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Moody's Downgrades Italy As Market Braces For EC budget Proposal Rejection

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The Italian government is reportedly bracing for the European Commission to reject its budget proposal on Tuesday. If this is the case, it will mark the first time in the history of the EU that the European Commission has had to ask a member state to revise a draft budget.

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Italian Aiming For Deficit Target of 2.4% of GDP

The proposal submitted by the Italian government last week outlines plans to increase spending while cutting some taxes, which in total would widen the country’s budget deficit to 2.4% of GDP, well above the prior 1.8%. While the 2.4% target is still within the EU limit of 3%, it does stand contrary to EU rules which outline that heavily indebted nations should focus on balancing their budget instead of increasing spending. At 130% debt to GDP, Italy is the second most indebted member state in the EU, behind Greece only.

The Italian government has come under heavy criticism from political leaders in the EU, Jean-Claude Juncker of the European Commission and also from external bodies such as the IMF. However, reaffirming its commitment to sticking to the promises made during the election campaign, the coalition government has been adamant in maintaining a 2.4% GDP target to allow for increased fiscal spending.

Italian Government Ready To Talk

Speaking with Italian radio this week, the Italian Deputy Prime Minister Luigi Di Maio told reporters that the government is ready and willing to “sit at the table” and discuss the country’s plans with the European Commission adding that he would send a letter to the group explaining the government’s reasons for the budget proposal.

Moody’s Downgrades Italian Credit Rating

The pressure is on, however, following the Moody’s credit rating downgrade on Friday which saw the rating agency cut Italy’s rating to the lowest investment level above junk. The situation gave important insight into the market’s perspective at the moment with Italian assets actually rallying in response to the news as most investors expected Italy to be downgraded to junk.

S&P To Follow Moody’s?

However, fears are growing over the fragility of Italian bank’s and the potential for Standard & Poor’s to follow with a similar or worse downgrade this week could cause heavy selling. The contagion fears around the Italian banking sector are what is really troubling the market, and should the European Commission reject Italy’s draft budget this week, these fears will intensify further which, given the current volatility seen in financial markets, could be terminally damaging for Italy.

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