Italy has a window of opportunity, says Fitch
Italy has an opportunity to bring its debt crisis under control, but this opportunity is conditional on retaining market access, says Fitch.
Access to the credit markets is under threat from the dramatic rise in Italian bond spreads and yields, which reflect a loss of confidence in the European policy response to the systemic crisis of the Eurozone. Italy’s debt profile means it has a few months to reassure markets of the credibility of its reforms.
Italy’s weakness stems from high public debt burden and weak growth performance, making it especially vulnerable to any intensification of the Eurozone crisis. This is reflected in Fitch’s current rating for Italy, which is ‘A+’/Negative.
Despite this, says Fitch, “there is a window of opportunity for the new Italian government to generate a positive surprise that would, if supported by European policy action, including intervention by the ECB, break the negative market dynamics and shift bond yields towards a more sustainable level.”
In a note, Fitch says it believes Mario Monti’s new government has the credibility to pursue fiscal and structural economic reform. Fitch also believes Monti can remain in office until the general elections scheduled in April 2013.
The first test of the new government is to secure a broad parliamentary and public support for the government and its fiscal and economic reform programme. This task will be complicated by the fact that Italy is probably already in recession, within the context of a downturn in activity across the Eurozone.
“Sustaining political and public support for structural reforms and austerity will be challenging in the face of rising unemployment,” says Fitch. “Convincing investors that the reforms will be effectively implemented and will boost economic growth over the medium term will be equally if not more challenging.”
The policy priorities of the new government are expected to focus on additional fiscal measures that would begin to lower the debt burden from 2012, as well as strengthen the credibility of the balanced budget target for 2013.
Of more significance for positively shifting growth expectations that are at the heart of the current crisis of confidence will be measures to reform public administration and reduce public spending, liberalise the economy and make the labour market more flexible.
Fitch believes that the duration and maturity of the Italian treasury debt (five and seven years, respectively) means that it could absorb an elevated marginal cost of funding for a prolonged period before the budgetary burden became unsustainable.
“Moreover, Italy’s treasury debt redemption profile over the remainder of this year and into January is moderate – around €31bn of Treasury bills mature that are likely to be refinanced, albeit at a high cost – and cash deposits stand at around €36bn. However, says Fitch, “more than €36bn of medium-term bonds mature in February and €193bn over the whole of next year. It is therefore imperative that Italy retains market access.”
European and international policy institutions would intervene to prevent a self-fulfilling liquidity crisis for any systemically important sovereign, including Italy, Fitch believes. However, “the emphasis on ‘private sector involvement’ (PSI) and the subordination of private creditor claims under the Greek PSI restructuring underscore that under such a scenario, the risks to bondholders would remain elevated even as short-term credit risk is lowered by external support.”
Fitch concludes that Italy’s sovereign ratings are premised on it retaining market access. “In the event that the Italian government loses market access – not Fitch’s base case – the ratings would be lowered, likely to the low investment grade category.”