Moody's warns on Italy's debt

Ratings agency Moody's Investors Service said Friday it was reviewing Italy's credit rating for a possible downgrade.

The change, if it happens, would affect Italy's Aa2 local and foreign currency government bond ratings, and would increase the government's borrowing costs.

Moody's cited challenges which hindered the country's recovery from recession including low productivity, inflexible labour agreements and domestic markets, and the prospects of an eventual rise in interest rates.

"Italy has so far only recovered a fraction of the nearly seven percentage points in GDP that it lost during the global crisis, despite low interest rates, which are likely to rise in the medium term," it said in a release.

It also raised the possibilities that there may not be the popular will to supportgovernment attempts to cut its debt load and that foreign lenders may increase borrowing rates if the European debt crisis escalates.

The move came the same day thathopes for a resolution of Greece's debt impasse appeared to increase after prime minister George Papandreou replaced his finance minister and Germany softened its position on giving Greece more help.

French banks also under review

It also came just two days after Moody's said itmight downgrade the credit ratings of the three largest French banks because of their exposure to the Greek debt crisis.

Moody's warned then that BNP Paribas and Credit Agricole could face one-notch downgrades and that Societe Generale could see a two-notch decline as a result of their holdings of Greek government bonds or through their local banking subsidiaries.

It also warned that the contagion could spread beyond France. "Moody's may take similar actions on other banks with direct exposures to Greece in the coming weeks," it said.

It added that it is also "closely monitoring" the risks of a Greek default scenario, including the impact on weaker countries, capital markets, and funding conditions.

"Banks across the euro zone" are potentially vulnerable, Moody's said. Moody's decided earlier this month to cut Greece's own rating by three notches from a B1 rating to Caa1 with a negative outlook.

It said there was an increased risk that the debt-ridden country will eventually have no choice but to restructure.