Italy’s sovereign debt rating was downgraded by the Standard and Poor’s rating agency on Monday which said to worry that the Mediterranean nation’s weak economic growth and fragile government might not be able to endure the sort of austerity measures that are deemed necessary to fend off a debt crisis.
The move comes as a disappointment for the third largest economy in the eurozone which is among the most heavily indebted countries in the world.
The downgrade is also a setback for the European Central Bank which agreed to extend its mandate and purchase Italian debt in August on the condition that Rome would hastily implement budget cuts. The conservative government of Prime Minister Silvio Berlusconi reneged on its promise however and plans to reduce spending by billions less than is needed to regain fiscal balance in the short term.
The ECB spent €41.6 billion buying Italian and Spanish debt last month. The Italian government urged the bank to continue the bond purchase program over German resistance. Fiscal hawks in Frankfurt are wary of investing billions in Italian debt in order to stem the European debt crisis if Rome isn’t willing to enact austerity.
Italy’s national debt amounts to more than 120 percent of its economy which is far less competitive than Germany’s. Cronyism, corruption and rigid labor laws constitute major impediments to growth. The judiciary is more political than is the case in most of the rest of Europe, forcing companies to often settle out of court while the prevalence of bribery and organized crime perpetuates a traditional imbalance between the industrialized north and the largely agricultural south of the country. Especially in the south, a high amount of economic activity is confined to the informal sector.
Due to its sheer size, its conservative banking industry and high level of personal savings, Italy should be able to stave off the specter of default but if there is a crisis of confidence, the country’s seemingly unstable political constellation can only deepen and prolong it.
The ruling party is beleaguered by corruption and scandals and may have to cope with a leadership vacuum if Berlusconi fails to stand for reelection two years from now. The leftist opposition, formally united in a single party since 2007, is easily scattered and generally opposed to spending reductions altogether.
The Italian treasury will be put to further test this month as €60 billion in redemptions are due.