As Italy gets ready for a new budget, some experts are preparing for the worst

  • At the moment, there is no clarity on how the right-wing Lega and the leftist Five Star Movement (M5S) will put together a budget that will raise pensions and the available income for households.
  • Ahead of the presentation of this crucial budget, the Italian government is embroiled in new controversy after a bridge collapse in the city of Genoa last week.
Italian Interior Minister Matteo Salvini speaks during a statement after a bilateral meeting prior to the European Union member states' interior and justice ministers conference on July 11, 2018 in Innsbruck, Austria. 
Andreas Gebert | Getty Images News | Getty Images
Italian Interior Minister Matteo Salvini speaks during a statement after a bilateral meeting prior to the European Union member states' interior and justice ministers conference on July 11, 2018 in Innsbruck, Austria. 

Italy has now turned into the weak link of the euro zone and market participants shouldn't rule out the possibility of a debt crisis further down the road, one economist told CNBC Wednesday.

Traders are increasingly wary of developments in Italy, where a recently established populist coalition has vowed to spend more, despite carrying the second largest public debt pile in the euro area. The government is currently preparing its budget plans for 2019 — the first time for this new government— in what will be a key test for investors.

"We have to see how the government does its fiscal numbers, it they don't add up by the end of September, things could indeed get somewhat rough for Italy," Holger Schmieding, chief economist at Berenberg, told CNBC's "Squawk Box Europe."

At the moment, there is no clarity on how the right-wing Lega and the leftist Five Star Movement (M5S) will put together a budget that will raise pensions and the available income for households. The fiscal plans are likely to deviate from previous commitments with Europe, but analysts are questioning how big the discrepancies will be.

"This grave uncertainty about the fiscal plans is a significant rollback for Italy because it does mean that down the road, an Italian debt crisis — (which) would look pretty unlikely a year ago — is now a possibility," Schmieding said.

Under previous governments, Italy approved new labor laws as well as constitutional changes, which were welcomed by market watchers. Issues with certain lenders, including Banca Monte dei Paschi di Siena and its bad loans, were also fixed.

The Italian flag waves over the Quirinal Palace in Rome, Italy May 30, 2018.
Tony Gentile | Reuters
The Italian flag waves over the Quirinal Palace in Rome, Italy May 30, 2018.

However, several years of sluggish growth and a migrant crisis supported the rhetoric of the two populist parties in the general election in March.

The M5S and Lega have since then spooked investors on several occasions — once with comments on requesting debt forgiveness, then with promises to renegotiate fiscal targets with the European Union.

The main market fear is that the new government will increase the public debt pile, which is already way above the European threshold of 60 percent of its gross domestic product (GDP). Rome's government debt stands at 130 percent of GDP, just below Greece's.

Credit ratings agencies are due to present their latest opinions on Italy in the coming weeks. Italian debt markets could see fresh turmoil if these outlooks prove negative on what the government is doing, analysts have told CNBC.

On Monday, Deputy Prime Minister Matteo Salvini said the government will stand up against any market attacks or debt downgrades.

Political saga over Genoa bridge collapse continues

Ahead of the presentation of this crucial budget, the Italian government is embroiled in new controversy after a bridge collapse in the city of Genoa last week, killing more than 40 people.

The two populist parties blamed Autostrade — the company in charge of the road, for not ensuring its stability. At the same time, M5S has been criticized for its comments back in 2013 that the bridge didn't need repairing. Meanwhile, Lega has been told off by the European institutions for blaming the incident on the lack of funding from the EU, which the institution has proven to be factually incorrect.

Shares of Atlantia fell 25 percent last Thursday after the Italian populist government said it would remove the concession to the company, which is responsible for 3,000 kilometers of toll roads in Italy, about half of the total amount.

Atlantia has offered 500 million euros ($507 million) in initial funding to support the victims.

"We think that probably the total costs for the company could be higher than the 500 million (euros) that they have already pledged, this could be just an initial payment for all the damages and for helping the city of Genoa to solve the crisis in the short term," Matteo Radaelli, equity analyst at Hammer Partners, told CNBC's "Squawk Box Europe" Wednesday.

"The total costs could be higher and it could reach at least 2 billion euros between damages and the rebuilding of the bridge," Radaelli said, adding that "this sum of money is clearly manageable for the company."

"If we don't consider the scenario of the removal of the concession, 2 billion (euros) is just two years of net income for the company."