Main bourse battered by Italy’s acute default risk

The main bourse tumbled yesterday as Europe entered a new state of panic given Italy’s proximity to a default.

The Kospi fell steeply in early trade, losing over 94.28 points from the previous day, and continued this trajectory throughout the day without much letup. It closed down 4.94 percent from the previous trade at 1,813.25.

The last time the market took such a battering came in the wake of an announcement about economic stimulus measures by the U.S. Federal Reserve on Sept. 23 that failed to calm jitters. This, coupled with disappointing economic indicators from China, saw the Kospi shed 5.73 percent, or 103.11 points.

Yesterday’s nosedive was triggered by the same fears that have undermined global markets for weeks, namely that the debt crises in Europe’s southern rim would spread to Italy, the euro zone’s third-largest economy.

Despite Italian Prime Minister Silvio Berlusconi’s offer to resign, government bonds with a 10-year maturity stretched to 7.45 percent at one point yesterday before recovering to 7.25 percent after the European Central Bank intervened.

Rates in excess of the 7 percent benchmark represent a psychological barrier but do not necessarily indicate that a country’s economy is collapsing.

Previously, Greece, Portugal and Ireland asked for bailouts after seeing their bond rates stray into this territory.

Additionally, Italy’s credit-default-swap premiums with a maturity of five years gained 0.5 percentage points from the previous day’s trade to end at 570.4 basis points.

This beat the previous high of 521 basis points set at the end of September.

A credit-default-swap premium is a derivative product that guarantees returns when a country or a company defaults. A rise in its premium shows that a default risk is growing.

If Italy does fall, the impact is expected to be much more dramatic than the crisis in Greece, which caused extreme volatility in markets across the globe.

It could create a Lehman Brothers-level of panic that could jeopardize world markets.

Considering that Italy’s debt currently stands at 1.9 trillion euros ($2.6 trillion), or 120 percent of GDP, the chances of it being rescued are practically nonexistent.

Italy is now saddled with the fourth-largest sovereign debt after the United States, Japan and Germany, a figure far larger than the 250 billion euros provisionally set aside by the European Financial Stability Fund.

“The problem is Italy’s fiscal debt, unlike Greece’s, is exceptionally large and cannot be bailed out through the EFSF,” said Lee Sang-je, an analyst at Hyundai Securities.

“An Italian default would not only crash the European banking systems in Germany and France, but could also trigger a massive global credit risk and economic recession once it spills over to U.S. financial institutions.”

Other major markets across the globe also fell yesterday, with Wall Street seeing its main index fall more than 3 percent. The market in Tokyo closed 2.91 percent lower from the previous trade, while the Hong Kong index was down more than 4 percent.

Seoul saw a steeper fall considering the market’s high exposure to foreign investors.

The Ministry of Strategy and Finance has been operating a crisis management meeting on a weekly basis since last month at the order of President Lee Myung-bak.

The aim is to coordinate cooperation efforts among government offices.

In 2008, Korea adopted a stimulus package that helped it recover relatively quickly from the credit crunch.

By Lee Ho-jeong [ojlee82@joongang.co.kr]