Monti's appointment as prime minister in November 2011, along with the ECB intervention in the sovereign bond market, reduced the urgency of Italy's financial situation. During its first 100 days in office, Monti's government introduced some 30.4 billion euros (about $40 billion) in new taxes and spending cuts, representing 3.25 percent of Italy's gross domestic product (GDP). The government also liberalized many sectors of the economy and promised labor reforms designed to encourage job creation. The immediate effects of Monti's measures (and the ECB assistance) were positive. Italy's benchmark borrowing costs fell to around 5 percent in early March from a peak of nearly 8 percent in November, and the spread against safer German bunds has declined to less than 3.2 percentage points (its lowest since September) from highs in excess of 5.5 points.

Although the "Monti effect" improved Italy's short-term situation, it will not be sufficient to solve Italy's long-term problems. Italy's main difficulty is that its economy simply does not grow enough. Even before the financial crisis, the Italian economy's growth rate was among the lowest in Europe. Since 2001, the country has experienced four recessions, and GDP is expected to decline 2.2 percent this year, according to the International Monetary Fund (IMF). Without sustained growth, Italy will find if very difficult to reduce its public debt, which now exceeds 120 percent of GDP. Italy's economy would need to grow at an average of more than 1 percent annually and maintain a surplus of nearly 6 percent to reduce its debt burden in the next decade, but this is highly unlikely -- from 2001 to 2010, Italy had an average growth of 0.41 percent annually.

The prospect of long-term growth is constrained by Italy's demographics. Twenty percent of the country's population is over 65 years old, but only 13.5 percent is under age 14, according to 2010 data. This means that in coming decades Italy will have fewer people joining the labor market generating taxable income, even as the less economically active segment of the population grows.

As the world's fourth-largest borrower, and with its sovereign debt amounting to almost 2 trillion euros (about $2.6 billion), Italy is vulnerable to cooling economic growth and to increases in market interest rates. If Italy were to lose access to the capital markets, even the combined funds of the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF) would not suffice to bail out Italy. The 230 billion euros left in the EFSF combined with the ESM, which is expected to take effect by July, will have a total funding capacity of only 500 billion euros.  

Italy's banking sector is also suffering. In February, Standard and Poor's gave the Italian banking system a negative outlook, anticipating persistently weak profitability for the banks over the next few years and a risk-adjusted return on core banking products that could be insufficient for banks to meet their cost of capital. The same month, a report from Italy's central bank warned of the danger of a credit contraction as Italian lenders tightened their standards for both corporations and homebuyers. However, Italy's private sector carries moderate debt at 128 percent of GDP, while household indebtedness, at 45 percent of GDP, is low compared to levels in peer countries. Additionally, Italian households' financial wealth is about twice GDP, which sustains their creditworthiness in case of financial difficulties.

The size of Italy's informal economy poses other problems. According to a study conducted by the Italian Labor Union in 2010, funds earned through illegal employment equated 10 percent of national GDP. Illegal workers amounted to 13 percent of the working population in the north, 15 percent in central Italy and 21 percent in the south. Italy's National Institute for Statistics estimated that the country's informal economy is worth 255 billion to 275 billion euros, or 16.3-17.5 percent of GDP. Tax evasion alone is equal to 8 percent of GDP.