Italy’s S&P Threat May Fan Contagion as Greece Presses Cuts

By Lorenzo Totaro and James Hertling
May 23 (Bloomberg) -- Standard & Poor’s threat that it may cut Italy’s credit rating risks fanning contagion among debt- laden European countries as Greece fends off speculation that it’s headed to a restructuring.
Italy’s Treasury said two days ago that it will “intensify” structural changes and push ahead with measures to balance the budget by 2014 after S&P said its A+ debt rating was at risk of a downgrade. Greek Prime Minister George Papandreou is set to brief his Cabinet today on added budget cuts and asset sales to keep the aid flowing. The yield on Italy’s 10-year bond rose 9 basis points to a three-week high of 4.87 percent.
More than a year after European policy makers approved a 750 billion-euro ($1.1 trillion) bailout blueprint to stem the sovereign crisis, bond yields in debt-laden peripheral countries are at record highs and officials are floating plans to extend Greek repayments. Hours before the S&P warning about Italy, Fitch Ratings cut Greece three grades and said it would consider an extension of maturities as a default.
“In isolation this is not a major event and under normal circumstances I would not expect it to have a significant impact upon the market,” said Gary Jenkins, head of fixed-income at Evolution Securities Ltd. in London. “However, these are not normal times.”

Euro Declines

The euro touched a record low against the Swiss franc today and the fell to the lowest in a week against the dollar as concern over Europe’s sovereign debt crisis deepened. The euro slipped to an all-time low of 1.2349 francs before trading at
1.2394 as of 7:45 a.m. in London from 1.2425 last week. Europe’s shared currency dropped to $1.4050 from $1.4161 on May 20.
Italy had its credit-rating outlook lowered to negative from stable by Standard & Poor’s, which cited the nation’s slowing economic growth and “diminished” prospects for a reduction of government debt, according to an S&P statement on May 20. S&P affirmed Italy’s A+ long-term rating, the fifth- highest, and its top-ranked A-1+ short-term rating. The rating company last cut the nation’s credit rating in 2006.
“With regard to the economy, the government has initiated and will intensify its reforms; in regard to the budget, a phase of measures are in advanced preparation in order to balance the budget by 2014,” the Treasury said May 21 in an e-mailed statement from Rome. It also said the measures will be submitted to the Parliament for approval by July.

Borrowing Costs

Italy’s budget deficit was 4.6 percent of gross domestic product last year, lower than that of France and less than half of Greece’s shortfall. Its debt, though, reached almost 120 percent of GDP, twice the European Union limit, and fallout from the region’s sovereign crisis is making it more costly to finance new borrowing. The extra yield that investors demand to hold Italian 10-year bonds over German bunds rose 13 basis points to 185, the highest in more than four months.
Italian economic growth was 0.1 percent in the first quarter, less than economists had forecast, as gains in exports failed to offset weak domestic demand. GDP in the euro region’s third-biggest economy won’t return to its pre-recession level for at least another two years, and it needs to raise productivity, the Organization for Economic Cooperation and Development said this month in a report.

S&P ‘Worried’

“Rating agencies don’t just look at what’s going on today, they also look at possible future developments, that’s the issue here,” said Nicola Borri, who teaches economics at Rome’s Luiss University. “How will Italy keep its commitments with no growth? Structural reforms are needed but no government Left or Right in the past 10 years has managed to undertake them. This is what S&P is worried about.”
S&P also warned that the “increased fragility” of Prime Minister Silvio Berlusconi’s ruling coalition could undermine implementation of fiscal measures needed to trim the debt.
Berlusconi has been weakened by defections of key allies and corruption allegations, and a setback in regional elections this month is further straining the unity of his government.
The Italian Treasury ruled out “absolutely” the risk of political gridlock and said Italy will keep all its economic commitments. It also pointed out in an e-mailed statement that S&P’s views are very different from those expressed by the International Monetary Fund, OECD and the European Commission.

‘Bottlenecks and Rigidities’

In Italy, “diminished growth prospects stem from what we consider to be a lack of political commitment to deregulating the labor market and introducing reforms to boost productivity,” S&P said. “We believe measures to reduce the bottlenecks and rigidities in Italy’s economy are especially important in light of Italy’s limited monetary flexibility.”
The negative outlook implies a one-in-three chance that Italy’s ratings could be lowered within the next 24 months.
Fitch on May 20 cut Greece’s long-term debt rating to B+, four notches below investment grade, and placed it on rating watch negative. Even a voluntary extension of the country’s bond maturities would be considered “a default event,” the rating company said in a statement. Greek 10-year bond yields surged to a euro-era record 16.6 percent.
In Athens, Papandreou will chair a cabinet meeting today to discuss his fifth austerity package since getting a 110 billion- euro rescue from the EU and IMF. The government is looking for ways to speed up plans to sell 50 billion euros of assets, the equivalent of about almost 25 percent of GDP. The meeting comes as a team of IMF and EU inspectors prepare to return to Athens this week to complete their review of Greece’s progress in meeting the bailout conditions.
Luxembourg’s Jean-Claude Juncker, who leads the group of euro-area finance ministers, endorsed an independent privatization agency to help sell off some of the government’s assets, Spiegel said, citing an interview with Juncker.