Italy Other


Fears of contagion spread to Italy

Despite the approval of a EUR 70 billion austerity plan, the state of Italy's public finances remained under the scrutiny of financial markets in July. Concerns are spreading regarding the credibility of the fiscal adjustment and the sustainability of the country's public debt, which - at almost 120% of GDP - is the second largest in the Eurozone. The pressure on Italy's finances intensified during the trading session of 8 July, when yields on 10-year Italian bonds peaked at 5.37%, the highest levels since March 2002. Analysts and investors were sceptical that the deficit reduction of plan - originally envisaged to amount to savings of EUR 47 billion - would be sufficient to put the country back on the track of fiscal sustainability. In addition, lack of information regarding the details of the plan, disagreements among the members of the governing majority and the involvement of Economy Minister Giulio Tremonti in a corruption scandal cast a shadow on the credibility of the Italian government and its ability to pull through the necessary fiscal cuts. In response to market concerns, the government presented a beefed-up version of the austerity package to both houses of Parliament, which approved the modified plan on 14 and 15 July. The new set of measures entails total savings of EUR 70 billion, which is to be achieved over the next three years through spending cuts in healthcare, reduced funding to municipalities and extending the 2010 public sector wage freeze to 2014. Furthermore, new taxes were introduced on gasoline and trading accounts, in addition to co-payment for certain healthcare services. The timely approval of the plan was not enough to quell financial markets concerns. While bond yields fell briefly following the European agreement on a bailout program for Greece on 21 July, the sell-off of Italian bonds resumed thereafter and yields reached 5.89% by the end of the month. Going forward, political instability and, in particular, further investigations into Tremonti's case will likely put further pressure on Italy's risk premium.

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