Moody's Investors Service on Friday downgraded Italy's credit rating by two notches, citing contagion risk from Greece and Spain, higher funding costs and a deteriorating economic outlook.
Italy's government bond rating was cut to Baa2 from A3. The agency maintained the 'negative' outlook on the rating, citing "substantial" risks to implementing the planned fiscal reforms.
"Italy is more likely to experience a further sharp increase in its funding costs or the loss of market access than at the time of our rating action five months ago due to increasingly fragile market confidence, contagion risk emanating from Greece and Spain and signs of an eroding non-domestic investor base," Moody's said in a statement.
It said that the risk of a Greek exit from the euro has risen and the Spanish banking system will likely experience greater credit losses than anticipated.
In addition, Italy's near-term economic outlook has deteriorated, as manifest in both weaker growth and higher unemployment. Moody's now expects real GDP to contract 2 percent in 2012.
This has created risk of failure to meet fiscal consolidation targets, Moody's said, adding that this, in turn, could weaken market confidence, raising the risk of a sudden stop in market funding.
The government now expects to achieve a nominal balanced budget in 2015, two years later than it expected when adopting a package of fiscal adjustment measures in December 2011.
According to Moody's, the implementation of planned reforms also faces considerable challenges as the deteriorating macroeconomic environment could add to austerity and reform fatigue among the population. Also, the political climate, particularly as the Spring 2013 elections draw near, is another source of implementation risk, it noted.
Earlier this month, the Italian government approved 4.5 billion euros in spending cuts for this year, with an aim to reduce the size of the public sector and to delay an increase in sales tax until the first half of 2013.
The government also plans to save 10.5 billion euros in 2013 and 11 billion euros in 2014 by reducing expenditure.
The Italian economy remained in recession in the first quarter of 2012 with the gross domestic product contracting 0.8 percent quarter-on-quarter. The GDP fell for a third consecutive quarter.
However, Italy's cost of borrowing for one-year funds declined sharply at a debt auction on Thursday, indicating that investor sentiment improved after the latest EU summit and the announcement of Spain's new austerity package.
by RTT Staff Writer
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