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Boston, MA -- (SBWire) -- 08/01/2013 --Following the February 2013 general election which resulted in a clear voter rejection of austerity, the coalition has pledged to do more to spur growth, implying an end to further fiscal consolidation. Although this will support short-term GDP growth, it also means the pace of structural reform implemented under former prime minister Mario Monti will slow dramatically, and in some cases reverse.

Lack of significant reform anytime soon seriously jeopardises Italy's long-term growth trajectory, and raises the risks that the public sector debt burden will become unsustainable.

However, the very high public sector debt levels imply that Italy will eventually be forced to undergo a period of fiscal consolidation over the next decade, which will likely have negative implications for the country's social fabric, regional and global standing and governability.

Major Forecast Changes

Given the change in rhetoric and direction of the new government, who have already suspended an unpopular housing tax, we do not expect further fiscal consolidation in 2013. As such, we have revised our nominal budget deficit forecast from -2.0% of GDP to -2.9% of GDP. This reflects our view that the government will do just enough to stimulate growth while staying under EU deficit limits.

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We now forecast the Italian economy to contract by 1.5% in 2013, from our previous -1.3% forecast, as export growth has slowed and fixed investment in 2012 saw steeper declines than we anticipated.

Key Risks To Outlook

Given a fragile and contentious government coalition, the main risk to our forecast stems from the potential for renewed government instability. Furthermore, there is the potential for the government to overreach in its attempts to stimulate economic growth, creating a visible deterioration of fiscal accounts. Both of these scenarios would potentially create a crisis of investor confidence that would necessitate decisive fiscal consolidation to protect debt sustainability. This would severely damage the outlook for investment and consumption, necessitating a downward revision of our growth forecast.

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