- On 3 February, Italy’s president asked Mario Draghi, former ECB president, to form a government.
- His arrival calmed markets and lowered Italy’s risk premium, the extra cost at which the country finances itself.
- Italy and Spain were the largest recipients of European funds: the credibility of those managing them affects the cost of financing.
On 3 February 2021, Italy’s president asked Mario Draghi, former president of the European Central Bank, to form a government in Italy. The news was well received by the markets: it reassured investors and lowered Italy’s risk premium, that is, the extra cost the country paid to finance itself compared with other European partners. The task came with the country in the midst of the health crisis and facing the challenge of managing European funds. His profile, associated with European monetary policy, shaped how investors read the news.
The market reaction to a change of government may seem remote, but it has concrete consequences. When a country inspires more confidence, it finances its debt more cheaply, and that saving filters through to the rest of the economy: to banks, to companies and, ultimately, to those who take out a loan. For anyone with interests in Europe, what happens in Rome, or in Madrid, is also their own business. Interest rates and risk premiums travel through the euro-area financial system with remarkable speed.
What the risk premium is
The risk premium is the difference in yield that the market demands for lending to one country compared with another considered safer; in the euro area, the benchmark is usually Germany. When confidence in a government rises, that gap narrows and the country borrows more cheaply. Draghi’s arrival had that effect in Italy, and the move showed up immediately in debt prices.
It is a thermometer of confidence, but also a real cost. A lower spread means the State pays less interest on its debt, which frees up public resources, and the country’s financial system works under less strain. When the opposite happens, the bill ends up reaching companies and households too, through more expensive or more restricted credit.
Italy, Spain and the European funds
Italy and Spain were the largest recipients of European funds. The credibility of whoever manages them matters, because it largely determines whether projects are carried out well and on time. It also matters for the financing costs of the country’s companies, which tend to move in the same direction as those of their State.
When the State can finance itself easily, banks and companies tend to benefit from more favourable conditions: credit that is cheaper, more available and over longer terms. Politics and corporate financing are more connected than they seem, and a company with customers, suppliers or investments in Italy may feel it directly.
What is worth following
For anyone managing wealth or a business with European ties, it is worth following the political stability of the euro area’s major countries and the way the funds are managed. A change of government can alter credit conditions, the timetable for aid and the investment climate, and its effects travel quickly from one country to another.
The point is not to predict elections or governments, but to understand which part of the business or the portfolio depends on the situation of a particular country: contracts, customers, suppliers, investments or debt. It is worth asking how much a deterioration in credit conditions or a delay in aid would affect you, and planning the cash buffer to absorb it, with the help of a financial adviser. It is best done before the context changes, not after.
Institutional stability is also an asset, even if it appears on no balance sheet.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
