The FT this morning has a piece about the looming battle over next years budget:
Romano Prodi, Italy's prime minister, struggled on Wednesday to keep intact his planned deficit-cutting 2007 budget as moderates and leftwingers in his ruling coalition fought each other over his proposals to slash public spending.
Communists and other radicals insisted they would not endorse cuts in expenditure on schools and local government, while centrists voiced concern that the budget was drifting in the direction of higher taxes rather than spending cuts.
Bloomberg also covers the story.
As the FT also points out:
Italy's budget, due for cabinet approval on Friday, is the country's most important since it joined the eurozone in 1999, because the nation's public finances and international competitiveness have significantly deteriorated over the past eight years.
So 2007 is going to be a very hard road for Italy to travel. In some ways the moment of truth time is coming. Again the FT:
"Italy remains at risk of seeing its sovereign debt downgraded by credit rating agencies if its forthcoming budget is not rigorous enough."
Really it is very hard to just at this stage the importance of this threat. Much more than the credit rating agencies it is the response from the ECB which will be important if Italy fails to keep to the terms of the new version of the Stability and Growth Pact. Last year, we should remember, the ECB asserted that it would not accept government paper (bonds) in the future from any country which has not maintained at least an A- rating from one or more of the principal debt assesment agencies. So the threat may not be a hollow one, since if the ECB stop treating Italian paper at par, then this could easily, in and of itself, send Italy off on a default path.
These are not little issues.
Precisely for this reason I am rather sceptical that the ECB would be in any rush to actually carry out its threat. News from Japan though suggests that the climate may be changing. Japan, as is reasonably well known, also has a rapidly ageing population and a large government debt problem. In principle Japan was programmed to take some important steps (like Germany) to begin to correct the situation. The election of Shinzo Abe as prime minister has begun to put question marks over this process, and Standard and Poors have not been slow in reacting:
Japan may slow the pace of fiscal reforms under its new Prime Minister Shinzo Abe, ratings agency Standard & Poor's said on Wednesday, a day after he formed his new cabinet with a "no growth, no fiscal consolidation" policy.
The ratings agency questioned Abe's preference for growth policies over fiscal consolidation, saying his stance may lead to a deceleration of the pace of fiscal consolidation.
S&P currently has a positive outlook on Japan's rating.
But the direction of the sovereign rating depends largely on Abe's government's ability to pursue public sector reform pushed by his predecessor, the agency said.
"The two biggest constraints on the rating are Japan's fiscal position, which though improving remains weak, and its outstanding debt," said the report.
"Critical factors are therefore the pace of fiscal consolidation, the stability of the Japanese government bond market, and interest rates," it said.
Citing Japan's aim to achieve primary account balance in fiscal 2011 through spending cuts and revenue increases, the agency said how the new government meets the target is a major issue for the future direction of the sovereign rating.
So I would say that the issue of sovereign debt is now well up and over the radar, and that the agencies will be serious about downgrades.
The big problem is that EU institutions cried wolf for so long about the Stability and Growth pact that they have been left with a credibility problem. This has been doubly undesireable since it meant that during the relatively good years of 2002-2006 many countries were running deficits when they should have been aiming for balance or even - god forbid - surplus. Now the headwind may have changed, and may well be about to turn negative. The next two or three years ,may well be much harder than the last two or three.
I know that this view seems to go against the prevailing wisdom, but frankly many of the people making the 'euro growth engine call' simply haven't been thinking about the demographic dynamics of the situation. Claus Vistesen has been admirably covering all this, and a very useful point of entry is this post.
So the real question we are left with is what exactly is to be done? This is a very hard question, and I don't have any simple answers handy in my back pocket to pull out at the appropriate moment. Clearly Italy needs to move onto a sustainable fiscal path. It also needs to attach itself firmly to the EU Lisbon Reform agenda, and generate a consensus among the Italian population that the reforms are needed by getting across to the Italian people just why they are needed.
Naturally the political class in Italy isn't exactly an asset here.
Immigration undoubtedly forms another part of the picture, but this immigration (which is largely unskilled) needs to be coupled with an expanison of the high value services and new technology business sectors, so that a labour market environment can be created where the best of Italy's young talent can find work appropriate to their abilities, and thus help pull Italy out of this mess.
Over the summer I saw a film from the Italian director Paolo Virzì entitled Caterina va in città. The plot is summarised as follows:
When her father, Giancarlo (Sergio Castellitto) is transferred to Rome from the small country town of Montaldo Di Castro, Caterina (Alice Teghil), a 12 years old girl, discovers her new classmates, a totally new world, an ambient extremely divided politically. She starts developing her friendship with the "left side", represented by Margherita(Carolina Iaquaniello), and the right, Daniela (Federica Sbrenna) side of her class. She will lose herself, without knowing who she really is.
This is the problem I think, an ambient which is extremely divided politically where young Italians do not know 'who they really are'.
Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.