24/7 Wall St.

There is a negative change in the sovereign rating of an EU nation each week it seems. Greece was downgraded again by Fitch last week, by three notches to B+. It was nothing more than an acknowledgment of what the market already knows–Greece will restructure its debt or default. Some investors will be harmed in either case and the Greek economy may not recover for years.

S&P placed Italy on negative credit watch. Italy has not been in the same spotlight that the troubled nations of  Greece, Portugal, Ireland, or even Spain have been. The action on Italy is a sign that economic problems among EU nations are getting much worse quickly and the odds that Germany will participate in new bailouts has dimmed.  The agency changed its outlook on Italy’s sovereign paper from “stable” to “negative.”

S&P commented:

“In our view Italy’s current growth prospects are weak, and the political commitment for productivity-enhancing reforms appears to be faltering, and potential political gridlock could contribute to fiscal slippage,” Standard & Poor’s credit analyst Eileen Zhang said. “As a result, we believe Italy’s prospects for reducing its general government debt have diminished.”

It would be a mistake to view Italy as part of the “contagion” which is so often mentioned and feared as the sovereign debt crisis in the EU spreads. Italy’s paper has been considered safe by most capital markets investors because its economy has not fallen into the severe slump that has hit other southern European nations, and its debt load has not been considered particularly onerous. Italy’s fortunes stand mostly on their own in Europe. Politicians there have not been attacked for austerity programs. Sharp tax increases are not part of government deficit reduction plans.

If Italy’s financial house is troubled, it is probably because the global economic recovery has begun to sputter and the GDPs of some of the larger nations like the UK, France, and the US are in the early stages of being affected. Growth in the euro zone’s private sector fell more than expected to its weakest pace in seven months in May. Bond price contagion would not spread from weak EU nations to Italy, but it could start in Italy and spread to England and then across the Atlantic. The credit watch is on now for weaknesses in the bigger Western nations. Credit agencies have already expressed doubts about the medium-term prospects of the US and UK. The fight over the debt cap in Washington has not helped. The “political gridlock” that S&P sees in Italy is not restricted to Italy at all.

It is not often stated directly by the credit agencies, but social unrest in nations which need balanced budgets has grown. The austerity agreements made by prime ministers and national legislatures are increasingly being ignored by the people. Those officials who agree to bailout terms are more likely to be voted out of office. The US may be on that course

Italy has been warned, which makes it more likely to turn to budget cuts to maintain its sovereign paper rating. The US has problems that are not unlike Italy’s. They are just  on a larger scale.

Douglas A. McIntyre