STRATFOR -- Italy: Damaging the Eurozone's Credit
Summary
Standard & Poor's has put Italy on notice that, unless its finances improve, it could suffer another reduction in its credit rating. The threat is neither idle nor overblown; Italy is dragging down the creditworthiness of the entire eurozone.
Analysis
Credit rating agency Standard & Poor's (S&P) reduced its outlook for Italy from stable to negative Aug. 8, citing high and rising government budget deficits and national debt. Credit ratings determine how much it costs for governments to borrow money on the open market -- something particularly important for states like Italy that suffer from high public debt. A lower credit rating would hurt not only Italy, but the entire European Union, as EU member countries are economically too interconnected to escape the reverberations.
Italy sports a budget deficit of 4.3 percent of gross domestic product, well in excess of the 3 percent ceiling that states who use the euro are supposed to remain under. S&P lowered Italy's rating to AA in 2004 for similar -- and as-yet-unaddressed -- concerns. S&P is also looking ahead to a red-ink-filled future, noting in its outlook that, "A general election must be held by May 2006 and neither of the two main political groupings has presented a cohesive strategy to address budgetary imbalances."
When the euro was formed, the idea was that everyone would lash themselves to Germany's rock-solid economic performance and fiscal management. At first it worked extremely well, and Europe echoed with celebrations and champagne corks as credit ratings rose across the Continent. The German association translated into easier credit terms, greater liquidity and increased wealth and economic activity.
But as German strength gave way to German weakness, Berlin became one of the first states to violate the (German-designed) eurozone fiscal guidelines. The result was a cascade of similar bad behavior elsewhere, with the Italians, Greeks and Portuguese among the worst performers. But unlike Germany and France, whose national debts were under relative control, Italy's was already massive. And unlike Greece and Portugal, who each make up less than 1 percent of the eurozone's total bulk, Italy's trillion-euro economy has some real heft to it.
The unifying effects of the euro are now working in reverse. Instead of German strength helping all ships rise, fiscal laxity -- of Italian flavor in this case -- is dragging all ships under.
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