the promise and peril of the euro, the unforgiving nature of markets, the disastrous management of his predecessor and the uncertain and dangerous future that lies ahead.

And in true operatic fashion, one man (well, in this case, a woman and, more precisely, a country) has the potential to save the day.

Enter the dramatic character known as Germany.

A recent proposal by the European commission to scrap all national bond issuance in favour of a joint Eurobond has come to be seen as the only viable solution to the vicious cycle of debt, low growth and lowered borrowing options faced by many eurozone countries.

Standing in the way of this solution is Germany, played by the baritone Angela Merkel (yes, baritone; no Italian opera ever gave so much power to female operatic voices). Here is where the baritone might reflect on the incongruity of Germans - disciplined, hard-working, thrifty, industrious - bailing out their more spendthrift and poorly managed cousins in Italy and beyond.

The European Financial Stability Facility (EFSF), the weightily named bailout fund for small countries like Greece and Portugal, will not be enough for a weighty player like Italy.

Thus, the Eurobond idea seems like the only viable option now and the chief obstacle remains a reluctant Mrs Merkel, Germany's political elite and a German public wary of putting German credibility on the line for undisciplined Europeans.

Make no mistake about it: a Eurobond that would allow Italy, Greece and others to borrow from the European Central Bank with the backing of all EU states would essentially be a "Deutsche bond"; Germany is the only reason that it might work.

As with many good tragedies, sometimes the hero decides to act after it is too late. Last week, there were signs of Germany's own weakness. It failed to draw bids for 35 per cent of its offering of 10-year bonds. That cold unremitting antagonist - markets - delivered a message.

Italy is simultaneously too big to fail and too big to bail out. We are in the middle of Act Two. The climax has yet to come. The world can only hope that this euro zone crisis will end better than most Italian operas.


Afshin Molavi is a senior fellow with the New America Foundation in Washington and a senior adviser at Oxford Analytica.