The negative outlook on Italy’s ‘BBB’ rating indicates that we are still uncertain whether the economic and policy trends we are seeing will hold. Despite some evidence of an incipient economic recovery and easing fiscal headwinds, we expect that weak demand for labor, combined with tight credit conditions, will limit average Italy’s GDP growth to 0.5% per year between 2014 and 2016. That would imply that even by 2016, Italian economic output would remain nearly 7% below 2007 levels. Against a backdrop of disinflationary conditions — reflecting limited monetary flexibility — we also see constrained growth in nominal GDP.
Such uncertain real and nominal economic prospects continue to raise questions about Italy’s public debt trajectory.
We expect gross general government debt to rise to 134% of GDP by the end of 2014. Our view is that key policy decisions this year may have an important bearing on economic performance, and therefore public finances. Should the current governing coalition implement growth-enhancing structural reforms, especially labor reforms, Italy’s potential growth rate could improve. This might reduce the fragmentation of Italy’s labor market and decentralize wage setting, promoting flexibility and employment. Improved governance could also go a long way toward reducing debt. We believe that decades-long governance issues have contributed to Italy’s very high net general government debt ratio, which in 2013 was the fourth-highest among the 128 sovereigns that Standard & Poor’s rates, surpassed only by Japan, Jamaica, and Greece. The governing coalition is aiming to build a cross-party consensus backing a new electoral law (as well as the adoption of a more unicameral parliamentary system), after the Italian Constitutional Court declared the 2005 electoral system to be unconstitutional. Without a new electoral regime, the next round of elections would be held under a highly proportional system, which could imply more fragmented coalitions and potentially weak policy delivery.
Our last release on Italy stated that we could lower the rating if, in particular, we conclude that the government cannot implement policies that would help to restore growth and keep public debt indicators from deteriorating beyond our current expectations. We also stated that sustained delays in effectively addressing some of the rigidities in Italy’s labor, services, and product markets–which we believe have been holding back growth–could contribute to a downgrade. On the other hand, we could revise the outlook to stable if the government implements structural reforms to the labor, product, and service markets that shift the Italian economy to a higher level of growth (for details see “Ratings On Italy Affirmed At ‘BBB/A-2’; Outlook Remains Negative,” published on Dec. 13, 2013).
source: What Are The Risks Ahead For European Sovereign Ratings In 2014? s&p