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May 1 (The following statement was released by the rating agency)
The formation of a new government is positive for Italy,
but the sovereign has very limited fiscal headroom and the coalition government
may not be strong enough, or last long enough, to deliver the structural
economic reforms needed to increase trend growth, Fitch Ratings says.
The coalition's broad base and large majorities in confidence votes in both
parliamentary chambers should enable a resumption of proactive policy making
after a two-month hiatus. It draws support from the centre-left Democratic
Party, the centre-right People of Freedom Party, and members of former Prime
Minister Mario Monti's Civic Choice party.
But the fragility of the new left-right coalition limits the scope for
meaningful reform that could raise Italy's low potential GDP growth. Prime
Minister Enrico Letta has committed the new government to electoral reform and
measures to tackle youth unemployment, but major structural economic reforms may
The recession in Italy is one of the deepest in the eurozone and so far there
are hardly any signs of a recovery. Furthermore, the medium-term potential
growth rate of the Italian economy is low even by European standards; Fitch
estimates it to be around 1%.
Letta's first outline of his government's programme, in a speech to Parliament
on Monday, lacked important detail on how major tax reductions will be funded. A
planned suspension of June payments under the country's recently introduced
housing tax ahead of a broader review of property taxes, combined with the
abolition of a 1pp VAT increase in July, would reduce revenue by around EUR6bn
Letta did not specify what, if any, measures would offset the lost revenue, but
he did say the new government was committed to meeting its budget commitments
and controlling the public finances. It will also be fiscally bound by the
Fiscal Compact and last year's constitutional amendment requiring the government
to achieve a balanced structural budget by 2013.
We would anticipate more detail in the coming weeks. Meanwhile, in its 2013
Stability Programme the previous government forecast a budget deficit of 2.9% of
GDP in early April 2013, including around 0.5pp contributed by government
arrears payments to boost domestic demand, while reiterating the commitment to
keep the deficit below 3%. This illustrates that despite substantial progress on
consolidation, Italy has very limited fiscal headroom. As we said when we
downgraded Italy to 'BBB+' with a Negative Outlook on 8 March, economic and
fiscal outturns that reduced confidence that public debt would be placed on a
firm downward path from 2014 after peaking this year would increase pressure on
the sovereign rating.
Letta's speech also outlined some initial reform proposals to boost employment
and growth, such as reducing hiring tax for young employees. This emphasis on
reform is encouraging, but making the Italian economy sufficiently flexible to
boost trend growth remains challenging. On labour law, for example, it is not
yet clear whether the previous administration's reforms have been effective, and
Letta's speech did not refer to liberalising closed professions.