Moody’s Warns Italy Over Debt as Eurozone Contagion Fears Spread

A rise in interest rates could make debt repayment harder for Europe’s fourth largest economy

A weekend warning by Moody’s about a possible downgrade of Italy’s bond rating brought shock to Italian stocks and raised further fears about Eurozone contagion.

The Milan stock exchange plunged by just over 2% on Monday after the credit rating agency placed Italy’s current Aa2 bond rating on review for a possible downgrade. Moody’s expressed concern about what rising interest rates might do to an economy that is struggling to recover from recession and burdened by heavy debt.

“Italy has so far only recovered a fraction of the nearly seven percentage points in GDP that it lost during the global crisis, despite low interest rates, which are likely to rise in the medium term,” Moody’s said in its announcement. A possible rate hike that the European Central Bank has signaled for July could further burden an economy struggling to extricate itself from structural impediments to growth.

In its warning, Moody’s expressed worry about Italy’s ability to adopt “conservative fiscal policies” at a time when the “government’s electoral support is weakening.”

A final reason Moody’s gave for the review was “the fragile market sentiment that continues to surround European sovereigns with high levels of debt.” A default by Greece or deepening problems in other peripheral areas of Europe risks spilling over to Europe’s core. Italy is a major economy, the world’s eighth largest, and one of Europe’s top four, after Germany, France and Britain.

Vincent Truglia (left), managing director of global economic research for Granite Springs Asset Management, and former head of Moody’s sovereign risk unit, told AdvisorOne he was not overly concerned about a Moody’s downgrade. “They’ve lived with worse ratings,” Truglia said, citing the A1 rating Italy had in the early ’90s. “Italy has had a history of having a very high debt-to-GDP ratio,” he said, noting the country still has time to improve its metrics.

For its part, the EU is now downplaying the idea of Euro-periphery contagion spreading to Europe’s Italian core, after early comments that may have inflamed market anxiety. Jean-Claude Juncker, Luxembourg’s prime minister and leader of the “Eurogroup” of Eurozone finance ministers, told reporters Italy was not even discussed in a lengthy meeting on Monday about terms of a bailout for Greece.

The European minister was backtracking from undiplomatic remarks made over the weekend that Italy and also vulnerable Belgium could be infected by the Greek debt crisis “even before Spain,” leading to extreme consequences. “We are playing with fire,” he had said.

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