Italy prepares a new budget, while some experts prepare for the worst

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Italian Interior Minister Matteo Salvini speaks during a statement after a bilateral meeting prior to the European Union member states’ interior and justice ministers conference on July 11, 2018 in Innsbruck, Austria. 

Italy has now turned into the weak link of the euro zone and market participants shouldn’t rule out the possibility of a debt crisis further down the road, one economist told CNBC Wednesday.

Traders are increasingly wary of developments in Italy, where a recently established populist coalition has vowed to spend more, despite carrying the second largest public debt pile in the euro area. The government is currently preparing its budget plans for 2019 — the first time for this new government— in what will be a key test for investors.

“We have to see how the government does its fiscal numbers, it they don’t add up by the end of September, things could indeed get somewhat rough for Italy,” Holger Schmieding, chief economist at Berenberg, told CNBC’s “Squawk Box Europe.”

At the moment, there is no clarity on how the right-wing Lega and the leftist Five Star Movement (M5S) will put together a budget that will raise pensions and the available income for households. The fiscal plans are likely to deviate from previous commitments with Europe, but analysts are questioning how big the discrepancies will be.

“This grave uncertainty about the fiscal plans is a significant rollback for Italy because it does mean that down the road, an Italian debt crisis — (which) would look pretty unlikely a year ago — is now a possibility,” Schmieding said.

Under previous governments, Italy approved new labor laws as well as constitutional changes, which were welcomed by market watchers. Issues with certain lenders, including Banca Monte dei Paschi di Siena and its bad loans, were also fixed.