Fear takes hold as eurozone debt crisis spirals out of control

Christine Lagarde, head of the IMF (Reuters)

Christine Lagarde, managing director of the International Monetary Fund, warned yesterday that the world is facing a "lost decade" of economic growth thanks to a eurozone sovereign-debt crisis that is spiralling out of control.

Ms Lagarde was speaking in Beijing on a day when the perilously fragile state of the Italian economy – the eurozone's third largest – came into sharp focus after the borrowing rates of the Italian government shot above levels that have seen other eurozone states forced to seek international bailouts.

Investors and traders desperately sold off Italian debt yesterday morning, pushing the yield – or interest rate – on 10-year Italian bonds to 7.4 per cent. At such elevated borrowing rates, Italy will be unable to roll over its €1.9 trillion (£1.6trn) sovereign debt pile, raising the prospect of an uncontrolled default by the country, an event that would plunge the global financial markets into chaos.

The sell-off of Italian debt was prompted by a decision yesterday morning by the London-based bond trading exchange, LCH.Clearnet, to increase the collateral that traders in Italian debt must pledge.

And the panic was compounded by confusion over whether Italy will hold early elections. Traders initially responded positively yesterday to the commitment on Tuesday night from the Italian Prime Minister, Silvio Berlusconi, to resign and make way for an administration committed to economic reform.

But fear took hold when news emerged of a disagreement between Mr Berlusconi and the Italian President, Giorgio Napolitano, over whether there should be elections early next year. Investors are worried that elections could cause lengthy political uncertainty in Italy at a time when the country urgently needs to demonstrate to its creditors that it is acting to get down its debt pile, which is equal to 120 per cent of the country's annual output.

A team from the EU is due to arrive in Rome today to supervise Italian efforts to cut the nation's borrowing pile. And David Lipton, the deputy director of the IMF, is also due to arrive in the Italian capital next week.

Ms Lagarde, at a banking conference yesterday, said that national leaders need to co-ordinate their efforts to prevent an international slump. "If we do not act boldly and if we do not act together, the economy around the world runs the risk of a downward spiral of uncertainty, financial instability and potential collapse of global demand," she said. "We could run the risk of what some commentators are already calling the lost decade."