S&P Says Political Instability `Key Risk' to Italy's Effort to Cut Deficit

Standard & Poor’s Ratings Service warned that political instability may jeopardize Italy’s bid to cut the budget deficit, even as it affirmed the credit rating of the euro-region’s most indebted economy.

Italy’s ratings “could come under downward pressure if political instability were to impede the implementation of the current plan,” S&P said in a statement today, affirming Italy’s A+ long-term and A-1+ short-term sovereign credit rating with a “stable” outlook. “Potential political instability could be a key risk,” S&P said.

Surging borrowing costs triggered by Greece’s near-default and Europe’s sovereign-debt crisis prompted Prime Minister Silvio Berlusconi’s government to pass deficit cuts worth 24.9 billion euros ($34.9 billion). The budget adjustment, which parliament approved in July, aims to reduce the deficit an additional 1.6 percent of gross domestic product to bring the shortfall within the European Union limit of 3 percent of GDP in 2012 from 5.3 percent last year.

The yield premium, or spread, that investors charge to hold Italian 10-year bonds over comparable German bunds, the European benchmark, widened by 6 basis points to 151.5 basis points today, the most in almost a month.

Berlusconi’s grip on power has weakened since his long- standing ally, Gianfranco Fini left the ruling People of Liberty party three months ago and founded a splinter group which has enough votes to sink the government. Tensions between the two intensified this week amid newspaper reports that Berlusconi allegedly secured the release of a 17-year-old woman from police custody in Milan.

Rift with Fini

Fini said Oct. 31 that Berlusconi will have to resign should it prove he used his powers to secure her release. When asked about the case, Berlusconi didn’t deny intervening, saying he only sent a friend to the police station to take custody of the girl because of the woman’s “tragic circumstances.”

“The increasing fragility of the current governing coalition makes implementing growth-enhancing structural reforms politically more challenging in the near term,” S&P said today.

On Sept. 29, Italy’s government maintained its budget- deficit forecast, while predicting stronger economic growth this year and higher debt. GDP will increase 1.2 percent in 2010, up from the 1 percent the government predicted on May 6. The $2.3 trillion economy will expand 1.3 percent next year.

Debt Levels

The government raised its debt forecast to 118.5 percent of GDP this year and 119.2 percent next year. It kept its deficit target of 5 percent of GDP this year and 3.9 percent next.

“Even if the government’s measures are fully implemented, we expect the gross debt ratio in Italy to touch 120 percent in 2011,” S&P credit analyst Eileen Zhang said in today’s report.

While Moody’s Investors Service has kept its rating of Italy unchanged at Aa2 since May 2002, S&P has been more willing to cut, slashing its rating twice in that period -- in July 2004 to AA- and again in October 2006 to A+. On May 7, Moody’s said that Italy is not among the countries most at risk from Europe’s debt crisis and its credit outlook for 2010 remained stable.

The euro region’s third-largest economy emerged in the third quarter of 2009 from its worst recession since World War II. It grew 0.5 percent in the three months through June as exports more than offset flat consumer spending.

-- Editors: Andrew Davis, Jeffrey Donovan

To contact the reporter on this story: Lorenzo Totaro in Rome at ltotaro@bloomberg.net

To contact the editors responsible for this story: John Fraher at jfraher@bloomberg.net

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