Italy's goal of refinancing some 90 billion euros of long-term debt by the end of April is beginning to look within reach after months when the weight of its debt burden looked likely to tip the euro zone even deeper into crisis.
In spite of this month's mass downgrade of most euro countries by credit rating agency Standard & Poor's, Madrid romped through a debt sale on Thursday with support from cheap ECB lending to banks and steady interest from domestic investors.
The same factors should also help Rome.
Saddled with a 1.9 trillion euro ($2.5 trillion) public debt, Italy is the euro zone's third largest economy and investors have long feared it may prove too big to bail.
The amount of debt it must refinance between February and April looked almost unmanageable in November after international investors fled Italian bonds, driving even the country's three-year borrowing costs to nearly 8 percent.
But a fall in short-term yields after Italian banks awash with cheap ECB funds snapped up domestic bonds at recent sales has improved the market picture for Italy, now rated among the lower investment grades at BBB+ by S&P, on a par with bailed-out fellow struggler Ireland.
I am convinced Italy can and will make it, said Intesa SanPaolo fixed-income analyst Chiara Manenti. Recent auctions tell us tensions eased slightly. Looking ahead, the return of a net demand also on medium- and long-term maturities and a stop to disinvestments from abroad are crucial for Italy, she said.
Much hinges on efforts to persuade investors to accept deep losses on Greek debt, key to avoiding an unruly default there.
It certainly isn't our main scenario, but we can't assign a zero probability to the event of Italy being shut out of debt markets. In the short term there are risks relating to a possible Greek default, said Matteo Regesta, a strategist at BNP Paribas in London.
For European debt comparisons: http://link.reuters.com/fat74s
Italy itself came dangerously close to sliding towards default in late 2011 and has since been striving to regain market confidence under the leadership of a new technocratic government headed by former EU Commissioner Mario Monti.
Crucially, Italy can count on the support of the European Central Bank both through its bond buying program and an unprecedented liquidity boost. At a December 21 ECB tender of three-year funds, Italian banks took 116 billion euros, almost a quarter of the total.
This cheap funding, analysts say, has fuelled demand for short-term Italian and Spanish paper at recent auctions -- a trend which Rome plans to exploit. With more ECB cash up for grab at a February tender, Italian investors would have enough to fill up any void resulting from lack of foreign interest.
Domestic investors are likely to continue to participate --and indeed are incentivized to do so in order to protect existing exposure, Citi analysts wrote in a report last week.
Italian investors held 54 percent of the country's 1.6 trillion euro bonds and bills in June, the Bank of Italy said. Analysts estimate this share may have risen towards 60 percent.
Like many issuers, Italy is relying more and more on its domestic investor base, said Citi analyst Jamie Searle.
To better target retail demand at home, Italy will also start issuing directly to small investors through electronic platforms in the first quarter of 2012.
Maria Cannata, in charge of debt management at Italy's Treasury, said on Tuesday that a higher domestic debt ownership helps but that Italy's debt is too great to rely almost exclusively on local buyers.
WOOING FOREIGN BUYERS
Domestic investors make up the bulk of demand for Italian short-term debt but its sales of longer-term bonds must also target foreign buyers. PM Monti went to woo them in London this week.
Unlike short-term rates, longer-term yields have retreated only modestly. At around 6.40 percent, 10-year yields are two percentage points above three-year ones and not far from the 7 percent mark that has led other countries to seek bailouts.
It is the 10-year sector where the battle for market access is likely to be won or lost, hence the particular importance of the end-month BTP auctions, Citi analysts said in their report.
Italy is due to sell five- and 10-year BTP bonds on January 30, at an auction that will settle on February 1, when nearly 26 billion euros of BTPs and about 10 billion euros in coupons mature.
Ten years is the longest maturity Italy has attempted to sell since offering an off-the-run 15-year bond in mid-October.
Maturities longer than 10 years fall outside the scope of the ECB's bond purchases, traders say, and these buys are key in indirectly supporting demand at Italian bond sales.
With virtually no bonds maturing in January, Italy has pre-funded some of its redemptions this month. Intesa estimates net issuance at auctions settled in January at up to 39 billion euros including next week's sales of Treasury bills, zero-coupon and inflation-linked bonds.
Cannata said on Tuesday Rome would certainly boost issues of short-term bills, commercial paper and bonds with a maturity of up to three years in the first part of the year.
Once past the February-April refinancing hump, which represents 45 percent of 2012 medium and long-term maturities, Italy would have minimal redemptions in May and June.
But significantly shortening Italy's debt average life of seven years would increase refinancing risks. S&P warned last week that this would weaken an important credit strength for Italy and the Treasury is well aware of the danger.
Already in the second half of the year we will necessarily have to return to a more uniform distribution along the yield curve to (ensure) a shortening in the average life of the debt ... remains modest, Cannata said. ($1 = 0.7757 euros)
(Editing by Ruth Pitchford)