Italy Struggles to Calm Creditors’ Fears After Debt Downgrade

Sources:
Guardian: Italy Downgrade Adds to Eurozone Contagion Fears
Spiegel: Belligerent Berlusconi Toys with Europe
Spiegel: Debt Downgrade
Telegraph: S&P Downgrades Italy: the full text
WSJ: Italy’s Frattini Sees Next Austerity Package Soon
WSJ: Italy Approves EUR54 Billion Austerity Plan

On Monday afternoon, credit ratings agency Standard & Poor’s (S&P) downgraded Italy’s credit one notch to A/A-1. The announcement came after S&P lowered its annual growth forecast for Italy to just 0.7% annually between 2011 and 2014, down from its earlier 1.3% prediction. The main reasons for the downgrade, according to S&P, is the political uncertainty regarding the country’s ability to deal with its economic challenges, especially finding a way to reduce its enormous public debt—currently at 120% of gross domestic product (GDP). S&P questions whether Italy’s plans to cut government spending and reach other fiscal targets will be as effective as the Italian government believes. S&P did not raise any concerns about Italy’s economic structure, external liquidity and investments, or the country’s monetary flexibility.

Italy is currently facing a fiscal deficit of 4% of GDP, an increase from just 1.5% in 2007. Although the government has attempted to limit spending, Italy’s exceedingly high public debt still accounts for 23% of all sovereign debt in the Eurozone. This immense debt burden has forced the Italian government to raise an equally large amount of capital by selling bonds (debt) on a regular basis to pay for its already-existing debts.

In an effort to tackle its increasing financial difficulties, the Italian government approved a €54 billion austerity package last week that increases taxes and cuts spending for the next three years. The package includes a 1% increase in the value-added tax (a European form of sales tax) which is expected to bring in €4.2 billion in new revenue per year. Additionally, observers expect the government to introduce a third round of austerity measures to Parliament within the next few weeks. The new legislation will likely aim to decrease the government’s medium-term debt by selling public property and privatizing some public services, although important businesses, such as oil and energy production and high-tech operations, are likely to remain under government control. The new measures are also aimed at promoting economic growth by attracting new foreign investments.

Many critics believe that Italy’s austerity plans will push the country into a recession by the end of the year as tax increases will reduce a major source of economic growth—domestic consumption—by taking money out of consumers’ hands. Thus, the country’s debt-to-GDP ratio will not decrease if a decrease in GDP accompanies any debt reduction the measures achieve. The only certain thing is that the Italian government has a difficult road ahead.