S&P Downgrades Italian Sovereign Debt Rating; Fear of Contagion Spreads

The U.S.-based ratings agency Standard & Poor’s has downgraded Italy's sovereign debt rating by one notch to A from A+, citing the country’s weak growth prospects and the government’s inadequate response to the eurozone debt crisis.

Although the Rome government recently approved a 54 billion euro ($74 billion) austerity budget, S&P complained it was insufficient to meet the country’s fiscal problems.

We believe the reduced pace of Italy's economic activity to date will make the government's revised fiscal targets difficult to achieve, S&P said in a statement.

Furthermore, what we view as the Italian government's tentative policy response to recent market pressures suggests continuing future political uncertainty about the means of addressing Italy's economic challenges.

S&P also said that budget’s plan to raise taxes even further would choke off growth.

Moreover, a downgrade in Italy raises fears that Greece’s economic meltdown has already spread across the Mediterranean to Italy and Spain.

Spain, Ireland, Portugal, Cyprus and Greece have also seen their credit ratings cut.

Italian Prime Minister Silvio Berlusconi described the move as being influenced by political considerations and did not reflect economic realities.

“The valuations of Standard & Poor’s seem dictated more by newspaper speculation than by reality, and appear influenced by political considerations,” Berlusconi’s office said in a statement.

S&P also blasted Italy’s political and social institutions as being part of the problem.

Even under pressure, Italian political institutions, incumbent monopolies, public sector workers, and... unions impede the government's ability to respond decisively to challenging economic conditions, the agency said.

It is unclear what can be done to break the deadlock between these political institutions and the government.

S&P also reduced its forecast for Italy’s economic growth to a 0.7 percent annual average for 2011 to 2014, down from a previous projection of 1.3 percent

Reportedly, another credit agency, Moody’s, may follow suit and also lower its rating on Italy.

However, European equity markets appear to have shrugged off the downgrade – major indices are up between 1.1 percent and 2 percent in mid-day trading.

A BBC correspondent in Rome, David Willey, commented: “The country desperately needs some strong measures. And in the opinion of Standard & Poor's, it isn't getting them. It is going to be a rather bleak autumn and winter: cuts in social services, cuts in transport and rising prices, including a one percentage point rise in [value-added tax] last week.”

Willey added: “There is an atmosphere of widespread dismay that the government's so-called austerity program doesn't seem likely to bite. Nor does it deal with two factors which color the Italian economic situation: namely, the government's inability to deal decisively with widespread tax evasion at all levels, and the general lack of stimulus that it gives to the economy. This is a country that has been stagnating under the leadership of Prime Minister Berlusconi for years now and doesn't show any signs of improvement.”

While Berlusconi’s government envisions balancing its budget within two years, Rome is also expected to reduce its GDP growth forecast this year to 0.7 percent from 1.1 percent.