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Italy unveils plan to calm fears of escalating debt crisis

August 6, 2011

But as European officials sought to reassure markets, there were more signs of the kinds of divisions that have left euro-zone leaders stumbling from one failed bandage to another in their attempts to resolve the region’s nearly two-year-old debt crisis, which is on the verge of being critical.

Ballooning Concern over Italy is growing in large part because Europe’s economies are slowing, along with the United States, at the same time that investors are newly focused on the crushing debt loads of wealthy nations. Though a snapshot of the Italian economy released by authorities Friday indicated that the country’s economic growth is doing better than some other nations in the region, investors were fixating on its whopping $2.2 trillion pile of debt and the question of who would aid Italy if it cannot pay its bills.

The Europeans have limited options. If Italy’s and Spain’s borrowing rates continue to soar, both nations could effectively be priced out of private markets.

Europe, led by Germany, has bailed out Greece, Ireland and Portugal. But voters in frugal Germany, the largest single economy in the euro zone, have had it with bailouts. In a worst-case scenario, Italy would need $1.2 trillion to cover its borrowing for the next three years, or more than double the size of an established European rescue fund.

This week, Jose Manuel Barroso, president of the European Commission, called for expanding the war chest for bailouts. But his effort was shot down by Germany, among others. On Friday, Olli Rehn, the European Union commissioner for economic affairs, said there was no consensus by leaders to go beyond a July 21 agreement that offered a further bailout to Greece, saying European leaders would not yet move to increase available rescue funds.

That July 21 deal would also allow European rescue funds to be used to buy up the bonds of troubled nations in times of crisis, but the pool of cash available, about $616 billion, does not approach the level needed to aid Italy or Spain. In addition, all 17 nations in the euro zone still need to ratify that deal before it can go into effect.

Analysts’ outlook

Analysts believe that the European Central Bank will step in with a massive program to buy up Italian and Spanish debt to drive down their borrowing rates. As a sign it is moving in that direction, the bank on Thursday began to scoop up the debt of smaller Portugal and Ireland. But even that measure was opposed by Germany, and analysts say it is likely to amount to only a short-term solution.

If Italy or Spain fails to quell market panic, analysts say, Europeans might be forced to move toward the advent of a new euro-bond, putting the economic weight of Germany behind its profligate neighbors. But Germany and other northern European nations remain opposed to such a deal, as well as the more radical step of a more established fiscal union that would go further in turning a vast chunk of Europe into one giant economy.

Analysts say it is the lack of clarity of how Europe could cope with a worst-case scenario in Italy or Spain that is fueling the crisis.

“A new phase of the euro debt crisis has developed,” Citibank economists warned in a report Friday. Rather than reflecting developments in Italy and Spain, they cited “the lack of an adequate policy response at the EU level and the absence of a lender of last resort for these two large euro countries.”

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