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Euro crisis: Lack of growth is killing Italy

With high debt but a primary budget surplus, Italy must enact growth policies to avoid euro crisis, an economist says. Italy's new prime minister may not have much time to enact reforms.

By Antonia van de VeldeCNBC Associate Editor / November 16, 2011

Italian Prime Minister designate Mario Monti talks to reporters at the Quirinale Palace in Rome Nov. 16, 2011. Mr. Monti, who unveiled Italy's new government after two days of consultations, doesn't have much time to enact reforms as the euro crisis looms.

Remo Casilli/Reuters/File

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Italy will face a long period of no growth, leading to the erosion of its primary budget surplus, as an interim government starts the tough task of undoing Silvio Berlusconi’s legacy, George Magnus, senior economic adviser at UBS said on Tuesday.

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That primary surplus has traditionally helped allay investors concerns over the country’s high level of public debt, currently hovering around 120 percent of gross domestic product.

Mario Monti, the former European Commissioner appointed on Sunday to succeed Berlusconi, is expected to conclude talks on forming a new government on Tuesday.

With yields on Italian government debt still close to 7 percent — the level at which Portugal, Ireland and Greece had to seek bailouts as the cost of funding their debt had become unsustainable — Monti will seek to introduce credible budgetary restraint, liberalize the labor market and introduce structural reforms.

“There’s not a lot of time to do this, and the markets obviously will be extremely nervous about the sensitivity of what effectively I think an unelected government is going to try and do…bearing in mind that some of these measures are going to be extremely unpopular,” Magnus told CNBC.

Magnus pointed out that Italy is one of only three countries in the advanced world — the others being Singapore and Korea — that has a small primary surplus, meaning its budget is in surplus excluding debt interest payments.

But this surplus has been eroding for the last ten years, Magnus said. “What really has killed Italy actually is the lack of growth.”

“Bearing in mind that it looks now that the euro zone has basically entered into a new contraction…(and) that Italy won’t have any growth for a long time to come, that surplus is going to wither. That is a problem,” Magnus said.

Berlusconi’s legacy has also left Italy slumping in world rankings when it comes to operation of the rule of law, corruption and government effectiveness, Magnus said.

Although such matters were not usually taken into account in economic modeling, “these things matter enormously” for the efficiency of measures governments can implement, Magnus said.