Italian Elections Backdraft

At the time of writing Berlusconi is still filibustering, but it seems to be that, rather than any serious attempt to question the outcome of the electoral process. Meantime the financial markets are realigning themselves:

Italy Ratings

The yield gap between Italian and German 10-year bonds earlier widened one basis point to 31 basis points after Romano Prodi claimed victory in Italy's closest election since World War II. Prime Minister Silvio Berlusconi demanded a recount.

Goldman Sachs Group Inc. last week recommended investors avoid bonds sold by Italy, the euro region's second-most indebted nation, because slowing growth means the country's credit rating may sink. Moritz Kraemer, head of European sovereign ratings at Standard & Poor's in London, said at a Feb. 8 press conference the company will judge whether to lower Italy's rating after a new government is formed.

``The prospect now for any reform of Italy's public debt must be close to zero,'' Marc Ostwald, a fixed-income strategist at broker Monument Securities Ltd. in London, said in an interview. ``I wouldn't want to hold Italian bonds until they get to a spread that acknowledges those risks, and they certainly don't at the moment.''

The Financial Times also takes a very realist stance:

As the nervous excitement mounted on Monday in Italy’s general election, it fell to Standard & Poor's, a credit ratings agency, to strike a sober note of realism. Half an hour after the first exit polls predicted triumph for Romano Prodi – a forecast later overtaken by events – S&P warned that it might cut Italy's long-term credit rating this year “unless there are signs of a sustainable and coherent strategy to reduce the public debt”.

It was a reminder of the hard work that lies ahead for the next government, whatever its political complexion.

S&P cut Italy's rating to AA- in July 2004, making it the first eurozone country to suffer this humiliation. Last year the Italian debt rose to 106.4 per cent of gross domestic product, its first increase since 1994.

Moreover, Italy's budget deficit climbed last year to 4.1 per cent of GDP, and the centre-right government disclosed during the election campaign that it was raising this year's deficit forecast to 3.8 from 3.5 per cent.

The challenge that now faces Italy is how to restore discipline to the public finances, when it seems unlikely that either Mr Berlusconi’s centre-right coalition or the centre-left opposition will have legislative majorities commanding enough to force cuts in public expenditure.