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Berlusconi Uses Vague Promises to Battle Default Fears—Again

It was billed as one of the most important speeches of Silvio Berlusconi’s political career, amid a crisis that threatens to engulf Italy and the euro zone. Unfortunately when he stood in front of lawmakers, his pledges on boosting growth offered very few details and led to skepticism from analysts.

Silvio Berlusconi
Tiziana Fabi | AFP | Getty Images
Silvio Berlusconi

“The country is economically and financially solid. In difficult moments, it knows how to stay together and confront difficulties,” said the Italian Prime Minister.

"The government and parliament will act, I hope, with a large political and social consensus to fight every threat to our financial stability. Today more than ever, we need to act all together," said Berlusconi.

Berlusconi speech will not calm markets because "markets like facts, not words, and so far no facts have been seen,” said Marcello Benedetti, Fixed Income Sales at Knight Capital, in an interview with CNBC following the speech.

It's not a new criticism against the Prime Minister. Italian GDP Growth has rarely topped 1 percent a quarter since the turn of century and in 2001 was elected promising to boost growth via lower taxes and red tape. Hope he would deliver on these promises have consistently been disappointed.

With the latest round of austerity measures from Italy giving it little scope for further cuts, Benedetti said the ball is now firmly in the European Union and European Central Bank's court as “Italy's room to maneuver and cut further is limited.”

Italian growth is now one of the key focuses for investors, and given that GDP growth there has underperformed much of the euro zone year after year this is worrying some.

“The first speech made today by PM Berlusconi in the Lower Chamber did not contain anything specific to turn market sentiment decisively. While we don't think markets had any specific expectations, in our view they are likely to remain focused on the issue of weak potential GDP growth,” said Fabio Fois, a European economist at Barclays Capital.

The chances of the opposition or unions working with a Berlusconi-led government are for all intents and purposes non-existent, as the opposition called for him to resign, with one union chief claiming his speech offered nothing new and had got talks off to a disappointing start.

That's particularly worrying, as Berlusconi is going to need the backing of unions to push through much-needed labor reforms, according to Fois.

“It will be key to see whether the government will be able to work with Trade Unions and Confindustria on the industrial relationships front, a key point to increase productivity in both private and public sectors,” said Fois in a note to clients following the speech.

One analyst, though, is predicting Italy, and even Spain, could default if nothing is done to boost growth rates.

“Hopes that the latest Greek rescue package would limit contagion effects on Italy and Spain have already faded,” Ben May, a European economist at Capital Economics said in a research note.

“But we still think that markets are too sanguine about growth prospects for both economies, and that one or both may eventually default,” said May.

Following big jumps in borrowing costs for Italy and Spain, May said he sees three key factors driving sentiment. These are the fact that the European Financial Stability Fund, which was set up to help address the euro zone debt crisis, does not yet have the power to buy government bonds on the secondary market. Also, the EFSF does not yet have enough funds to deal with Italy or Spain if they get into trouble.

“Third, while bond purchases may address liquidity problems, they will not boost growth or solve the economies’ more deep-seated structural problems,” May said. “Both economies suffering from huge structural problems, such as a lack of competitiveness, rigid labor markets and a poor productivity growth record, we expect both Italy and Spain to stagnate at best over the next few years”

“While policymakers might be able to temporarily prompt yields to fall back by increasing the size and the scope of the EFSF further, we think that this would be no more than another sticking plaster. Indeed, it seems increasingly likely that Italy and/or Spain may eventually restructure their debts, with disastrous consequences for the euro-zone economy and financial market," said May.