Italy downgraded amid IMF warnings on world economy

Updated On: Sep 21, 2011

Standard and Poor's (S&P) has downgraded Italy's credit rating, cutting it from to A/A-1 from A+/A-1+ and kept Italy's outlook negative.  Analysts, alluding to poor growth prospects and political uncertainty, said the downgrade did not bode well for the global economy and would add to further stresses on European banks amid slow-moving talks to avoid a Greek default.

The International Monetary Fund (IMF) remarked that Europe's leaders were failing to act decisively enough to resolve the crisis. "There is a wide perception that policy-makers are one step behind markets," IMF chief economist Olivier Blanchard said. "Europe must get its act together."

Italy's downgrade dampens news of progress in Greece's negotiations with international lenders to avoid running dry of money within weeks, with an official from the Greek Finance Ministry saying on Tuesday that Athens has agreed to front-load austerity measures and is close to concluding a deal with international lenders. Brazil was also reportedly willing to contribute $10 billion to Europe through the IMF.

Italian Prime Minister Silvio Berlusconi said the downgrade "did not reflect reality" and his government was readying measures to promote growth. The Italian government, under pressure to cut debt, pushed a €59.8 billion austerity plan, consisting of tax hikes and spending cuts, through parliament the week before, and promised a balanced budget by 2013. But the plan has inspired little confidence that it would be able to tackle Italy's fundamental problem of stagnant growth.

Europe has come under mounting pressure to resolve its financial crisis that has seen sovereign rating downgrades and rescue packages for Greece, Portugal, and Ireland. An additional bailout of Italy is likely to overwhelm euro zone resources.

Analysts said the crisis should be addressed by policy makers, starting with the US. However, it is noted that the US had pressured euro zone leaders to take more decisive action, but received a cool response.

Report: Italy downgraded, IMF says Europe behind the curve (Reuters, 20 Sep 2011)

The IMF's Blanchard added that the European Central Bank (ECB) must keep Italian debt rates low to ensure the integrity of the Italian economy, which is Europe's fourth-largest. "If Rome implements declared budget measures, Italy should remain solvent," Blanchard said "If for some reason, the markets start to believe Italy's debt is not sustainable and start asking for eight, nine or 10% interest rates, then it's clear that Italy's debt is unsustainable."

The IMF has cautioned in its economic outlook that if Europe's policy makers do not act swiftly enough to resolve the European sovereign debt crisis, the Western economies could enter a deep recession. It warned that if growth in Italy was 1 percentage point below its prediction, the Italian debt-to-GDP level could shoot up to 140%, about the same level that of Greece's is expected to peak at.

Report: UPDATE: IMF Urges ECB To Keep Italian Borrowing Rates Down (Wall Street Journal, 20 Sep 2011)

Blanchard has warned that the world economy has entered a "dangerous new phase". "The recovery has weakened considerably. Strong policies are needed to improve the outlook and reduce the risks," Blanchard emphasized.

According to the IMF, the US economy is expected to grow only 1.5% this year and 1.8% in 2012, down from the IMF's June forecast of 2.5% in 2011 and 2.7% in 2012. To achieve the newly predicted level of growth, the US economy would still need to expand at a much quicker speed in the second half of the year than its 0.7% annual growth during the first six months.

The IMF also lowered its outlook for the euro zone, forecasting 1.6% growth in 2011 and 1.1% in 2012, down from its June projections of 2% and 1.7% respectively. "Markets have clearly become more sceptical about the ability of many countries to stabilise their public debt," Blanchard said.

Overall, the IMF projects global growth to be at 4% for both years, with stronger growth in China, India, Brazil and other developing countries to offset the weaker growth in developed countries.

Report: World economy enters 'dangerous new phase': IMF (Straits Times, 21 Sep 2011)

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