Fitch downgrades Italy – cites election, deeper recession risk

Fitch Ratings has downgraded Italy’s long term Issuer Default Ratings to BBB+ from A-, with a negative outlook.

The downgrade reflects the following key rating factors, Fitch said:

   – The inconclusive results of the Italian parliamentary elections on 24-25 February make it unlikely that a stable new government can be formed in the next few weeks. The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession.

   – Q412 data confirms that the ongoing recession in Italy is one of the deepest in Europe. The unfavourable starting position and some recent developments, like the unexpected fall in employment and persistently weak sentiment indicators, increase the risk of a more protracted and deeper recession than previously expected. Fitch expects a GDP contraction of 1.8% in 2013, due largely to the carry-over from the 2.4% contraction in 2012.

   – Due to the deeper recession and its adverse impact on headline budget deficit, the gross general government debt (GGGD) will peak in 2013 at close to 130% of GDP compared with Fitch’s estimate of 125% in mid-2012, even assuming an unchanged underlying fiscal stance.

   – A weak government could be slower and less able to respond to domestic or external economic shocks.

However, despite the downgrade and negative outlook, Fitch also notes the strengths that Italy still possess. One is the economy, which the ratings agency describes as “high value-added and diverse…with moderate levels of private sector indebtedness.”

It said the country has made substantial progression in the past two years in dealing with its fiscal restructuring. And there is a relatively low level of risk to the taxpayer from the banking sector.

“An underlying budgetary position close to that necessary to stabilise the government debt to GDP ratio; and sustainable pension system underpins confidence in the long-term solvency of the Italian state.”

“The Italian sovereign has demonstrated its financing flexibility and resilience during the crisis reflecting a strong domestic investor base and average duration of 4.74 years,” Fitch added.

Some  other risk factors remain, however, which explains the negative outlook. One is that the current recession could last longer than forecast. That would undermine attempts to continue the process of putting the country’s tax system in order, as well as increase the risk to the taxpayer from uncertainties in the financial sector.

Fitch also raises the spectre of further crisis in the eurozone, which could result in lower demand for Italian goods and services, and lead to tigher credit.

As to the issue of whether Italy might need support from Europe’s bailout mechanism or the ECB, Fitch said: “Financing conditions have been relatively benign in recent months. The potential backstop of external support from the ESM and ECB reduces the tail risk of a sovereign liquidity crisis for Italy and is supportive of the rating. While it remains uncertain under what conditions Italy would apply for official assistance, the request itself would be neutral for the rating.”

Fitch’s assumption still is that Italy will start to recover from its deep recession in the second half of 2013, and that liabilities for the taxpayer from the financial sector will remain low.

The rating agency “maintains its assumption that medium-term potential growth is 1% even in light of structural reforms adopted over the last two years.”

“The current rating reflects Fitch’s judgement that Italy will retain market access and, if needed, EU intervention would be requested and provided to avoid unnecessary strains on sovereign liquidity.”

“Furthermore, Fitch assumes there will be progress in deepening fiscal and financial integration at the eurozone level in line with commitments by euro area policy makers. It also assumes that the risk of fragmentation of the eurozone remains low.”


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