London, 14 December 2012
Fitch Ratings has affirmed Italy’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘A-‘ with a Negative Outlook. The short-term foreign currency IDR is affirmed at ‘F2’ and the Country Ceiling at ‘AAA’.
The affirmation of Italy’s sovereign ratings follows the conclusion of a formal review in line with the forward guidance provided by Fitch when it last reviewed Italy’s sovereign ratings on 19 July 2012. The affirmation of Italy’s sovereign ratings reflects the following key rating factors:
– Progress with fiscal consolidation and structural reform in 2012 broadly in line with Fitch’s expectation. The budget deficit this year will be below 3% of GDP, implying a primary surplus close to 3%. The budget deficit has gradually declined from a peak of 5.4% in 2009.
– Low contingent fiscal risks from the banking sector, an underlying budgetary position close to that necessary to stabilise the government debt to GDP ratio and a sustainable pension system which underpins confidence in the long-run solvency of the Italian state.
– The Italian sovereign has demonstrated its financing flexibility and resilience during the crisis reflecting a strong domestic investor base and average duration of 4.7 years. Moreover, the announcement of the ECB’s Outright Monetary Transaction (OMT) programme has materially eased stresses in European sovereign bonds, including for Italian debt.
– The rating remains supported by the relatively wealthy, high value-added and diverse economy with moderate levels of private sector indebtedness.
RATING OUTLOOK -NEGATIVE
Negative: The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:
– Failure to place the gross general government debt (GGGD) to GDP ratio on a firm downward path from 2014.
– Government instability following the forthcoming elections and prolonged uncertainty over economic and fiscal policies and policy continuity.
– A deeper and longer recession than currently forecast by Fitch that undermines the fiscal consolidation effort and increases contingent risks from the financial sector.
– Sustained deterioration in fiscal funding conditions with adverse implications for financial stability and public debt dynamics.
– The re-intensification of the eurozone crisis could lead to a direct increase in GGGD through contingent liabilities due to additional EFSF/ESM commitments and could further weaken the economy through a fall in external demand and more unfavourable financing conditions for the private sector.
Positive: Future developments that may, individually or collectively, lead to a stabilisation of the Outlook include:
– A sustained economic recovery that supports on-going fiscal consolidation.
– A stable government committed to the fiscal consolidation path and the medium term fiscal rules.
– Confidence that the public debt to GDP ratio is on a firm downward path.
– Further structural reforms that enhance the competitiveness and growth potential of the Italian economy.
KEY ASSUMPTIONS AND SENSITIVITIES
Italy is going through a deep and protracted recession with a cumulated loss of GDP close to 3% in 2012-13. The severity of the recession is due to the combination of three major factors: fiscal consolidation, tight financing conditions and weak external demand. While front-loaded fiscal tightening measures, equivalent to about 2.5% of GDP in 2012, significantly contributed to a contraction of aggregate demand, Fitch’s fiscal and economic projections are consistent with Italy avoiding a self-reinforcing debt trap.
It is assumed that the economy will begin to recover in H213 as headwinds from fiscal austerity and the fragmentation of financing conditions across the eurozone ease. Nonetheless, recovery will be primarily driven by improving external demand as domestic demand will remain subdued for a longer period.
Fitch maintains its assumption that medium term potential growth is 1% even in light of recent structural reforms.
Fitch projects the GGGD to GDP ratio will peak in 2013 at around 128% and decline gradually to around 110% by 2021, assuming a modest economic recovery from 2014 and average interest rates close to current levels.
The current rating reflects Fitch’s judgement that Italy will retain market access and, based on the OMT programme, external intervention would be forthcoming if bond yields were to rise significantly. Fitch judges that in the unlikely event of the loss of market access the new eurozone mechanisms, the ESM and OMT, would be able to ensure Italy continued to honour its sovereign obligations.
The rating also incorporates Fitch’s assumption that the medium-term fiscal trajectory and commitments made by Italy under the Stability and Growth Pact and implied by the constitutional balanced budget amendments will also be sustained by future governments.
Fitch also assumes that both Houses of Parliament will, within the short period remaining from the current term, adopt the Stability Law, containing the 2013 budget, and the remaining secondary legalisations needed to complete the medium term fiscal framework.
The current rating is based on the assumption that a stable new government will be formed shortly after the forthcoming elections and the government’s policies will be consistent with recent structural reforms and further measures to enhance the economy’s competitiveness and growth potential will be adopted.
Fitch assumes that the contingent liabilities from the banking sector for the Italian government are limited. Nonetheless, if the recession is deeper and longer than currently anticipated, the risk that the government may be required to make further injections of capital cannot be discounted.
Furthermore, Fitch assumes there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by eurozone policy makers. It also assumes that the risk of fragmentation of the eurozone remains low.