London 25 April 2014
Fitch Ratings has revised Italy’s Outlook to Stable from Negative. At the same time the agency has affirmed Italy’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘BBB+’. The issue ratings on Italy’s senior unsecured foreign and local currency bonds were also affirmed at ‘BBB+’. The Country Ceiling has been affirmed at ‘AA+’ and the Short-term foreign currency IDR at ‘F2’.
KEY RATING DRIVERS
The revision of the Outlooks to Stable from Negative reflects the following key rating drivers, all of which are of medium weight:
– The deep and prolonged recession of the Italian economy ended in 2H13, in line with Fitch’s previous forecasts.
– The Italian sovereign has benefited from a significant improvement in financing conditions since mid-2012. The average issuing yield was 1.6% in 1Q14, a historical low. Furthermore, Italy demonstrated financing flexibility and resilience during the sovereign debt crisis and the average life of gross general government debt (GGGD) was 6.4 years at end-2013.
– Contingent fiscal risks from the financial sector have declined as larger Italian banks took advantage of improved market conditions to strengthen capital ahead of the ECB’s comprehensive asset quality review and some EUR10bn new share issues have been announced to date. Debt issuance of Italian banks in 1Q14 was markedly higher compared with the previous year.
– Italy had a current account surplus in 2013, the first time since the financial crisis. Fitch expects the surplus to widen in 2014, driven by stronger export demand, not least from eurozone partners, while imports will remain subdued due to the weakness of domestic demand.
Italy’s ‘BBB+’ IDRs also reflect the following key rating factors:
– GGGD will peak at 135% of GDP in 2014, marginally higher than Fitch’s previous forecast (133% of GDP), due to weaker nominal GDP growth. Fitch expects GGGD to decline slowly and remain above 130% of GDP until 2017, compared with the ‘BBB’ median of 40%. The high debt leaves very limited fiscal space to respond to any adverse shock.
– The new government of Matteo Renzi announced a structural reform agenda with an ambitious timetable and confirmed in the 2014 Stability Programme the previous governments’ commitment to the eurozone fiscal framework, in particular, keeping deficit below 3% of GDP in 2014 and maintaining the medium-term fiscal consolidation path.
– Labour market indicators and inflation highlight the fragility of the economy. Unemployment increased to 13% in February 2014, as employment continued to fall and annual inflation declined to 0.3% in March 2014.
– The Italian economy contracted by a cumulative 4.1% since mid-2011, experiencing one of the sharpest recessions among eurozone members. Italy’s average GDP growth over the last five years was negative 1.5% versus the ‘BBB’ median of positive 3.2% growth. Notwithstanding the cyclical improvements, Italy’s growth potential is weak, compared with both rating peers and eurozone members.
– Following the substantial pro-cyclical fiscal consolidation in 2012 and 2013 during the recession, the government will not tighten the fiscal stance in 2014. According to the Stability Programme the government will use the limited fiscal flexibility created by savings from the spending review to support the economy through tax cuts in the short run. Consequently Fitch forecasts public sector deficit at close to 3% of GDP in 2014, for the third consecutive year.
– Net external debt was high at 56% of GDP at end-2013, compared with the ‘BBB’ range median of 9%.
– The ratings are supported by a large, fairly wealthy, high value-added and diversified economy with moderate levels of private sector indebtedness and a sustainable pension system.
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are currently balanced.
Factors that may, individually or collectively, result in a negative rating action are:
– Political turmoil resulting in paralysed economic and fiscal policies, or weakening political support for the medium-term fiscal consolidation path
– Nominal and real economic shocks or fiscal measures that reduce confidence that GGGD/GDP will be placed on a downward path
Factors that may, individually or collectively, lead to a positive rating action are:
– Stabilisation of GGGD/GDP and increasing confidence that it will be firmly placed on a downward path
– Sustained and broad-based economic recovery, including an acceleration in nominal GDP growth
– Marked decline in the net external debt to GDP ratio
The ratings incorporate Fitch’s assumption that following a broadly unchanged budget deficit (close to 3% of GDP) in 2014 the primary balance will improve in 2015 and 2016 and the underlying fiscal stance will converge towards the balanced budget requirement over the medium term. The European Commission’s assessment of the draft 2014 budget highlights that Italy needs further measures to fully comply with the reinforced Stability and Growth Pact.
Fitch maintains its assumption that real GDP will grow by 0.6% in 2014 and 1% in 2015. Growth will not accelerate substantially further over the medium term, notwithstanding the various rounds of structural reforms proposals and the closing of the likely large negative output gap. The EUR50bn-60bn (3.2%-3.5% of GDP) repayment of commercial arrears during 2013-14 would not provide a large impetus to the economy, but would rather help to mitigate downside risks to Fitch’s base case.
Fitch assumes that Italy will avoid deflation. Based on its real economic forecast and a gradual increase in inflation from the current low level Fitch assumes in its debt sustainability analysis that the nominal growth of the Italian economy will remain below 3% until 2018. Therefore, interest rate-growth differential will remain positive for an extended period, despite the substantial fall in sovereign yields, requiring a large primary surplus to ensure a decline of the high debt/GDP ratio.
Fitch assumes that methodological changes due to the implementation of the new ESA 2010 accounting rules will not have a material impact on GGGD/GDP ratio and its dynamics.
Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.