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Italy’s Bond Ratings May Be Downgraded by Moody’s Amid ‘Growth Challenges’

Italy’s credit ratings may be reduced by Moody’s Investors Service because of economic growth challenges, risks associated with efforts to reduce debt and the potential for higher borrowing costs.

The nation’s third-ranked Aa2 local and foreign-currency government bond ratings were placed under review for a possible downgrade, Moody’s said in a statement yesterday. The country’s short-term Prime-1 ratings were affirmed.

Italy may have trouble reducing its public debt to more affordable levels as borrowing costs rise and support for the government of Prime Minister Silvio Berlusconi weakens, Moody’s said. Investor speculation about a possible Greek default has focused attention on the finances of Italy and other high-debt euro area nations. Italy had to offer 3.9 percent to sell five- year bonds this week, matching March’s 2 1/2-year high.

“There are some potential contagion problems going on now in Europe,” Jay Bryson, a senior global economist at Wells Fargo Securities LLC in Charlotte, North Carolina, said in an interview. Italy’s “debt dynamics look a little shaky as well. They also have a growth problem there.”

Italy had debt of about 1.8 trillion euros ($2.6 trillion) at the end of last year and a ratio of debt to gross domestic product of about 119 percent. The International Monetary Fund yesterday projected Italy’s economy would expand 1 percent this year, down from 1.3 percent in 2010.

The ratings review will focus on the growth prospects for the euro region’s third-largest economy and the outlook for a removal of structural bottlenecks that could hinder a medium- term economic recovery, Moody’s said.

‘Growth Challenges’

“The Italian economy faces growth challenges in an environment characterized by long-term structural impediments to growth,” Moody’s said in yesterday’s statement. “The fragile market sentiment that continues to surround European sovereigns with high levels of debt poses additional risks for Italy.”

European officials are in the midst of discussing how to provide additional funding for Greece and get the private sector involved without triggering a default. Greek Prime Minister George Papandreou’s failure to win support for more austerity is fueling speculation of a default that would infect Europe’s banking system and credit markets beyond the region.

“It’s this environment of some uncertainty and questions around the resolution of the management of the euro-zone debt crisis, which is a factor,” Alexander Kockerbeck, a Moody’s Investors Service sovereign-debt analyst, said in a telephone interview. He said that the crisis “can have consequences” for countries like Italy where “economic growth is relatively low, and borrowing costs can increase in that environment.”

IMF Warning

International Monetary Fund chief economist Olivier Blanchard said at a press conference yesterday that a failure to agree on measures or funding for countries at the “periphery” of the euro region could lead to a sovereign defaults and derail the world recovery.

“It’s another piece of negative news here,” Bryson said. “Is that going to change the political dynamic in Greece? No, I don’t think it has any effect.”

Yesterday’s announcement follows a similar move by Standard & Poor’s last month. Italy had its credit-rating outlook lowered to negative from stable by S&P, which cited the nation’s slowing growth and “diminished” prospects for a reduction of government debt.

S&P affirmed the country’s A+ long-term rating, the fifth highest, and its top-ranked A-1+ short-term rating, the company said in a May 20 statement.

Growth Outlook

The Italian economy expanded 0.1 percent in the first quarter, less than economists had estimated, as gains in exports failed to offset weak domestic demand. The economy won’t return to its pre-recession level for at least another two years, and the $2.3 trillion economy needs to raise productivity, the OECD said last month in a report.

Berlusconi, reeling from two electoral defeats in two weeks, wants to win back voters with tax cuts that threaten to split his Cabinet and inflate the euro region’s second-biggest debt.

Berlusconi and his Northern League allies have stepped up talk of tax cuts after losing lost control of key cities, including Milan, in regional elections last month. Berlusconi suffered a further setback this week when almost 60 percent of eligible Italians voted to overturn a series of policy initiatives, the first referendum to achieve the necessary 50 percent participation threshold since 1995.

To contact the reporter on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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