By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Italians must feel like Hercules fighting the hydra. “Lo spread”, the difference between Italian and German bond yields, hung over Italy’s economy and politics for more than a year. Now, just as the European Central Bank’s promise of bond-buying seems to have calmed markets, the government says it wants to fight another “spread” – the productivity gap.

Italy’s sagging productivity and competitiveness isn’t a new topic. Nominal unit labour costs rose on average 2.3 percent each year between 1999 and 2011, well above the euro zone average of 1.6 percent. Now Rome is in danger of getting left behind even peripheral states. Eurostat reckons unit labour costs will rise 1.7 percent this year in Italy, whereas they are falling steeply in Spain, Portugal and Greece. A spate of industrial crises – including fears of a retrenchment by Fiat, and the closure of a smelting plant in Sardinia – has stoked public debate.

One topic that is gaining traction is wage and contract bargaining. Both the International Monetary Fund and the European Commission want the country to do more to encourage businesses to set their own labour contracts, instead of depending on national or industry-wide agreements. That should increase flexibility and align wages with real productivity. There are precedents; Fiat used workforce referenda to create its own contracts, in spite of opposition from the country’s oldest union. However, an agreement in 2011 to encourage firm-level bargaining has had limited effect, and the government wants unions and employers to come up with a new deal. The prospect that the IMF may one day dictate tougher terms, if a bailout becomes necessary, should help.

Contract bargaining is part of the picture. Italy’s many small companies need support to improve technology and compete on a global scale, but state resources are limited. Companies also struggle under a stifling tax burden and complex bureaucracy. The public sector too needs to be made more competitive and efficient, and local services need to be opened up to competition.

The good news is that the government has made growth and competitiveness a matter of urgency in the last months of its mandate. But with bond yields now back at tolerable levels, there is a risk that the pressure to reform ebbs over time, particularly after next year’s election. “Lo spread” may return.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Rome is half out of the woods. Italy’s 10-year bond yields have fallen by over a percentage point since European Central Bank Chief Mario Draghi hinted at a new bond-buying programme. With yields falling and confidence returning, the need for a bailout is waning.

If a bailout can be avoided, it should; nobody wants to see the euro zone’s third-largest economy on life support. And at current yields, Italy’s debt looks almost sustainable: Rome would need nominal growth of 2.4 percent of GDP – which would be below its long-term average – and a primary surplus of 3 percent of GDP, which the International Monetary Fund expects this year.

However, Italy needs to convince investors it can grow its way out of debt, forecast by the IMF to hit 125 percent of GDP this year. And there is a long way to go to make the economy competitive again.

Mario Monti’s government is working on this. But he needs progress on talks with unions and employers to reform labour markets, and more clarity on privatisations. Even then, investors will still worry that the reform agenda may not survive next year’s election.

Unfortunately, the political landscape after Monti remains a puzzle. The two leading parties, the Democratic Party and centre-right People of Freedom Party, can’t agree on a new electoral law. Neither can count on a majority. Uncertainty reigns across the political spectrum. The Democratic Party is facing a potentially destabilising leadership contest between Pierluigi Bersani and Matteo Renzi, the charismatic mayor of Florence. The prospect of a comeback by Silvio Berlusconi still hangs over the right. The Five-Star movement fronted by comedian Beppe Grillo, now the third-largest party, is a wild card. One hope is that in the absence of a clear majority, a new grand coalition backed by both right and left parties could be formed. But that may not happen soon. In the meantime uncertainty and a heated campaign could push up yields.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It’s not clear what Mario Draghi meant when he said the European Central Bank would do was needed to preserve the euro zone. The market thinks the ECB president was promising more purchases of Spanish and Italian bonds to drive down their oppressive yields. Investors may be right. But anyone expecting a game-changing crisis response could be in for disappointment.

Draghi’s comments, made at a UK investment summit, are easy to overplay. The reality is that he didn’t specifically mention bond buying, and some form of ECB action was already looking likely given the worsening crisis in Spain and Italy.

Moreover, bond buying isn’t Draghi’s only option: the ECB could lend to euro zone banks on longer terms, cut interest rates, buy other assets, or agree to finance the European Stability Mechanism if the bailout fund is given a banking licence. The idea of turning the ESM into a bank resurfaced this week after comments from Austrian central bank governor Ewald Nowotny. The ECB’s existing stance has been that such a move would breach the European treaty, making it an unlikely prospect in the short term.

That said, more bond-buying is almost certainly on the cards. Draghi spelt out how bringing down sovereign yields could be considered within the ECB’s mandate if necessary to restore the transmission of monetary policy – a justification used for sovereign bond purchases in 2010 and 2011. In his view, the ECB should intervene when yields reflect factors that are not “inherent” to a particular country or its credit risk, say because markets are pricing in a euro break-up.

The real question is what the size and scope of any bond-buying would be. To really end the crisis, markets would need to see unlimited purchases, or a commitment to fix yields at low levels. But the Bundesbank would certainly frown on that. The ECB would need to overcome markets’ concern that bonds held by the central bank rank senior to other creditors, as happened in the Greek restructuring. Otherwise, the more bonds the ECB buys, the more markets will worry about being subordinated to it.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It had all the hallmarks of a boom-time finance disaster. Permira’s leveraged 5.4 billion euro acquisition of a controlling stake in Hugo Boss through Valentino Fashion Group was one of the biggest deals of 2007, the year that the sub-prime crisis kicked off in earnest and Terra Firma bought EMI Group. Five years on, the UK buyout firm is selling Valentino to the Qatar royal family for a punchy price. That leaves Permira’s fashion binge looking respectable, if not glamorous.

The original acquisition, alongside the Italian Marzotti family, got off to an inauspicious start when the high-end fashion firm’s founding couturier Valentino Garavani retired shortly afterwards. Then in 2009 Permira had to restructure the group’s 2.3 billion euros of debt, upping its bet by buying back loans at a steep discount from Citigroup.

The sale of Valentino brings Permira’s fashion spree to a respectable point. The new owners are to pay 700 million euros, a whopping 20 times this year’s EBITDA, for the enterprise. That’s in line with LVMH’s purchase of Bulgari last year, but far above the average sector valuations of 10 times. SVG, one of Permira’s investors, reckoned its stake in the group was worth just half the purchase price three months ago.

Add the Valentino sale proceeds to the far larger continuing stake in Hugo Boss and Permira’s various investments in the group are now worth about 1.6 times their original cost, according to a person with knowledge of the matter. That seems like a respectable outcome at this stage given the state of the world economy in the last few years.

But Permira still needs to find a suitable exit for Hugo Boss, which has a market capitalisation of 5.1 billion euros. It will need to steer its way through a probable global slowdown and protracted slump in Europe, which still makes up over half of its revenues. Sizeable exposure to Germany and growth potential in Asia provide some comfort: Hugo Boss’s 469 million euros of EBITDA last year is nearly double its level when Permira bought in. The target is 750 million euros by 2015. If that’s achieved, and a lucrative exit follows, Permira will be looking truly smart.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Last November, the euro zone crisis forced the European Financial Stability Facility to delay a bond deal. Now the crisis is back, but the bailout fund is holding up. It has just issued its largest public bond, paying just 1.652 percent for five-year money. That has eased concerns after a previous bond issue was not fully subscribed. However, bigger challenges lie ahead.

The EFSF will soon need to raise as much as 100 billion euros to recapitalise Spanish banks. If the crisis worsens, it may also need to provide financial aid to Italy and Spain too, either by buying those countries’ bonds, or by providing lines of credit.

It certainly helps that investors are currently desperate for any half-safe asset that offers a positive yield. Nevertheless, prospective bond buyers have two concerns. First, the EFSF’s funding needs could flood the market, depressing prices. And second, its credit quality will suffer as its guarantors – primarily Germany and France – increase their exposure to the periphery.

One way to avoid market indigestion is for the EFSF to issue bonds directly to Spanish banks, which can then use them as collateral when borrowing from the European Central Bank. The euro zone recently used that trick in Greece.

Europe has another weapon, the permanent bailout fund known as the European Stabilisation Mechanism (ESM) should come on line soon, and will replace the EFSF. Rather than relying on promises of payment from its guarantors, the ESM will have 80 billion euros of hard capital, which should make it easier for the fund to borrow. Its preferred creditor status should also mean loans are safer, easing the strain on its guarantors’ creditworthiness.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Hit by a perfect storm of economic slump and man-made disasters, Cyprus has been forced to seek euro zone help. Though implementing reform could be controversial, the 10 billion euro rescue is peanuts for the zone’s bailout funds. Europe will need a different strategy to cope with Spain and Italy.

The Cypriot economy has been hit by the euro zone crisis and rising unemployment. It has also suffered two separate catastrophes; an explosion at the main electricity plant which generated half the island’s electricity, and Greece’s debt restructuring, which left Cypriot banks with severe losses on their holdings of Greek government bonds. Despite being locked out of markets since mid 2011, Cyprus has got by borrowing from Russia.

Cyprus will probably need about 10 billon euros, equivalent to roughly 55 percent of GDP. Deutsche Bank reckons it needs 4.2 billion euros to cope with banks’ losses on Greek bonds and loan write downs, and a further 6.3 billion euros to fund deficits and maturing debt until 2015. In this scenario, debt would peak at about 99 percent of GDP in 2013. But that would be optimistic if Greece left the euro; bank loans to the Greek economy total just shy of 120 percent of Cypriot GDP.

Though the euro zone is getting used to bailing out its members, Cyprus won’t be easy. The country will need to tackle a lingering competitiveness problem, evidenced by persistent current account deficits, forecast at 7.8 percent of GDP this year. The government is implementing a diet of austerity and wage freezes, but euro zone paymasters may be tougher, and will also want a crackdown on tax-collecting inefficiencies and evasion. The risk is that reforms get bogged down by presidential elections next year.

Luckily, the size is small. The euro zone’s bailout funds can easily finance Cyprus from their existing resources, and there is no immediate need for a Greek-style private sector debt haircut. Yet the Cypriot bailout marks the end of an era for the euro zone. It has bailed out four relatively small countries, and is now rescuing Spain’s banks. The next problems are Spain and Italy. With 526 billion euros of debt maturing over the next two years, they are far too big for the Cyprus treatment.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Italy and France are proposing to use the euro bailout funds to buy sovereign debt in the market, in a bid to restore confidence. More likely, it would be used by creditors to dump their holdings.

Italian Prime Minister Mario Monti wants the euro zone’s rescue funds, the European Financial Stability Facility (EFSF) and its successor, the more permanent European Stabilisation Mechanism (ESM), to buy sovereign debt. And French President Francois Hollande says the idea is worth exploring.

This is not a novel idea. The funds can already, theoretically, buy bonds in the secondary market. But countries would need to ask for it, and accept some form of conditions in exchange for the intervention. Monti’s proposal looks more radical. He seems to favour an automatic arrangement whereby the funds would buy sovereign bonds whenever yields rise above certain levels. That could persuade investors they won’t lose money on sovereign debt, and help restore confidence in the near-broken Spanish and Italian bond markets.

The proposal would need to overcome the obstacles that already hamper the funds. First, their capacity is finite; the EFSF can lend a further 248 billion euros, and the combined new lending once the ESM comes on line will be 500 billion euros. That’s before taking into account the 100 billion euros promised to Spain for the recapitalisation of its banks. If the funds can’t be increased or leveraged effectively, investors will worry that the bond-buying is temporary, and dump their holdings. The funds would be swamped, and Italy no better off.

Moreover, half-hearted bond-buying can make things worse. The risk is that the bonds bought by the bailout funds will be protected in a debt restructuring. The European Central Bank showed how this could be done in the Greek debt swap. And if bond-buying doesn’t work, Europe would quickly move to plan B, a proper bailout for Spain and Italy which would likely involve debt restructuring for private creditors. That’s a powerful reason for investors to run for the hills. If that type of bond buying is the only idea EU leaders can agree on at their summit next week, it could fall way short of what investors will want if they are to be convinced that the monetary union isn’t heading for a break-up.

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Euro bond proposals are proliferating. Euro zone politicians will chew over the multiple variations on the theme of debt mutualisation at this month’s summit. Here’s our guide to everything you always wanted to know about Eurobills, redemptions bonds, red/blue bonds, deficit bonds etc but never dared ask.    Eurobills

This is the easiest and least controversial proposal, because it requires a relatively small transfer of risk, and little surrender of sovereignty. The idea, proposed by two French academics – Christian Hellwig and Thomas Philippon – just covers short-term debt.

Countries would issue short-term debt guaranteed by each other and capped at a given percentage of national GDP, probably 10 percent. Potential losses would be low as short-term debt is rarely restructured; and countries that ran up excessive deficits could be kicked off the programme, reducing moral hazard. Moreover, countries would still have to issue long-term debt, exposing them to market discipline. One problem is that euro zone governments may shy away from kicking a country off the programme for fear of triggering default.

Eurobills could be quickly implemented and wouldn’t require a change to the European treaty that prohibits countries from assuming each other’s liabilities. But they can’t solve the crisis on their own, as they would cover only a small portion of a government’s debt and only the short-term borrowings. Think of them as a first step on the very long road to a real common bond.    Deficit bonds

A second proposal, deficit bonds, is to mutualise only new debt. The idea is being explored by a quartet of senior officials including the ECB’s President Mario Draghi, according to Der Spiegel.