Last weekend's setback in the Italian local elections for Prime Minister Matteo Renzi should serve as a stark warning to European policymakers not to be overly complacent about the fallout from a Greek default. The elections reveal that Renzi's honeymoon with the Italian electorate is over and that populist anti-European forces in Italy are again on the march.

This has to be of considerable concern since the Italian economy, which is the third-largest in the eurozone, remains wracked with an excessively high public debt level. That makes it imperative that Italy perseveres with both budget consolidation and with structural economic reform that might lift the country's sclerotic economic growth rate in order to help the country dig out from under its public debt mountain.


Among the more disturbing aspects of last weekend's election was not simply that Renzi's reform-minded Democratic Party was able to garner only 23 percent of the vote. Rather, it was that the anti-reform and anti-European parties did so well in those elections. The populist Five Star Party led by Beppe Grillo managed to get as much as 19.5 percent of the vote, while the anti-European Italian Northern League increased its share of the vote to 12.5 percent. Renzi's relatively poor showing at the polls has to raise serious questions about his ability to retain his reform momentum.

Italy's precarious public debt position does not afford the country the luxury of slowing down on budget adjustment and economic reform. Indeed, it has to be a matter of major concern that Italy's public debt to gross domestic product (GDP) ratio has steadily risen from 106 percent in 2008 to around 136 percent at present. It also has to be of concern that this high debt level is giving rise to very large rollover needs. It is estimated that in 2015, the Italian government's gross borrowing needs will be as high as 24 percent of GDP.

The dimension of Italy's budgetary and economic reform challenges is highlighted by the International Monetary Fund's latest Italian debt sustainability analysis. To attain the relatively modest objective of reducing Italy's public debt to GDP ratio from 136 percent in 2014 to 124 percent in 2019, the IMF estimates that Italy would both need to increase its primary budget surplus from 2 percent of GDP in 2014 to 5 percent of GDP by 2019 as well as to increase its average economic growth rate over the next five years to 1.1 percent.

Italy's dismal economic growth record over the past 15 years can leave little doubt that bold reforms will be required to deliver the economic growth needed to stabilize its public debt. Over the past 15 years, Italy has averaged barely 0.3 percent a year economic growth. This has meant that in 2014, Italy's output level was only some 4 percent higher than it was in in 1999.

Italy's troubling public debt situation and the political setback it has now experienced could mean that it will come under market pressure in the event that we do get a Greek default later this summer. This would especially be the case considering that a Greek default could very well coincide with the start of a Federal Reserve rate-hiking cycle that could tighten global liquidity conditions. It also does not help that a Greek default would be occurring on the eve of upcoming general elections in Portugal and Spain later this year that could further confirm Europe's political fragmentation. If the results of last month's local Spanish elections are any indication, those elections could constitute a further setback for economic reform in those countries.

Italy's precarious public debt position, coupled with the fact that this debt now totals over $2 trillion, should be cautioning European policymakers not to be too cavalier about the longer run consequences of a Greek debt default that could cause the market's spotlight to focus on Italy's shaky public debt fundamentals. It should also be highlighting to European policymakers the imperative for them to redouble their policy efforts to get the European economy moving again, which is a necessary condition for Europe to grow its way from under its excessive debt burden.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.