Political instability clouds Italy's recovery outlook-Bank of Italy

MILAN, July 20 Sat Jul 20, 2013 3:45pm BST

MILAN, July 20 (Reuters) - Political instability could undermine Italy's ability to exit its longest post-war recession, the head of the country's central bank said on Saturday.

"This is a critical phase," Bank of Italy governor Ignazio Visco told a Moscow meeting of ministers and central bankers from the Group of 20 nations.

"There is a stability issue, also from a political point of view, which affects the (country's) ability to pursue opportunities for recovery," Visco said according to quotes provided by his spokeswoman.

A failure to kick-start the Italian economy could dent Rome's chances of cutting a public debt which, at 130 percent of gross domestic product, is the second biggest in the euro zone after Greece.

The government survived a no-confidence motion against the interior minister on Friday, averting a crisis which could have brought down a fragile coalition formed only three months ago.

The Bank of Italy forecasts a contraction of Italian gross domestic product of 1.9 percent this year and expects a timid recovery to start at the end of the year.

Visco sounded more upbeat about the health of the Italian financial system but asked the country's lenders to further boost their capital base.

The results of a stress analysis conducted by the International Monetary Fund at the beginning of this year "showed the resilience of the Italian banking system against external shocks", Visco said.

"Of course capital base is fundamental and needs to be enlarged, but there are no sign of excessive concern" for the country's financial system, said the central banker.

The Bank of Italy forced the country's lenders to raise their provisions against bad debt some months ago as the long recession translates into an increasing burden of problematic loans for the banks.

The recent decision by Standard and Poor's to downgrade Italy's sovereign rating to 'BBB' was not consistent with the country's fundamentals, Visco said. (Reporting by Francesca Landini and Alessandra Prentice; Editing by Mark Potter)