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What might the collective noun for credit ratings agencies be? Certainly not a pride (lions), given the agencies' track record of untimely calls. Maybe a descent (woodpeckers). Better yet would be a murder (crows), because Italy could get killed by the ratings agencies. Italy is the new epicentre of the European debt crisis and if the country is buried under a mountain of junk-rated sovereign bonds, the euro zone is finished.

Earlier this week, Italy was downgraded by Standard & Poor's by one notch, to single-A from single-A-plus, with a negative outlook, meaning another ratings whack job is likely. Because the agencies tend to move together, Moody's is bound to follow with its own downgrade. On Wednesday, S&P went after the Italian banks, downgrading seven of them, including industry leaders Mediobanca and Intesa Sanpaolo.

What triggered the downgrade? And why now? Difficult questions to answer, especially since Italy was one of the few euro zone countries whose fiscal situation, if anything, seemed to be on the mend. To be sure, Italy has a gruesomely high debt, equivalent to 120 per cent of gross domestic product. But its debt has always been fat and no one in bond land seemed overly worried about it. Italy has a deep and liquid debt market – the world's third largest – and willing buyers were always found (though Rome has had to pay much higher yields in recent auctions).

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Italy is running a budget deficit, but one that has been admirably low by euro zone standards. Last year's deficit figure was 4.6 per cent of GDP, which was half of Spain's or Britain's. This year the figure should land at 4 per cent, according to Deutsche Bank, and less than 2 per cent next year. With a little help from its austerity programs, Italy intends to balance the budget in 2013. In the meantime, the government is actually running a primary budget surplus (the measurement that excludes interest payments).

S&P cites falling growth as one of the main reasons for the Italian downgrade. Fair enough, but most countries in the 17-member euro zone and the wider European Union are watching their growth rates get slaughtered. The International Monetary Fund has just reduced its growth forecast for Britain to 1.1 per cent his year; it had forecast a 2-per-cent bump at the start of the year. Italy is arguably in no worse shape than Britain, yet Britain gets away with paying very low yields on its bonds, almost as low as Germany, whose debt is considered Europe's safest.

So what's the real reason behind the downgrade? S&P appears to have picked a subjective reason: It doesn't have much faith in Silvio Berlusconi's "fragile governing coalition" to make the tough decisions. Never mind that Italy last week approved a €54-billion ($74-billion) austerity program or that "fragile" could be used to describe half the governments in Europe. If general elections were held today, both German Chancellor Angela Merkel and French President Nicolas Sarkozy would be tossed onto the political scrap heap.

Of course, Mr. Berlusconi should be spending less time entertaining showgirls and more time figuring out how to protect his country from the debt crisis in Greece that threatens to sink the entire euro project. Still, the S&P downgrade seems both unwarranted and dangerous, given the economic reality.

The reality is that ratings downgrades and austerity programs are all feeding on one another to crunch growth, at best, or at worst to plunge Europe into a deep recession that could end up with busted banks and a busted common currency.

Investors drive up bond yields because they see waning growth and rising deficits and debt. The finance ministers, who are utterly obsessed with public debt ratios, launch punishing austerity programs during an era of private sector retrenchment. The economy sinks, in turn triggering more downgrades and pressure for more austerity. Fresh austerity programs arrive, hammering growth again and renewing the attention of the ratings agencies. And so on.

This vicious cycle could push Europe to the brink of destruction. Greece has already reached that point. The austerity programs demanded by the European Commission, the European Central Bank and the IMF (the "troika") have gone from sensible to nasty to counterproductive. The Greek economy is imploding and the streets of Athens are becoming dangerous as society breaks down.

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The Italians are watching in horror as the Greek economy unravels at alarming speed. They wonder whether the troika and the ratings agencies are evolving from saviours to executioners.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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