Moody's has cut Italy's long-term senior unsecuredd government debt rating outlook from 'stable' to 'negative', leaving it at Baa2 for now. Citing "slow and halting progress" on economic and fiscal reform in Italy, noting that reduction in Italy’s large debt burden will be further postponed given subdued medium-term growth prospects, recent fiscal slippage.
The drivers for today's rating action are:
(i) the slow and halting progress on economic and fiscal reform in Italy, the prospects for which have diminished further following the 'no' vote in Sunday's constitutional referendum; and
(ii) the resulting rising risk that the reduction in Italy's large debt burden will be further postponed given subdued medium-term growth prospects and recent fiscal slippage, thereby prolonging the sovereign's exposure to unforeseen shocks.
Concurrently, Moody's has today maintained the local-currency and foreign-currency bond ceilings at Aa2. The local-currency and foreign-currency deposit ceilings remain unchanged at Aa2. The short-term foreign-currency bond and deposit ceilings remain unchanged at P-1.
RATINGS RATIONALE – RATIONALE FOR CHANGING THE OUTLOOK TO NEGATIVE
FIRST DRIVER: DIMINISHED PROSPECTS FOR STRUCTURAL ECONOMIC AND FISCAL REFORM FOLLOWING THE REJECTION OF CONSITUTIONAL REFORM
The first driver of Moody's decision to change the outlook on Italy's Baa2 rating to negative relates to the diminished likelihood, following the 'no' vote in Sunday's constitutional referendum, that the Italian government will make meaningful further progress on the structural economic and fiscal reforms needed in order to stabilise the government's credit profile and improve its capacity to absorb shocks.
Real GDP growth in Italy has, on average, been flat for more than 15 years, and real productivity has barely increased in 20 years. Both nominal unit labour costs and Italy's real effective exchange rate show a marked loss of competitiveness. Past and present administrations have identified a series of reforms to address structural weaknesses in the Italian economy and in the government's finances. In Moody's opinion, these reforms should, if implemented in full, support Italy's credit profile by lifting growth over the medium term and supporting a reduction of the Italian government's very high debt burden. In pursuit of these objectives, the Italian government has in recent years introduced pension reform, reforms to the judicial system and to the public administration, as well as labour market reform and a programme of privatisation.
However, reforms implemented to date have had only a limited impact on Italy's medium-term growth and fiscal outlook. Many, such as the government's public sector reforms, have been only partially implemented, and others, such as pension reform and property tax reform, have been diluted or even abandoned. As a result, Italy's growth remains subdued and its growth prospects poor, and longer-term challenges to the government's fiscal strength persist. If sustained over time, low growth alongside high indebtedness will contribute to a gradual erosion in Italy's credit profile, and leave it increasingly exposed to shocks.
In Moody's view, the popular rejection of constitutional reform in Sunday's referendum poses a further threat to the achievement of these reforms, raising the risk of accelerating a weakening of Italy's credit profile. The contemplated changes were aimed at streamlining Italy's political processes which might have provided future Italian governments with the stability and continuity to implement further reforms. In addition, electoral dissatisfaction, illustrated by the referendum outcome, although varied in nature and objective, is likely to constrain further the country's economic and fiscal reform agenda. It also raises the possibility of further policy reversals, particularly if the outcome were to precipitate a general election.
SECOND DRIVER: RISING RISK THAT THE REDUCTION IN ITALY'S ELEVATED DEBT BURDEN WILL BE FURTHER POSTPONED, PROLONGING THE SOVEREIGN'S EXPOSURE TO SHOCKS
The second, closely related, driver of the change in Italy's rating outlook to negative is the rising risk that the stabilisation and reduction in Italy's large debt burden will be further deferred, given the likelihood that medium to long-term growth prospects will remain subdued and recent fiscal slippage.
Italy's subdued growth outlook leaves little scope for any material reduction in the country's very high debt burden over coming years, which represents a key credit weakness: Italy's debt- to-GDP ratio (133% of GDP forecast for 2016) exceeds both the median of Baa-rated countries as well as its euro area peers. In fact, Italy's debt ratio is large on a global scale: in Moody's sovereign rating universe, only Japan and Greece have higher debt ratios.
The high debt burden leaves the sovereign vulnerable to shocks, including not just lower-than-expected real GDP growth but also higher-than-expected fiscal deficits and worsening debt affordability. By lowering the probability that further meaningful reform will be undertaken, the outcome of the referendum increases the risk of a future shock to growth. It also shifts upwards the risk of a shock to debt affordability, particularly should the outcome signal, now or in its aftermath, an increase in support for a change in Italy's relationship with the euro area, and ultimately for membership of the euro. It may also increase the risk that contingent liabilities emanating from Italy's very weak banking sector crystallise on the government's balance sheet, should the 'no' vote lower the prospects of private capital being available to recapitalise the weaker parts of the sector.
Over the nearer term, Moody's believes that the prospects of further fiscal slippage also weigh upon Italy's fiscal outlook. According to European Commission forecasts, Italy's structural deficit is expected to deteriorate significantly as compared with both euro area and wider EU peers between 2015 and 2017. Italy's headline deficit is expected to be 2.4% of GDP in 2016, missing by some margin the target of 1.8% set in the 2015 Stability Programme. A combination of tax cuts and spending initiatives in 2016 have limited progress in reducing the deficit: particularly the government's reversal of expected hikes in VAT and other taxes, and its decision to abolish a property tax on first residences.
A key measure in the 2017 draft budget is the EUR7 billion allocated in additional spending for retirees on the lowest pensions, to be spread over three years with EUR1.9 billion disbursed in 2017, EUR2.5 billion in 2018, and EUR2.6 billion in 2019. This measure is a significant reversal of Italy's 2012 pension reform which introduced new minimum contribution requirements for early retirement. The 2017 draft budget also earmarks more than EUR6 billion, or 0.4% of GDP, in additional spending on migrants and to cover reconstruction costs following several major earthquakes. The European Commission has flagged concerns that Italy could deviate significantly from its medium term objective in 2017, stating that the structural deficit will increase to 1.6% in 2017 from the 1.2% estimated by the government for 2016, instead of declining, as previously expected by the government.
As a consequence, Moody's expects that Italy's debt burden will increase next year. The rating agency now expects Italy's debt to be slightly over 133% in 2017, and to decline only very slowly thereafter. The outcome of the referendum suggests that risks to the deficit and the debt burden remain high.
RATIONALE FOR AFFIRMATION OF THE Baa2 RATING
Moody's decision to affirm Italy's Baa2 rating reflects a number of continuing credit strengths, including the scale of Italy's economy and its elevated wealth levels. Italy has the third-largest economy in the euro area, after Germany and France, the fourth largest economy in the EU, after Germany, the UK and France, and its economy is significantly larger than that of Spain. Other factors underpinning the country's economic resilience are the relatively low indebtedness of Italy's private sector and the significant diversification of its economy. The high strength of Italy's institutions, whilst lower than some of the country's close peers, also supports the Baa2 rating.
Moreover, notwithstanding the shift in the balance of risk as a consequence of the 'no' vote, the affirmation reflects the assumption that the political process will nevertheless lead to a continuation of the reforms needed to lift growth, and that the debt burden will stabilise this year at around 133% of GDP and decline, albeit slowly, thereafter.
WHAT COULD CHANGE THE RATING DOWN / UP
Moody's would consider downgrading Italy's Baa2 issuer rating if it were to conclude that the country's economic prospects would remain poor over the medium term, that the stabilisation and reversal of its debt trajectory would continue to be deferred and remain weak, and that its ability to absorb shocks would continue to deteriorate. Proximate causes of a downgrade would include a material decrease in its primary surplus which the rating agency might conclude was unlikely to be reversed, a deterioration in the sovereign's funding conditions, or further shocks to the government's balance sheet, including the need for a significant recapitalisation of banks by the government. An emergence of elevated financial and debt market stress and/or a more turbulent political environment would also be credit negative.
The negative outlook implies that the probability of an upgrade is low. Moody's would consider stabilising, and ultimately upgrading, Italy's Baa2 issuer rating if a stronger consensus were to emerge in favour of the reforms needed to strengthen the economy's growth prospects. A sustained reversal of the upward trajectory of Italy's debt-to-GDP ratio against the backdrop of a resumption of significant growth would also be credit positive.
The referendum on constitutional reform required the publication of this credit rating action on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.
- GDP per capita (PPP basis, US$): 35,781 (2015 Actual) (also known as Per Capita Income)
- Real GDP growth (% change): 0.7% (2015 Actual) (also known as GDP Growth)
- Inflation Rate (CPI, % change Dec/Dec): 0.1% (2015 Actual)
- Gen. Gov. Financial Balance/GDP: -2.6% (2015 Actual) (also known as Fiscal Balance)
- Current Account Balance/GDP: 1.6% (2015 Actual) (also known as External Balance)
- Level of economic development: High level of economic resilience
- Default history: No default events (on bonds or loans) have been recorded since 1983.
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