Published On: Tue, Jun 12th, 2018

How to Exit the Euro in a Nutshell – ‘Il Piano Savona’

  By Daniel Gros

This article offers an eight-point analysis of a Plan adopted by the Lega Party for Italy’s exit from the euro that seems designed to confirm Germany’s worst fears.

Paolo Savona will now become Minister for EU Affairs in Italy’s new Lega-Five Star Movement government. He is the main author of a plan for Italy’s exit from the euro. This document, which has now been made public, is briefly analysed here to shed some light on the strategy that has apparently been adopted by the Lega Party, which has insisted on Savona’s participation in the government.

Eight key points contained in the Plan are presented below, with numbers in bold referring to the number of the relevant slide in his presentation. See also the Annex for excerpts of the Plan (in Italian) referenced in the text.

The Plan

  1. Plan B? The introduction asserts that Italy needs a Plan B as both a ‘deterrent’ and a negotiation tool, but then proceeds to show that Italy needs a large devaluation in any event. There is no indication of any ‘concessions’ that would be demanded in exchange for shelving the Plan. It looks more like a proposal that would be implemented regardless of any reforms of the euro that might come about.
  2. A curious view of democracy. In domestic legal terms, the Plan emphasizes the Lex monetae as a power of the government. Hence there should be no referendum (unconstitutional for Savona, slide 21). A simple decision taken by the government would be sufficient (a vote in Parliament is not mentioned).
  3. No eurobonds! The Plan is also opposed to any Eurobonds because they would not be under exclusive Italian jurisdiction (and would thus make default more difficult).This means that the author would also be opposed to any of the many variants of common bonds that have been proposed so far.
  4. Remain in EU. The introduction mentions in general the need to maintain good relations with EU partners and the importance of Italy remaining in the EU. But this seems impossible given the planned default on official debt.
  5. Capital controls. The operative plan is quite standard: Imposition of strict capital and banking controls with the announcement of the intention to leave the euro area, timed for a weekend with the change in currency following almost immediately.  Savona envisages that the exchange rate of the new currency with the euro would initially be 1:1, but it would then depreciate.
  6. Default on public debt. Only public debt would be redenominated in the new currency – which should depreciate by about 15-25% (to establish competitiveness vis-à-vis Germany, not on a weighted average basis). A haircut on public debt should follow in order to bring the debt/GDP ratio to 60-80%.. It is not stated in the document, but the (nominal) haircut would have to about one half in order to reach a debt/GDP ratio of 65 % (today’s is over 130 % of GDP).  Given that the lower nominal value would be paid in ‘new’ lira, the overall loss of value for investors would thus have to be more than one half.  Savona does not mention that since 2012 all new debt has a collective action clause requiring the agreement of a majority of 3/4th of all creditors to any change in the terms.
  7. Default on official debt and Target2 balances. The Plan says foreign official creditors (except the IMF) should also accept a haircut, explicitly mentioning Target 2 balances, which should be denominated in the new currency (and be cut). The Plan refers to Sinn’s book, asserting that the legal basis for enforcing Target 2 balances is weak .
  8. Give to the rich, take from the poor. The Plan explicitly foresees re-distribution of wealth towards the better off Foreign assets of the private sector (which are substantial) would not be re-denominated, and the gains, which would accrue to the ‘medium to upper’ levels of the population would not be taxed. But real wages should fall.

In a nutshell

All in all, this Plan seems designed to confirm Germany’s worst fears: exit would be accompanied by a massive default on public debt, including foreign official debt, such as Target2 balances. But rich Italians who have considerable assets abroad would be able to keep their euros (and without any taxation).

This insistence of a default on foreign official creditors is difficult to understand, given that Italy’s net international asset position is almost in balance (net position only minus 8% of GDP). There is thus no objective reason why Italy would need to cut its foreign debt. In the case of Greece. most debt was held abroad. A cut in foreign debt was thus unavoidable. But not even Varoufakis entertained a default on Greece’s official debt.

But what is particularly astonishing about Plan is not the idea that Italy might need a devaluation, but rather the open intention to stick it to the rest of the world – particularly Italy’s euro partners – to the benefit of the wealthy part of the Italian population.

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