L’agenzia Scope abbassa l’outlook del rating Italia da Stabile a Negativo

Scope affirms Italy’s rating at A- and revises the Outlook to Negative

Euro area membership, a large and diversified economy, primary surpluses, and low private debt support the rating. Implications of anti-establishment landscape, the new government’s programme and impact of tensions with Europe drive the Negative Outlook.

Scope Ratings GmbH has today affirmed the Republic of Italy’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at A- and revised its Outlook to Negative. The agency has also affirmed the short-term issuer rating of S-1 in both local and foreign currency and revised the Outlook to Negative.

Rating drivers

The revision of the Outlook to Negative from Stable on Italy’s A- sovereign ratings reflects the following two drivers:

1. Progressive shifts in Italy’s political landscape in favour of anti-establishment groups, raising political uncertainty and instability – developments which may persist beyond a single new administration, with potential long-term implications for the direction of policy setting in the resolution of Italy’s significant structural challenges; and
2. The policy programme of this singular new Italian government formed by the Five Star Movement (M5S) and Lega – which seeks to undo a series of fiscal, pension and banking system reforms. Although many programme elements are unlikely to be implemented in their current forms, even the adoption of some of the suggested measures may have significant consequences, in the absence of offsetting factors, given pre-existing debt sustainability concerns.

The assignment of a Negative Outlook reflects changes in Scope’s assessments in the ‘public finance risk’ and ‘domestic economic risk’ categories of its sovereign methodology. In Scope’s view, the economic and fiscal policy platform of the new government poses considerable challenges to sustainability. Moreover, the anticipated alteration in stance on economic and non-economic issues may test Italy’s relationship with European institutions. The affirmation of Italy’s A- sovereign rating reflects continued meaningful credit strengths including euro area membership, a large, diversified economy, a track record of primary surpluses, and moderate private debt.

The first driver underpinning Scope’s decision to assign a Negative Outlook is the shift in Italy’s political landscape since the global financial crisis in favour of anti-establishment groups, and the associated implications for the nation’s longer-term economic policymaking. The relevant groups have made gains even in the midst of an economic rebound. A change in expectations regarding domestic policymaking extends potentially beyond this current administration to future Italian governments – for instance, even in a scenario of early elections if this coalition meets internal divisions, anti-establishment parties may similarly be competitive in a repeat election scenario. Lega achieved its best-ever result in the March 2018 elections (with 17.4% of the votes) and has seen gains in the polls since.

This situation will give rise to a lengthy phase of political instability, the likelihood of prolonged inaction in areas requiring reform, and the risk of policy reversals. Italy’s elevated debt stock and weak growth potential are just two reasons why the Italian government can ill afford to be idle with regard to fiscal and structural policies. Over the coming period, Scope will seek to gain greater clarity on the degree to which policies moderate once the group is in government, and the impact on sovereign creditworthiness. This will include a review of the constitutional, European-level and financial system-predicated checks that exist to prevent governments from implementing unsustainable programmes.

The second driver of the outlook change is the new government’s programme. The coalition agreement includes Lega’s proposed tax reduction to a rate of as low as 15% for companies and individuals, the repeal of the 2011 pension reform, the cancellation of a VAT hike due in January 2019, as well as the introduction of a universal basic income. Estimates have placed these actions at a cost of more than EUR 100bn (more than 5.8% of GDP) per annum, and they would largely be uncovered by revenue increases or spending rationalisation elsewhere. The programme also suggests the review of Basel bank regulations, reform of bail-in rules, and the reimbursement of retail shareholders of banks for earlier losses imposed. While many such proposals are unlikely to be enacted in their current forms, and will probably continue to be moderated, if not blocked, the implementation of even some of the suggested measures may have significant consequences, in the absence of offsetting measures, given pre-existing challenges.

Even prior to the new administration, Italy’s budgets have successively been neutral to expansionary (including the 2018 budget) with structural deficit adjustments weaker than anticipated. Moreover, bail-in rules have been bypassed due to domestic concerns, resulting in the recurrent use of government monies to assist bank rescues instead. In recent years, these factors have contributed to a stagnation in Italy’s debt ratio at about the 131.8% of GDP level as of Q4 2017 (32pp higher than Q4 2007 levels and the second-highest in the euro area, after Greece), even though the economy is recovering (including current above-potential growth). In Scope’s view, owing to Italy’s low medium-run growth potential, the pursuit of pro-cyclical fiscal policies and the limited improvement in debt levels during expansionary economic times raise debt sustainability risks in a future downturn. Consequently, Scope will assess the implementation of the new government’s programme, and its impact on Italy’s fiscal consolidation and growth potential. This approach is consistent with the rating-change drivers noted in Scope’s last rating action, which named risks to debt sustainability, a weaker commitment to fiscal consolidation and structural reforms, and more sluggish growth as downside drivers.

Italy’s A- rating is underpinned by euro area membership with a strong reserve currency and an independent European Central Bank effectively acting as a lender of last resort, alongside access to European financial facilities. However, such regional assistance, critical to easing market panic and avoiding sovereign default in extreme moments of stress, depends nonetheless on a government agreeing to established economic governance norms. Scope will assess the new government’s stance vis-à-vis European institutions and evaluate the degree to which it impacts the availability of and willingness to resort to European support in times of stress.

Italy’s economy has experienced a sustained recovery since 2014, with YoY growth of 1.4% as of Q1 2018. The European Commission sees the budget balance improving to -1.7% of GDP in 2018 (from -2.3% of GDP in 2017), but mostly due to cyclical effects. While it is by and large still too soon to judge the economic impact of recent post-election uncertainties, some high-frequency survey data suggest some adverse effects in the early stages following the March elections. More importantly, the long-term growth picture is fragile: Scope estimates medium-run potential growth at 0.75%, speaking to the need for proactive structural reforms. Here, Scope will review the policies underscoring the government’s objective of eliminating the growth differential with the rest of the European Union.

In contrast to these factors, Italy’s ratings are supported by the nation’s euro area membership within a large common market. Scope believes that institutional developments and the adjustments of past years have increased euro area member states’ protection from adverse shocks, underpinning their sovereign creditworthiness. Italy’s ratings are, moreover, supported by its large and diversified economy (with nominal GDP in 2017 of EUR 1.72tn). In addition, non-financial private debt is moderate at 159% of GDP as of Q4 2017 – comparing well with that of European peers, down from peaks of 176% of GDP in Q4 2011. With the exception of 2009, Italy has maintained a significant track record of primary surpluses in past decades, and the combined European-level and domestic fiscal framework, enhanced during the debt crisis – which obligates Italy to adhere to a balanced budget – is a credit strength, in Scope’s view.

The relatively long 6.9-year average maturity of Italy’s debt stock shields the government’s interest costs to a certain extent from the impact of higher government market yields, in the face of recent market turbulence. The current account is estimated to have reached a surplus of 2.8% of GDP in 2017, compared with a deficit of 3.4% of GDP as of 2010. Italian banks’ stock of non-performing loans is still very high compared with the European average (Italy’s at 14.5% of total loans in Q4 2017, though this is down from 17.4% a year earlier and compared with 18.2% during a 2015 peak). Risks in the banking sector are a continued rating constraint, though Scope views positively the increase in tier 1 capital ratios to 13.8% of risk-weighted assets in Q4 2017. However, significant action still needs to be taken to improve insolvency and debt enforcement procedures, facilitate bank rationalisation and consolidation, and make timely and consistent use of the resolution framework.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “A” (“a”) rating range for the Republic of Italy. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

For Italy, the QS signals relative credit strengths for the following analytical categories: i) market access and funding sources; and ii) vulnerability to short-term external shocks. Relative credit weaknesses are signalled for: i) the growth potential of the economy; ii) the economic policy framework; iii) the fiscal policy framework; iv) debt sustainability; v) recent events and policy decisions; and vi) banking sector performance.

The combined relative credit strengths and weaknesses generate a downward adjustment and signal an A- sovereign rating for Italy.

The results have been discussed and confirmed by a rating committee.