Italy escapes a second rating downgrade a Week After Moody’s

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New Delhi | Updated: October 27, 2018 9:42:27 AM

italy, italian economyItalian bonds may rally Monday

Italy avoided a second rating downgrade in a week as S&P Global Ratings decided only to lower its outlook on the nation’s creditworthiness amid market unease.

The move, while less drastic than had been expected, still leaves the country at risk of a rating cut. The BBB grade, two levels above junk, now has a “negative” outlook, S&P said in a statement on Friday.

Just a week ago, Moody’s Investors Service took a more drastic step, downgrading Italy to one notch above non-investment grade, though it set the outlook at “stable.”

Italian bonds may rally Monday, buoyed by the prospect that both S&P and Moody’s have retained their investment grade rating, ensuring they stay in global indexes. Before the review, ING Groep NV estimated that the 10-year yield spread over Germany could narrow to 250 basis points from around 310 basis points Friday, especially if a budget compromise with the European Union is reached.

“By crowding out investment in the private sector, the government’s economic and budgetary plan risks weakening Italy’s economic growth performance,” S&P said in its report. “At the same time, the plan represents a reversal of Italy’s previously sustained fiscal consolidation path and partly undoes past pension system reform.”
’Change is Coming’

The move follows another week of clashes between the Italian government and the European Commission. The EU’s executive arm rejected the nation’s 2019 budget, an unprecedented step in the bloc’s history, but Prime Minister Giuseppe Conte told Bloomberg that there’s no “Plan B” for the fiscal program.

“Rating agencies don’t measure the welfare of a country’s citizens, but whoever was waiting on S&P in order to continue to go against the government had a bad surprise today — Italy’s rating was affirmed,” Italy Deputy Prime Minister Luigi Di Maio said on Twitter. “We move forward! Change is coming.”

Italy’s bonds have suffered since the populist administration came to power on June 1, with the yield on the 10-year debt rising to the highest in more than four years.

In its assessment last week, Moody’s noted the “material shift in fiscal strategy.” It said debt is at a level that “makes Italy vulnerable to future domestic or externally-sourced shocks, in particular to weaker economic growth.”

Rome targets economic growth of 1.5 percent in 2019, followed by 1.6 percent and 1.4 percent in subsequent years. By comparison, the median in Bloomberg’s latest survey is for expansion of no more 1.1 percent for the next three years.

S&P projects that Italy’s real GDP will grow by about 1.1 percent this year and next, supported by domestic demand, compared with its previous forecast of 1.4 percent. “The government’s policy reversal could undermine Italy’s gradual economic recovery as the erosion of investor confidence is passed on to economic agents,” the rating agency said.

The country has a debt-to-GDP ratio of more than 130 percent, the second-highest in the euro region, after Greece.
EU Criticism

To reach its goal, the government says it has to let the 2019 deficit widen to 2.4 percent of output, before narrowing to 2.1 percent and then 1.8 percent. The 2020 and 2021 figures are lower than initially announced, a concession to investors and criticism from the EU.

Italy’s government debt-to-GDP ratio will no longer continue on a downward path, S&P said. Instead, the country’s gross and net government debt will remain at about 128.5 percent and 123.2 percent of GDP, respectively, over the next three years.

Still, the Treasury’s targets include an increase in the structural deficit, net of the effects of the economic cycle and one-time measures, to 1.7 percent of output in each of the next three years. That’s wider than the 0.9 percent estimated for this year. The figure is considered key by the European Commission in its assessment of budget plans.

Italy’s parliament has to approve the budget law by year’s end.

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