Snap Analysis: Italy austerity credible but backloaded

ROME Thu Jun 30, 2011 10:09pm BST

ROME (Reuters) - Italy's austerity budget approved on Thursday contains tough and credible deficit cuts but it is too backloaded, lacks structural reforms and may not impress markets and ratings agencies.

The package, which contains 47 billion euros ($66.7 billion)of deficit cuts to balance the budget in 2014, trims the budgets of central government ministries and local authorities and reduces tax breaks for companies and families.

Final details have not yet been announced but most of the package has been leaked in a series of drafts. The measures in themselves are largely convincing, but the vast bulk will only take effect from 2013, when the next election is due, and 2014.

Only around 7 billion euros of the cuts will come into effect before 2013.

"What we know is most of the measures will be postponed until 2013 and 2014, which is something that will probably not be much appreciated my markets," Citigroup's Giada Giani said.

"All other countries involved in fiscal consolidation have been trying to frontload rather than delay the tightening."

Unicredit analyst Chiara Corsa said bringing forward more of the deficit cuts to 2012 "would have been a stronger shield against market tensions and possible rating agency action."

Italy has kept its deficit in check better than most euro zone countries but that did not stop Standard and Poor's and Moody's cutting its ratings outlook in recent weeks.

The agencies focussed on Italy's political inability to pass the reforms needed to boost growth in the euro zone's most sluggish economy. And without growth, it has little chance of cutting its huge public debt, which at 120 percent of gross domestic product is one of the largest in the world.

REFORMS NEEDED

There is little in the budget plan to liberalise markets, reform the labour market or pass any other growth enhancing structural reforms.

"I don't think this package will be enough to stop Moody's cutting Italy's rating," said Gianluigi Mandruzzato of Banca BSI. Moody's said it would review the situation in September.

"It would have been better to see some reforms which may be unpopular but have no cost to the budget and can help growth."

Gilles Moec of Deutsche Bank agreed that the fiscal management was something Italy was already doing well, but this was no longer enough.

"The problem in Italy right now is not really the deficit, which is under control," he said. "The problem is the lack of growth, this is what is currently creating a certain level of stress about Italy."

The yield spread between Italian government bonds and safer German bunds has risen steadily and yields on Italian 10-year bonds auctioned on Tuesday hit their highest level since October 2008.

Italy posted growth of just 0.1 percent in the first quarter and the fourth quarter of 2010, compared with strong recoveries in its main peers, and Moec warned that its domestic demand was so weak that it could easily fall back into recession.