Italy slashing budget to fend off debt crisis

Battered by rising borrowing costs and under the eye of other European governments, Italy’s Senate on Thursday upped the size of planned budget cuts in an effort to prevent the euro zone’s third-largest economy from slipping into the debt crisis that has already claimed three smaller nations.

As the Senate approved a $68 billion package of tax hikes and spending reductions, Finance Minister Giulio Tremonti warned that the problems facing the euro currency zone had become like “the Titanic, not even first class passengers will be saved.”

His comments underscored the anxiety felt throughout Europe and in Washington about the speed with which even a large and seemingly stable economy could be brought under the same type of pressure that has forced Greece, Ireland and Portugal to seek emergency help from their neighbors and the International Monetary Fund.

Thursday’s vote, which ratcheted up the amount of belt-tightening planned by the government, was meant as a forceful reassurance that Italy is serious about balancing its books in the next few years and beginning to reduce an outstanding pile of debt that is around 120 percent of annual economic output. The lower house of parliament is expected to approve the measures on Friday.

More than a year and a half after Greece’s still-unresolved crisis began, the issue of mounting government debt has become a political problem as much as a financial one — triggering dozens of urgent summits and profound changes in how Europe operates, but so far no conclusive response.

The fear is a sort of self-fulfilling prophecy: The lack of a convincing political response begets even deeper skepticism among investors and markets, causing the problems to worsen and spread to more countries. That, in turn, complicates the political debate over who pays for which country’s problems.

“You need to act quickly to restore confidence,” said Valdis Dombrovskis, prime minister of Latvia, a country credited with sticking to a tough round of wage and budget cuts during the 2008 crisis that helped restore it to strong economic growth. “To postpone the adjustment doesn’t lead anywhere,” he said.

The only thing that changed in Italy during the past week was the perception that Tremonti, known as a fiscal disciplinarian, was losing influence within the government. But that was enough to make bond investors question whether Italy had the political will to follow through with a multi-year plan to curb its prodigious borrowing. Bank stocks plummeted and interest rates spiked, with the country forced on Thursday to pay a record high of near 6 percent on its latest bond issues.

A continued rise in borrowing costs could push Italy down the same path as Greece, Ireland and Portugal — but at a far greater cost to those involved in any bailout, and at far greater risk to the regional and world economy.

“This was a very powerful demonstration of the sensitivity of the market, and I don’t think we will be rid of this kind of thing,” said Carlo Bastasin, an Italian economist and Brookings Institution analyst. “You have great uncertainty among the Europeans about the endgame for Greece, and all of a sudden Tremonti's position seemed wobbly.”

It was the type of small tremor that threatened to become a bigger one — to the degree that German Chancellor Angela Merkel, whose country has become a pillar of Europe’s economy and a primary funder of the different bailout programs, called Italian Prime Minister Silvio Berlusconi over the weekend and urged fast action lest financial “contagion” consumes Italy.

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