There is reporting today from Bloomberg, via an Italian daily La Stampa, that the IMF is preparing a big bailout for Italy should its troubles worsen. The figure is being put at near €600 billion (or $800 billion) which would be a critical development for the euro-zone situation.

From Bloomberg: The International Monetary Fund is preparing a 600-billion euro ($794 billion) loan for Italy in case the country's debt crisis worsens, La Stampa said.

The money would give Italy's Prime Minister Mario Monti 12 to 18 months to implement his reforms without having to refinance the country's existing debt, the Italian daily reported, without saying where it got the information. Monti could draw on the money if his planned austerity measures fail to stop speculation on Italian debt, La Stampa said.

Italy would pay an interest rate of 4 percent to 5 percent on the loan, the newspaper said. The amount could vary from 400 billion euros to 600 billion euros, La Stampa said.

It would put Italy in the ranks of Greece, Ireland, and Portugal as recipients of  rescue aid, and would give the Italians a large cushion in which it would not have to tap the private bond markets for financing. We have been tracking the deterioration in Italian bond markets here at FXTimes almost daily, as European banks dump their periphery yields, in anticipation of a credit crunch.

How to Solve a Liquidity vs Solvency Issue? A Bridge Loan aka Bailout...

This move means that the yield that Italian bonds trade at becomes less important for Italy and the sovereign debt crisis, though it remains critically important to banks. A possible IMF bailout would therefore be a response to the classic liquidity versus solvency issue. For Italy, if its indeed caught in a liquidity crisis, then having time to implement its reforms and getting its finances back in order would be a welcome relief for bond markets.

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Italy has €33 billion of debt coming due in the final week of January and a further €48 billion in the last week of February. And, altogether has €306 billion maturing in 2012. This bailout therefore would give Italy about 2 to 3 years of breathing space in which to push through its reforms.

Italy's new government, headed by Mario Monti, has already taken up tough austerity measures, as well as plans to liberalize the labor and tax markets in order to increase growth.

Italy plans to cut public-sector jobs, overhaul the tax system and introduce incentives for venture-capital investments, the Finance Ministry said in a letter to the European Commission. Italy plans to raise its retirement age faster than other European Union countries and to cut 300,000 public-sector jobs by 2014, according to the letter, a copy of which was obtained by Bloomberg News.

width=400Those are long term goals, that will take years to implement, while the situation now is that Italian debt is starting to sell at unsustainable levels. This loan should theoretically act as a bridge to ease that disconnect, as the bailouts for Greece, Portugal and Ireland where meant to do.

Details Lacking and Would a Request to Top Off the IMF Resources Pass the US Congress?

On the hook for this bailout will be the US, European nations,  and other countries at the IMF (the BRICS among them). The terms would likely be similar to the loans to Greece, roughly around 4-5%. One important rub is that the IMF would have to expand its lending capability to have the funds to provide such a bailout, which would require the vote of the US Congress. The US taxpayer would in essence be giving Italy subsidized loans. We'll see if that flies at all politically.

In any case, the news about a possible IMF Italian bailout, caused riskier, higher-yielding currencies to gap higher in opening trade this week.

We therefore away further details to this initial reporting, to see if this story has any legs and if it would be possible to have such a measure pass through national parliaments.

If yes, that presents us with a risk-on scenario as we could see a possible relief rally which would also be a short-squeeze of EUR positions.  However, if this is just a rumor or is unworkable for other reasons, the pressure of the euro-zone debt crisis will continue unabated, with risk-off trading returning again to the forefront.

Nick Nasad
Chief Market Analyst
FXTimes