Italy looks to foreigners as retail bond market loses steam

By Sara Rossi

MILAN (Reuters) - Italy's campaign to put more of its huge public debt in the hands of small domestic savers will grow increasingly difficult, analysts say, but foreign investors lured by Rome's political stability and improving finances can plug any funding gap. 

Italy has been courting retail investors since the euro zone debt crisis in 2012 in the belief that they are less likely to withdraw their cash than foreigners at times of market stress.

The strategy has been successful, raising around 245 billion euros ($257.52 billion) in a succession of bond issuances dedicated to the sector.

The proportion of Italy's 3-trillion-euro debt - the second largest in the euro zone - in the hands of these small savers rose to nearly 15% in November from 13.5% a year earlier, according to the latest Bank of Italy data.

That compares with 31% in the hands of foreign investors.  

Most recently, the Treasury raised 14.9 billion euros in February from the sale of a new 8-year "BTP Plus" retail bond, in the mid-range of two similar instruments issued last year.

But analysts say that with Italians' savings eroded by the surge in inflation in 2022-23 and European Central Bank interest rates declining, the appetite of ordinary citizens for these bonds, which reached a peak two years ago, is set to dwindle. 

"After the high retail issuance volume in recent years, a large proportion of available savings from retail investors should already be invested, limiting the amounts that can be raised in the future," said Hauke Siemssen, interest rate strategist at Commerzbank.

He said it was unlikely that this year Rome could match the almost 30 billion euros raised in dedicated bonds for small savers in 2024. That was down from almost 44 billion in 2023.

UniCredit strategists Luca Cazzulani and Francesco Maria Di Bella estimated that net households' contribution - including retail bonds and other government bonds - to Italy's financing needs would amount this year to around 50 billion euros, roughly in line with 2024 but far below the 130 billion in 2023.

DWINDLING DEPOSITS

In a sign of small savers' diminishing investment potential, Italians' deposits with domestic banks stood at 2.3 trillion euros in December, near their lowest level since February 2017.

That was down from a record high of 2.86 billion in April 2022 when household savings were flush after the limited spending opportunities during the COVID-19 pandemic.

With gross financing needs of up to 350 billion euros and the ECB having fully ended its PEPP bond-purchasing programme in December, Italy needs to compensate with other funding sources.

Several analysts said foreign investors can provide the answer, encouraged by Italy's relatively high bond yields, uncharacteristic political stability and falling budget deficit. 

The trend is already in place. 

In November, foreign holdings of Rome's government bonds reached their highest level since the launch of the euro in absolute terms at 771.421 billion euros. Commerzbank's Siemssen sees further upside potential.

"Rome may be able to attract more foreign investors if the government's fiscal consolidation efforts succeed," he said.    

The latest signs are positive. Data this week showed Italy's 2024 budget deficit plunged to 3.4% of output from 7.2% the year earlier, well below the government's 3.8% goal and almost in line with the 3.3% targeted for this year.

Moreover, Prime Minister Giorgia Meloni is riding high in opinion polls after two-and-a-half years in office, making Rome a source of political stability in Europe and belying its reputation for revolving door governments.

DANGER AHEAD?

The danger is that sooner or later Italy will be hit by another market rout. 

For all the current stability and fiscal progress, Italian bonds still yield more than those of any other euro zone country because investors demand a risk premium for holding them.

Memories remain vivid in Rome of the 2011 turmoil when a sell-off by foreign investors brought down the government of Silvio Berlusconi as the spread between Italian and German 10-year yields widened to more than 500 basis points.

The word "spread", hitherto unknown to ordinary Italians, became widely used in the country, as it still is today.

Yet for now Italy's policymakers are happy to welcome the rise in foreign debt purchases as a vote of confidence in their economic management.

Recent Italian syndicated bond sales have seen a marked increase in demand from foreigners, whose 31% of total debt holdings in November was up from 27.7% a year earlier. 

"We expect a consolidation of the foreign share going forward given the improvement in the political situation," said Annalisa Piazza, fixed income research analyst at MFS Investment Management.

UniCredit's Cazzulani and Di Bella took a similar view, saying in a note to clients that foreigners "are likely to be still underweight BTPs relative to pre-COVID."  

Piazza said Italy's fiscal consolidation may also be rewarded at some point by a debt upgrade from ratings agencies, which would stoke further foreign interest.

"Some insurances and pension funds will take advantage of the relatively steep Italian curve to buy longer dated BTPs," she said.

($1 = 0.9514 euros)

(Editing by Gavin Jones and Alexandra Hudson)