Fitch says that Italy faces economic and reform challenges

(Source: Reuters)

Ratings agency Fitch has said that while the formation of a new government is positive, the country now has limited fiscal headroom and the agency is concerned that the government may not be sufficiently strong or staying power, to deliver necessary structural reforms to increase trend growth.

Italian Prime Minister Enrico Letta of the centre-left coalition was appointed last week, two months after Italian elections took place.

But the fragility of the new left-right coalition limits the scope for meaningful reform that could raise Italy's low potential GDP growth. Prime Minister Enrico Letta has committed the new government to electoral reform and measures to tackle youth unemployment, but major structural economic reforms may prove elusive.

The recession in Italy is one of the deepest in the eurozone and so far there are hardly any signs of a recovery. Furthermore, the medium-term potential growth rate of the Italian economy is low even by European standards; Fitch estimates it to be around 1%.

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Letta's speech also outlined some initial reform proposals to boost employment and growth, such as reducing hiring tax for young employees. This emphasis on reform is encouraging, but making the Italian economy sufficiently flexible to boost trend growth remains challenging. On labour law, for example, it is not yet clear whether the previous administration's reforms have been effective, and Letta's speech did not refer to liberalising closed professions.