What it means
The idea draws on the earlier example of Brexit, when the United Kingdom left the European Union. Italy is one of the largest economies in the euro area, so the possibility of its exit raises much bigger questions than the exit of a smaller country would.
Debate about it tends to rise when Italian politics shifts or when the economy struggles. The financial worry has two parts.
If Italy left the euro and created a new currency, contracts written in euros would have to be converted, and the new currency would likely weaken against the euro. Debts owed to foreign lenders in euros would then become more expensive to repay in the new currency.
Markets react to the mere possibility. When Italian politics raises the chance of an exit, the extra yield investors demand on Italian government bonds over German bonds, known as the spread, widens.
A wider spread raises Italy's borrowing costs and affects banks, which hold large amounts of government debt. For businesses, the question is one of contract and currency risk.
A company with Italian customers or suppliers may include clauses about the currency in which payments are made and what happens if it changes. Treasury teams may also hedge exposure to Italian counterparties or avoid long-term fixed commitments.
It is important to keep perspective. Surveys have repeatedly shown that leaving the euro is a minority position in Italy, and a withdrawal would face legal, practical and political obstacles.
Italexit is therefore best seen as a tail risk, meaning an unlikely event with large consequences, rather than a forecast. Contract law adds another layer of difficulty.
Most legal systems have a principle that a debt is owed in the currency in which it was written, and a new currency would force courts to decide how existing contracts should be converted. Many lawyers advise including a clause that fixes the currency and the governing law, which reduces uncertainty if the scenario ever became real.
In practice
Real-world examples.
Example
A multinational with an Italian subsidiary reviews its contracts for currency clauses. The legal team asks which law governs each contract and in which currency payments are due. The treasurer then decides whether to hedge the euro exposure of the subsidiary.
Example
A bond fund manager compares Italian and German government bond yields. When the spread widens sharply on exit fears, she reduces her holding of Italian bonds. She explains her reasoning in the quarterly report to investors.
Example
An exporter selling machinery to Italian customers asks for payment in euros through a bank in another country. The finance director believes this reduces the chance of being paid in a weaker currency. She also reviews credit insurance for the larger accounts.
Formula
Calculation
Increase in cost of euro debt in the new currency = 1 / (value of new currency in euros) - 1
Suppose an Italian company owes 10,000,000 euros, and after an exit the new currency falls to 0.80 euros. Each euro now costs 1 / 0.80 = 1.25 units of the new currency. The debt was 10,000,000 units before the fall and is 10,000,000 x 1.25 = 12,500,000 units after it. The cost increase is 1.25 - 1 = 25%, even though the company's sales in the new currency have not changed.Case study
Seen in the real world.
Tuscan Valley Foods is an illustrative, fictional exporter of olive oil. A national election raised talk of Italexit, and the company's lender asked how the business would cope if the euro were replaced by a weaker currency.
The finance director modelled two scenarios. In the first, the company sold in euros and paid its costs in euros, so little changed. In the second, domestic costs were paid in a new weaker currency while its export income stayed in euros, which would have increased profit.
The real danger turned out to be a loan owed in euros that was secured against income in the local currency. The company moved some of the debt to match its currency of income. The illustrative lesson is that currency mismatch, not the event itself, creates most of the risk.
Watch out
Common mistakes.
- Treating Italexit as a forecast, when it is a hypothetical scenario that has never occurred.
- Confusing leaving the euro with leaving the European Union, when they are separate decisions with different legal routes.
- Ignoring currency mismatch between debts and income, when that mismatch is where most of the loss would arise.
Questions
People also ask.
What does the bond spread tell us about Italexit fears?
A widening spread between Italian and German government bonds suggests investors want more compensation for perceived risk.
Has Italy ever voted to leave?
No, Italy has not held a vote to leave the euro or the European Union.
How can a business prepare?
By reviewing currency clauses, matching debts to the currency of income and keeping treasury plans for stressed scenarios.
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