Scenarios for government debt in Europe

Almost two years since the outbreak of the government financing crisis in the euro area, the long-term debt sustainability of some member states on the area's geographical periphery remains clouded by uncertainty.

The spotlight has even landed on the eurozone's third-largest economy, Italy. One question that is frequently raised is how Italy will be able to break out of the "debt spiral" in an environment of "stagnating growth" and "interest of up to 7%". The average interest rate on sovereign debt that is relevant to the change in the debt ratio is likely to have come in at 4% last year, a far cry from the now prevailing market interest rate of 7% (2012e: 4.4%).

While the considerable easing on the Italian bond market shows that the ambitious austerity program prescribed by the new government under Mario Monti has gone some way to building trust in the country's policies, the fact that the refinancing costs for Greek and Portuguese bonds, in particular, remain high suggest that the markets are not yet entirely convinced that the debt crisis can be overcome.

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