Italy hit by market fears of contagion from Spain

[June 13, 2012]  MILAN (AP) -- Italian Premier Mario Monti saw nearly seven months of confidence-building by his government wiped out by Wednesday, when a debt auction showed the country's borrowing rates were back near levels last seen in December.

A sale of 12-month bonds, a warm-up for Thursday's weightier long-term debt auction, demonstrated the speed with which market jitters spread from Spain following Madrid's weekend concession that its banks need a bailout.

Italy paid an interest rate of 3.972 percent -- up from 2.34 percent in a similar auction last month -- to borrow (EURO)6.5 billion ($8.12 billion) in 12-month money from bond markets. Though demand was strong, the high rate suggests investors worry Italy may need a rescue of its own if Spain takes one.

`'Contagion is back with a vengeance, and Italy is bearing the brunt of the fallout from Spain's request for external assistance," sovereign debt expert Nicholas Spiro said. Markets, he noted, are no longer differentiating fiscally-stronger Italy from Spain, `'which is a sign that panic has set in."

Just before the sale, Monti urged lawmakers to speed the pace of reforms in a bid to persuade skeptical investors -- whom he referred to as "observers that don't nurture an innate sympathy for our country"- that Italy was willing to make the necessary sacrifices to escape the debt crisis.

Although Italy's deficit is relatively low, at 3.6 percent of GDP compared with Spain's 8.5 percent, the economy is not growing and overall debt is huge, at (EURO)1.9 trillion ($2.4 trillion). To lower that debt, the economy needs to become more competitive.

That has been Monti's task since taking office in November. His technocratic government passed a package of tax hikes and spending cuts in December, and has been moving ahead with structural reforms but has found resistance from both lobbies and politicians alike.

One of investors' biggest concerns is that Italy's notoriously divisive political parties, which have officially declared bipartisan support for the government, will hold up the reforms. In a worst case scenario, they could even stop backing the government, forcing Monti to call early elections without having completed his task of overhauling the economy.

After enjoying months of strong support, Monti's government has recently started to face political headwinds.

A labor reform package was passed by parliament only after being watered down, allowing judges to order companies to reinstate workers fired for economic reasons and softening limits on short-term workers. An important pension reform, meanwhile, has yet to be finalized as the government and the state pension agency quibble over the numbers of workers affected by key changes.

As Italy saw its bond yields rise this week amid concerns over Spain and the wider 17-country eurozone, the Austrian finance minister suggested Italy may also eventually need a bailout. She quickly backtracked on the remarks, however, after Monti and other European officials criticized them as inappropriate and counterproductive.

Monti firmly denied Italy will need outside assistance to keep up with payments on its debt, noting Wednesday that public finances are on much better footing than a few months ago.

He warned, however, the country's political forces needed to stay the course on reforms or risk having European authorities impose them upon the country.

`'The efforts that Italians have made and are making are difficult, but it would be even more difficult to accept, and the sense of alienation and frustration would be greater, if these forces were dictated" from outside, Monti told lawmakers ahead of a vote on anti-corruption measures .

Monti met Wednesday evening with leaders of the main political parties to urge them to speed passage of reforms.

He also made it clear that a broad European action plan is needed to avoid a spread of market panic from Spain to other countries like Italy, calling for concrete measures to be agreed at a June 28 EU summit.

Monti backed measures such as eurobonds, jointly issued European debt that would spread risk across countries, but which Germany has adamantly opposed. He said they would not need to be introduced this year, but should at least start being planned.

[Associated Press; By COLLEEN BARRY]

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