- We are affirming our unsolicited ‘BBB/A-2′ long- and short-term sovereign credit ratings on Italy.
- The affirmation reflects our view of Italy’s wealthy and diversified economy amid risks to a fragile recovery within the context of high public debt.
- The outlook on the long-term rating remains negative.
On Dec. 13, 2013, Standard & Poor’s Ratings Services affirmed its unsolicited ‘BBB’ long-term and ‘A-2’ short-term sovereign credit ratings on the Republic of Italy. The outlook on the long-term rating remains negative.
The ratings are supported by our view of Italy’s wealthy and diversified economy and the country’s relatively robust external balance sheet. As confirmed by data published by the Banca d’Italia, the Italian economy’s net international investment position is considerably stronger than our measure of narrow net external debt. We believe this reflects Italy’s traditionally elevated private-sector savings rate.
The ratings remain constrained by our assessment that growth prospects remain weak, while the net general government debt burden continues to be among the highest of all the sovereigns we rate. The ratings are also constrained by what we view as an impaired monetary transmission mechanism, which has led to very tight credit conditions for Italy’s private sector, as well as what we believe is a risk of marked deterioration in external financing from worsening financial sector conditions.
After two consecutive recessions, the volume of economic activity in Italy continues to be about 8% below its pre-crisis level (fourth quarter of 2007) and unemployment has doubled to more than 12% of the labor force, where we expect it will remain over the next two to three years. For 2014 and 2015, we
project only a slow recovery in Italian real GDP output of 0.4% and 0.9%, respectively (see “Credit Conditions: Europe Sees A Slight Improvement, But Structural Weaknesses Persist,” published on Dec. 9, 2013 on Ratings Direct).
In nominal terms, we forecast GDP growth to average just over 1% in 2014 (versus the government’s assumption of 3%) and less than 2% on average in 2015 and 2016. In our opinion, risks to real and nominal GDP performance could prevent the government from successfully reversing the upward trend of the general government debt ratio.
We have observed that Italian nominal wage increases have continued to outpace underlying productivity growth, including during the last few years of rising unemployment. As a consequence, we view Italian competitiveness as continuing to deteriorate compared to key trading partners, in the absence of productivity-boosting reforms.
In light of what we interpret as Italian policymakers’ varying levels of conviction as to the urgency of labor reforms–as well as reforms to the services and energy sectors, and the tax framework–we remain uncertain as to whether such reforms will be implemented during 2014 and 2015. In our view,
reform implementation could also be influenced by the evolution of electoral and political institutions over the medium term, subject to a broader political consensus.
In what we view as a constructive development, the Letta government has moved to implement some cuts in business and payroll taxes in the 2014 budget. However, we estimate the effects from these cuts will be relatively limited at 0.2% of GDP; the government has decided to realize only limited savings on the expenditure side of the budget within the context of the official commitment to stabilize debt to GDP by 2014.
We project a general government deficit of -3.0% of GDP for 2013, and close to this figure for 2014, compared to the government’s projections of -3.0% of GDP and -2.5% of GDP for 2013 and 2014, respectively. Our more conservative budgetary deficit projection for 2014 largely reflects our less optimistic GDP projections. The government has taken some steps to keep the deficit from rising, primarily by raising local services taxes, to offset the reduction in expected property tax receipts next year.
Since mid-2012, ECB actions have helped reduce financing tensions for the sovereign, facilitating a return of net nonresident purchases of Italian government debt. We view this as a positive rating factor, but we recognize that the exposure of the domestic financial sector to the sovereign remains considerable, at an estimated 20% of Italian commercial banks’ total assets.
In September 2013, credit to the nonfinancial sector continued to contract at an annual estimated pace of just over 6.0%, according to data released by the Banca d’Italia (in third-quarter 2013, lending to nonfinancial corporations fell by 4.2% quarter-on-quarter). This weighed on investment activity in the Italian economy. Our assessment is that this pace of contraction should gradually ameliorate, particularly during the second half of 2014. Nonperforming loans remain high, at 14.7% on average, although performance varies materially among banks.
On the external side, Italy’s current account is set to shift into a surplus of just under 1% of GDP this year, largely reflecting weaker imports. That said, two-thirds of the improvement in Italy’s current account position since 2006 has resulted from higher exports; the rest is on the back of lower imports. We believe the outlook for export sector performance remains uncertain given competitiveness pressures arising from increasing unit labor costs, the high cost of energy inputs, and an effective appreciation of the euro since mid-2012, as Bank of International Settlements data indicates.
The negative outlook reflects our belief that there is at least a one-in-three chance that we could lower the ratings in the next 12 months. According to our criteria, we could lower the rating if, in particular, we conclude that the government cannot implement policies that would help to restore growth and keep debt indicators from deteriorating beyond our current expectations. Similarly, sustained delays in effectively addressing some of the rigidities in Italy’s labor, services, and product markets–which have been holding back growth–could put downward pressure on the ratings. Under our criteria, a downward revision of our assessment of Italy’s institutional and governance effectiveness could lead us to lower the rating by one notch or more, depending on the severity of the circumstances.
On the other hand, we could revise the outlook to stable if the government was to implement structural reforms to the labor, product, and service markets that would likely shift the Italian economy to a higher level of growth.