The euro zone is undergoing serious socio-political fragmentation which could lead to further de-stabilization in the bloc, Nouriel Roubini warned Friday.
Speaking at the Ambrosetti Workshop in Italy, Roubini, renowned for his pessimistic economic forecasts said the political situation in Italy was a "tsunami" risk and was a reflection of the broader problems facing the currency bloc.
"In Italy there's the beginning of a political storm. The result of the Italian elections signal that the majority of people are against austerity and not just in Italy also in Lisbon half a million people were in the streets and 25 percent unemployment in Greece and Spain, 50 percent amongst young people and there is restlessness," Roubini said.
Italy's election last month failed to give any party an outright majority and so far the leading center-left bloc has been unable to muster up a coalition government.
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Roubini, the co-founder and chairman of Roubini Global Economics, added that the most likely scenario was for new elections in Italy within six months but this would bring economic gloom.
"In this time the economy will get worse given the political uncertainty, less investment, less job hiring and less consumption. There's a meaningful chance that the new [political] forces in Italy, whatever combination there is, these will be significantly against austerity and then we'll get a clash between Italy and Germany and the ECB," he said.
However, he said a replay of the Greece scenario which reached a crucial point last year with serious fears of a euro exit would not affect Italy because of its leverage within the euro zone.
"Italy is not Greece and it has leverage within the euro zone and can credibly threaten Germany by saying that if there is no loosening of conditionality things could become implosive and [it could potentially] exit from the euro zone," Roubini said.
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He added that with these factors brewing the ECB would'loosen up' policy within the next few months but this would not be enough to avert a crisis in Italy.
On Thursday, ECB President Mario Draghi sounded confident on Italy and failed to provide any reassurance to the markets. He said markets had reverted back to where they were before the elections and that Rome's fiscal adjustment would continue on auto pilot.
Echoing the negative outlook for Italy, however, Lorenzo Bini Smaghi, a former European Central Bank (ECB) board member and visiting scholar at Harvard University cautioned that financial markets were underpricing the risk of Italy.
"To some extent, the market doesn't really understand what's going on in Italy. They think that the government is going to be created in the next few days and have a majority but things are much more complicated."
Italian ten-year bond yields rose slightly after the elections on February 24 and 25, but have fallen back to levels seen before the polls in recent days. Meanwhile, European shares have brushed off worries over Italy, with the FTSEurofirst 300 rising 1.8 percent this week.
"Italy has not been growing for over 15 years and we are back to the GDP per capita levels that we saw in 1992 and 1993, so this is the worst performance in an advanced economy. This is because the [reforms to the]labor market, goods and products market and liberalization have not been done,"Bini Smaghi said.
"My fear is that immobility in the political sphere is going to create more economic woes than expected," he added.
According to him, investor sentiment could quickly become negative as reform measures are delayed, though the "market pressure has yet tocome."