Italy’s economy remains in trouble. The economy was flat in 2011, and the combination of austerity measures, falling market and consumer confidence, and weaker demand will likely result in the economy contracting by about 0.5% in 2012.

The new technocratic government led by Prime Minister Mario Monti is committed to further austerity measures (in the form of budget cuts, higher property taxes, and a new wealth tax) and liberalizing the economy (including opening up highly-regulated professions and speeding up privatizations). But Italy’s refinancing needs are the largest in Europe, and a key risk factor for Italy and the Eurozone. A massive 345 billion Euro ($465 billion) of Italian debt is due in 2012.

Prime Minister Monti is set to address labor market rigidities as a key issue. In particular, the government will pursue an amendment to article 18, which now requires firms with more than 15 employees to reinstate a worker if a court finds that termination was without just cause. The amendment will replace this compulsory reinstatement with severance payments scaled to the employee’s tenure.

A new research report is predicting that Monti may struggle to retain his parliamentary majority given Italy’s fractious politics and the electoral calculations of the major political parties. The center-right People of Freedom Party of former prime minister Silvio Berlusconi and other small centrist groups have already indicated that their support for Monti is not guaranteed. So far, the center-left Democratic Party has been more supportive, but this could change when the government turns to labor market reform.

Still, the vast majority of the public wants Monti to stay in power until the end of the current term in May 2013, and all eyes are watching to see whether or not his government’s reforms will achieve the savings and economic stimulation required for longer-term stability.

For more on risks facing the Italian economy, as well as detailed insights for 55 of the world’s most important economies, download the latest Global Market Brief and Labor Risk Index.

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Photo Credit - Flickr®User - Giovanni Orlando.