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Budget Rigor Fails to Shield Italy in Falling Market

Italian Prime Minister Mario Monti
Italian Prime Minister Mario Monti. Photographer: Ed Jones/Pool via Bloomberg

Italy, mired in a fourth recession since 2001, is struggling to shake the threat of debt-crisis contagion even as the nation’s budget constraints are set to surpass almost all its euro-region peers in the next two years.

Boosted by Prime Minister Mario Monti’s 20 billion-euro ($26 billion) austerity package, Italy will post a structural budget surplus of 0.1 percent of output in 2013, second only to Finland’s 0.3 percent and better than Germany’s deficit of 0.3 percent, the European Commission forecast on May 11. Structural data exclude the economic cycle’s effects and onetime measures.

Budget rigor alone isn’t shielding Italy from the sovereign crisis as the region’s second most-indebted country after Greece grapples with a deepening recession and contagion from political chaos in Athens and a worsening fiscal outlook in Spain. The yield on Italy’s 10-year bond rose during seven of the past nine weeks, increasing to 5.83 percent today. The rate is 440 basis points more than similar German debt, the most since Jan. 19.

“Doing better for this year and next is fine, but the truth is, Italy is going to have to do well for the next 10 years,” Gary Jenkins, director of Swordfish Research Ltd. in Amersham in the U.K., said by phone. Italy “can’t afford any kind” of budget overruns and “there’s no quick fix to a big debt overhang,” he said.

Ballooning Debt

Italy’s economy, bogged down by debt that the government forecasts will increase to 123.4 percent of gross domestic product this year, fared the worst of the 12 euro-area countries that reported first-quarter data yesterday. GDP in Italy fell 0.8 percent, while it stalled in France and the euro region and grew at a greater-than-estimated 0.5 percent in Germany.

Given its belt-tightening efforts, Italy is no longer “contributing to the crisis,” Monti said today. Still, should the situation in Europe “explode, Italy might find itself with a clean conscience, but financial markets would be very concerned” about the nation’s outlook, the premier said.

The GDP report prompted economists at Barclays Capital and UniCredit SpA to say they may cut their forecasts for Italy in the second quarter and one of Monti’s key allies called on Monti to renegotiate the government’s deficit goals.

‘Unrealistic’ Forecasts

Yesterday’s report shows the government’s economic forecast are “unrealistic” and Italy needs to scale back its effort to trim the overall deficit to 0.5 percent of GDP next year from the 1.7 percent projected for 2012, Stefano Fassina, economic spokesman for the Democratic Party that backs Monti’s government, said in an e-mailed statement.

“The first measure for growth is stopping this self-destructive austerity,” Fassina said. “The deficit targets must be redefined with the European Commission.”

The IMF, presenting its report on Italy’s public finances in Rome today, said the country’s economic outlook is “tilted to the downside” as the escalating debt crisis pushes up bond yields and prompts banks to tighten lending.

Monti, a former European Union competition commissioner who took over in November after Silvio Berlusconi’s government fell, has lobbied European leaders to pursue policies to boost growth without widening budget deficits. Monti has called on the EU to allow national investments in so-called strategic industries to be exempt from fiscal rules to help ease the effects of austerity measures and jumpstart the expansion.

The government forecasts the economy will return to growth next year, expanding 0.5 percent and 1 percent in 2014. Public debt will start falling in 2013 to 121.5 percent of GDP and to 118.2 percent in 2014. That would leave the country’s debt at almost twice the EU’s 60 percent limit.

“The real question is whether public debt can stabilize and then start to fall in relation to the economy and if the improvement in public finances is sustainable,” Riccardo Barbieri, chief European economist at Mizuho International Plc in London, said by e-mail. “The most recent economic data cast some doubt on what will happen from here on out.”

Hollande’s Arrival

Italian consumer confidence plunged last month to the lowest since 1996, while business sentiment declined to a two-year low amid concern that the recession may worsen. Monti’s government forecasts that the euro-area’s third-biggest economy will contract 1.2 percent this year and says the jobless rate, already at an almost 12-year high of 9.8 percent, won’t start declining until next year.

Francois Hollande, sworn in yesterday as France’s president, has called for a renegotiation of the euro area’s fiscal treaty, saying it puts too much emphasis on austerity. He’s also urged the European Central Bank and the European Investment Bank to play more active roles in stimulating growth.

ECB President Mario Draghi has also called for a “growth pact” in the currency region.

Italy’s 10-year bond yield has surged more than 50 basis points since Greece’s inconclusive election on May 6, which raised the risk that the nation where the debt crisis began 2 1/2 years ago may exit the euro.

Banks Downgraded

While Italian banks may be in better shape than their Spanish counterparts, which are hobbled by property losses, Moody’s Investors Service downgraded its ratings May 14 on 26 Italian lenders, including UniCredit and Intesa Sanpaolo SpA, because of the country’s dim economic outlook

As Spain’s crisis deepened this year, markets have cut Italy some slack. Spain’s 10-year bond yields 46 basis points more than Italy’s, a swing of about 2.5 percentage points from the start of the year when Italy’s yield hovered close to 7.11 percent and Spain’s was at 5.09 percent.

The cost of insuring Spanish debt against neared a record today, pushing up credit-default swaps on Italy’s borrowing as well. Spanish swaps rose almost 5 basis points to of 545.2 and Italy’s held near a four-month high of 501 basis points.

“In the space of just 10 weeks, a rally in Spanish and Italian bond markets has gone into reverse and threatens to turn into a rout if euro-zone ‘break-up contagion’ starts to take hold,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. “A Greek exit would place Spanish and Italian debt markets and banking sectors under unprecedented strain.”

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