Frankfurt am Main, February 14, 2014
Moody’s Investors Service has today changed the outlook on Italy’s Baa2 government bond rating to stable from negative. Concurrently, Moody’s has affirmed Italy’s Baa2 and Prime-2 debt ratings.
The key drivers for changing the rating outlook to stable are:
1.) The resilience of Italy’s government financial strength. This is reflected in (i) Moody’s expectations of a levelling-off of Italy’s general government debt-to-GDP ratio in 2014; and (ii) the country’s robust debt-affordability profile, which is underpinned by low funding costs by historical standards, and a largely stable ratio of interest payments-to-general government revenues throughout the euro area debt crisis.
2.) The reduction of the risks for the Italian government’s balance sheet related to contingent liabilities from (i) the potential recapitalisation needs of Italian banks; and (ii) loans by the European Financial Stability Facility (EFSF, Aa1 negative) and the European Stability Mechanism (ESM, Aa1 negative) provided to euro area countries under an EU/IMF support programme.
Italy’s foreign and local-currency country ceilings for debt and deposits remain unchanged at A2/P-1. These ceilings act as a cap on ratings that can be assigned to the foreign and local-currency obligations of entities domiciled in the country.
RATIONALE FOR CHANGING THE OUTLOOK TO STABLE
–FIRST DRIVER: RESILIENCE OF ITALY’S GOVERNMENT FINANCIAL STRENGTH–
The first factor supporting the outlook change to stable is the resilience of Italy’s government financial strength, as reflected in the anticipated levelling-off of Italy’s general government debt-to-GDP ratio in 2014. More precisely, Moody’s expects Italy’s debt-to-GDP ratio to peak this year at below 135% in its central scenario in which modest economic growth resumes, the authorities implement fiscal consolidation according to plans, funding costs do not materially increase and no significant contingent liabilities or bank recapitalisation needs crystallise on the government’s balance sheet. Today’s resignation of Prime Minister Enrico Letta and the expectation that Matteo Renzi will head a newly formed government does not alter Moody’s expectations in this respect.
Moreover, Italy’s fundamental credit profile benefits from the government’s robust debt affordability, as reflected in Italy’s interest payments-to-general government revenues, a ratio that has been largely stable throughout the euro area debt crisis. For 2013, we estimate Italy’s interest payments to have remained at 11.3% of government revenue, unchanged from 2012, albeit higher than the pre-crisis (2003-07) average of 10.8%. The 2013 ratio of 11.3% compares to ratios of 13.8% for Ireland (Baa3 positive) and 9.2% for Spain (Baa3 stable).
Italy’s robust debt affordability is underpinned by historically low funding costs. The Italian government bond market is the largest in Europe, and Europe’s core banks, insurers and retail investors have significant exposures to Italy. Hence, low yields provided by bond liquidity and supported by Italy’s systemic importance have allowed the Italian government to borrow large amounts at sustainable levels. The yield on 10-year government bonds is now 3.9% (January 2014), lower than in April 2013 (4.3%) when Moody’s affirmed Italy’s Baa2 rating and maintained the negative outlook. It is also lower than the pre-crisis (2003-07) average of 4.1%.
Furthermore, the Italian government’s debt management risks are limited by (1) the favourable debt-maturity profile of public debt (average maturity is 6.4 years); (2) the government’s negligible foreign-currency exposure, as approximately 99.9% of total debt is denominated in euro; (3) the availability of domestic funding resources due to Italy’s moderately high savings rate (estimated 19.5% of GDP in 2013) — the depth of domestic funding resources was shown again in 2013 with two successful BTP Italia issuances in April (EUR17.1 billion) and in November (EUR22.3 billion), which were predominantly placed in the Italian retail market; and (4) moderately indebted non-financial corporate and households sectors.
–SECOND DRIVER: REDUCED RISKS OF CRYSTALLISATION OF CONTINGENT LIABILITIES–
The second factor underpinning the outlook change is the reduction of the risks for the Italian government’s balance sheet stemming from contingent liabilities. Moody’s now assesses the risks related to the banking sector’s potential recapitalisation needs as more limited, as the country’s largest banks either have stronger capital adequacy, or are in the process of raising capital in the coming months. It is possible, in Moody’s opinion, that some banks may still experience difficulties, and the outcome of the ECB’s “comprehensive assessment” is a potential source of uncertainty. Asset quality also remains under pressure and trends in problem loans, which reached 14.7% at June 2013, are likely to move upwards further throughout 2014, until the effects of the gradual economic recovery take hold. The ECB’s exercise comprises a supervisory risk assessment, an asset quality review and a stress test of the Italian banking system, and is to be concluded in October 2014. In Moody’s view, the potential need for recapitalisation from the ECB exercise is likely to result in a relatively limited scale of potential contingent liability for the government.
With respect to Italy’s contingent liabilities related to the support of other euro area countries through EU/IMF programmes, Moody’s acknowledges that they are significant — as Italy’s guarantee commitments to the EFSF and its capital share in the ESM are both a function of Italy’s sizeable GDP, which makes it the third largest euro area country after Germany (Aaa negative) and France (Aa1 negative) –, but notes that the likelihood of a crystallisation of those contingent liabilities has decreased over the past year due to a fundamental stabilisation and improved funding conditions in non-core countries.
This stabilisation is fundamentally based on macroeconomic adjustment and fiscal progress in non-core countries, including Italy. Moody’s expects Italy to have recorded a current account surplus of 0.9% of GDP in 2013 (compared to a deficit of 0.4% of GDP in 2012), and to have complied with the 3%-of-GDP fiscal target for the second year in a row. Concurrently, other non-core countries — particularly Ireland, Spain and Portugal — have made significant progress on (1) macroeconomic rebalancing as reflected in improved current account balances; (2) restoration of competitiveness as shown in internal devaluation processes through unit labour cost adjustments; and (3) fiscal consolidation, as reflected in spending reviews and sizeable budget deficit cuts.
In addition to the fundamental progress, the increased flexibility of the ECB and the set-up of back-stop facilities like the EFSF and the ESM have brought relative market calm and improved funding conditions in non-core countries through a mitigation of liquidity concerns on euro area government bond markets. This is most notable in the announcement of a new instrument in 2012, the Outright Monetary Transactions (OMT), and the implementation of the ESM with a lending capacity of EUR500 billion. Non-core countries’ decreased susceptibility to contagion from elsewhere in the euro area was evident when events in Cyprus and Slovenia (Ba1 stable) during 2013 failed to trigger disruptions there.
WHAT COULD MOVE THE RATING UP/DOWN
Moody’s would consider upgrading Italy’s government bond rating if there is an effective strengthening of the economy’s growth prospects triggered by the successful implementation of economic and labour market reforms. Moreover, a sustained reversal of the upward trajectory of Italy’s debt-to-GDP ratio against the backdrop of a resumption of significant growth would be credit positive.
Moody’s would consider downgrading Italy’s government bond rating in the event of a deterioration in the country’s economic prospects, a decrease in its primary surplus, a deterioration in the sovereign’s funding conditions, or a need for a significant recapitalisation of banks by the government. That said, Italy’s Baa2 rating and its stable outlook are resilient to bank contingent claims against the government materializing in amounts equal to the current range of market estimates, i.e. below EUR20 billion.
GDP per capita (PPP basis, US$): 29,812 (2012 Actual) (also known as Per Capita Income)
Real GDP growth (% change): -2.5% (2012 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2.3% (2012 Actual)
Gen. Gov. Financial Balance/GDP: -2.9% (2012 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -0.4% (2012 Actual) (also known as External Balance)
External debt/GDP: [not available]
Level of economic development: High level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 10 February 2014, a rating committee was called to discuss the rating of the Italy, Government of. The main points raised during the discussion were: The issuer’s fiscal or financial strength, including its debt profile, has increased. The issuer has become less susceptible to event risks.
The principal methodology used in this rating was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on http://www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this rating action, if applicable.