Italy has weathered the financial crisis better than many of its peers but some economists say that because of its huge debt mountain and traditionally weak growth it is not immune from a Greek-style debt crisis.
The euro zone's third largest economy, Europe's biggest bond market, has been one of the most sluggish in the 16-nation currency bloc for well over a decade, due to low productivity and competitiveness.
Although its debt ratings do not appear at risk in the short term, analysts warn that unless it can push through long-delayed, unpopular structural reforms, it will struggle to achieve a strong and lasting reversal of its high public debt and the costs of servicing it.
Following are some of the key factors to watch:
Debt and Deficit
Italy's debt burden is seen rising to 117 percent of GDP in 2010 from 103.5 percent in 2007, according to government projections. Although the rise over the period is less than forecasts for Ireland, Greece, Spain and Portugal, the ratio is still among the euro zone's highest and comparable to Greece's.
Debt is projected to fall below 115 percent of GDP in 2012 while the budget deficit, which stood at 5.9 percent in 2009 — compared to 12.7 percent for Greece — is targeted to fall to 5.0 percent this year and dip below the EU's 3 percent ceiling in two years' time.
However, the European Commission has warned Italy it may miss those targets due to over-optimistic growth forecasts and a lack of specific austerity measures.
After contracting by 5.0 percent in 2009 — the largest drop in its post-war history — GDP is expected by the government to rise 1.1 percent this year — but the European Commission and the Bank of Italy both forecast just 0.7 percent growth.
Italy was the first G-8 country to lose its AAA credit rating in the 1990s, and analysts say its long record in dealing with high public debt makes it a less immediate target for financial markets.
Yet if growth remains weak, then tax revenues will be lower than expected and social spending will be harder to cut, making fiscal targets more difficult to reach and potentially putting Rome back on markets' radar screen.
What to Watch:
— More details on the reforms the government wants to implement, such as fiscal federalism, and what benefits or dangers those could have for the economy.
— Any sign of Greece's debt problems spilling over to other weak countries in the euro zone. The spread on Italy's 10-year Treasury bonds compared with German bunds widened to nearly 100 basis points at the end of January as concerns over Greek debt and other European weak links mounted. By early April it had fallen back to below 80 basis points, compared to a euro lifetime high of over 450 basis points for Greek bonds on Thursday. (One basis point is equivalent to 0.01%, or one-hundredth of a percentage point.)
— Any sign that the main rating agencies are unhappy with the pace of deficit and debt cutting, or that they may lower their outlooks for Italy. Standard & Poor's currently has a A plus sovereign rating on Italy, Moody's has Aa2 and Fitch has AA negative.
— Any indication that growth will undershoot targets or that the borrowing requirement is widening more than expected.
— Any sign that demand for Italian bonds is faltering. Italy is relatively less vulnerable to market speculation because only 42 percent of its public debt is in foreign hands, compared to 77 percent for Greece and over 80 percent for Portugal, according to data from end 2009. Economy Minister Giulio Tremonti said in January Italy would have to issue debt for around 485 billion euros this year.
Tremonti has been credited with steering Italy through the crisis with limited damage to its public finances by resisting calls for tax cuts and big stimulus measures.
A strong showing by the Northern League, which backs Tremonti, in last month's regional elections has bolstered his position within the government, although some of his cabinet colleagues resent his firm hold on the purse strings.
What to Watch:
— Any sign that Tremonti's position is in danger — he was ousted by coalition infighting during Prime Minister Silvio Berlusconi's previous administration in 2004 — or that he may be falling out with Berlusconi, whose election platform includes pledges to cut taxes. There's no obvious candidate to replace Tremonti, and Bank of Italy Governor Mario Draghi — a well respected figure who would please markets — has his sights set on the ECB presidency.
The prospect of three years without major electoral tests and a big majority in parliament means the government has a rare window of opportunity to carry out overdue structural reforms. However its track record on this front is not promising and its immediate priorities — overhauling the judiciary and the constitution — would not address Italy's key economic problems. The kind of reforms economists say are mostly needed would aim to lower public spending to allow tax cuts, make the labor market more flexible to increase chronically low employment rates, cut red tape, invest more in R&D and infrastructure and raise the retirement
What to Watch:
— Any signs of friction within Berlusconi's coalition. The Northern League's gains in the regional elections have put fiscal federalism — essentially devolving taxation and spending powers to regions — back at the top of the government agenda.
The League wants to stop the rich north bankrolling the poor and corrupt south but that puts it at odds with the interests of southern-based political forces, such as lower house speaker Gianfranco Fini's right-wing powerbase.
— The risk of social unrest has been limited so far. But rising unemployment, a fall in households' incomes in 2009 which the national statistics office says is the worst since the 1990s and the crisis of small and medium businesses in the northeast — the backbone of Italy's economy — are fueling discontent.
— Berlusconi's legal woes, which have so far absorbed the government's energies in trying to restore his immunity from prosecution at the expense of any determined economic agenda. New investigations or setbacks to his attempts to stay out of court could further delay any serious attempt at reforms.
The Race to Succeed Berlusconi
A turbulent year, marked by sex and corruption scandals, has hit Berlusconi's popularity — though it is still high at around 45 percent. Behind the scenes, the race to succeed the 73-year old media tycoon has started with Fini and Tremonti seen as possible front-runners.
What to Watch:
— Any signs of internal bickering within Berlusconi's coalition — particularly more criticism of government policies by Fini or increasing demands for power by the League.
The next national election is in 2013 and Berlusconi is likely to stay at the helm until then, but the mayoral ballot for the city of Milan, Italy's financial capital, in 2011 is a potential flashpoint for his government, as it is likely to put his PDL party up against the League. Italy has a history of political instability so a change of government would probably not spook markets, or in any case not for long.
Tremonti has gained a lot of credibility over the past year for his fiscal prudence, but he is also a vocal critic of globalization. Fini has a higher political profile. His ideas on the economy are less well-known but his party's roots are nationalistic.
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