by Tyler Durden
As usual, a corrupt and pathetic Moody's continues to boldly not go where
everyone else has gone before. Luckily, S&P, which had the balls to cut the
US, has just done so to Europe's next domino, by downgrading Italy from A+ to A,
outlook negative. Then again, this was pretty much telegraphed 100% earlier
today as noted in "Italy
Expected To Cut Growth Forecasts Further." Anyway, those incompetents from
Moody's are next.
Full report:
Italy Unsolicited Ratings Lowered To 'A/A-1' On Weaker Growth
Prospects, Uncertain Policy Environment; Outlook Negative
Overview
- Italy's net general government debt is the highest among 'A' rated sovereigns. We have revised our projections of Italy's net general government debt and now expect it to peak later and at a higher level than we previously anticipated.
- In our view, Italy's economic growth prospects are weakening and we expect that Italy's fragile governing coalition and policy differences within parliament will continue to limit the government's ability to respond decisively to domestic and external macroeconomic challenges.
- In our view, weaker economic growth performance will likely limit the effectiveness of Italy's revenue-led fiscal consolidation program.
- We have revised our base-case medium-term projections of real GDP growth to an annual average of 0.7% between 2011 to 2014, compared with our previous projection of 1.3% (see "Credit FAQ: Why We Revised The Outlook On Italy To Negative," published May 23, 2011). As part of our ratings analysis, we have also prepared upside and downside macroeconomic scenarios that could drive our future rating actions on Italy.
- We are lowering our long- and short-term unsolicited sovereign credit ratings on Italy to 'A/A-1' from 'A+/A-1+'.
- The negative outlook reflects our view of additional downside risks to public finances related to the trajectory of Italy's real and nominal GDP growth, and implementation risks of the government's fiscal consolidation program.
Rating Action
On Sept. 19, 2011, Standard & Poor's Ratings Services lowered its
unsolicited long- and short-term sovereign credit ratings on the Republic of
Italy to 'A/A-1' from 'A+/A-1+'. The outlook is negative. The transfer and
convertibility assessment remains 'AAA', as it does for all members of the
eurozone.
Rationale
The downgrade reflects our view of Italy's weakening economic growth
prospects and our view that Italy's fragile governing coalition and policy
differences within parliament will likely continue to limit the government's
ability to respond decisively to the challenging domestic and external
macroeconomic environment.
Under our recently updated sovereign ratings criteria, the "political" and
"debt" scores were the primary contributors to the downgrade. The scores
relating to the other elements of our methodology--economic structure, external,
and monetary--did not contribute to the downgrade.
More subdued external demand, government austerity measures, and upward
pressure on funding costs in both the public and private sectors will, in our
opinion, likely result in weaker growth for the Italian economy compared with
our May 2011 base-case expectations, when we revised the outlook to
negative.
We believe the reduced pace of Italy's economic activity to date will
make the government's revised fiscal targets difficult to achieve. Furthermore,
what we view as the Italian government's tentative policy response to recent
market pressures suggests continuing future political uncertainty about the
means of addressing Italy's economic challenges.
In our opinion, the measures included in and the implementation timeline of
Italy's National Reform Plan will likely do little to boost Italy's economic
performance, particularly against the backdrop of tightening financial
conditions and the government's fiscal austerity program (see "Italy Delivers",
published by the Italian Ministry of the Economy and Finance at http://www.mef.gov.it/documenti/open.asp?idd=27880).
Our reduced expectations concerning Italy's growth prospects also reflect key
structural impediments that we have written about before:
Low labor participation rates and tightly regulated labor and services
markets;
What we consider to be an inefficient public sector; and
Relatively modest foreign investment inflows.
In our view, the authorities remain reluctant to tackle these issues (see our
full analysis on Italy, published Dec. 1, 2010, on RatingsDirect on the Global
Credit Portal). For example, we note that in the July 2011 political discussions
about the Decree Law No. 98/2011 (converted into Law No. 111/2011), several
proposed supply-side measures, including the liberalization of professional
services, were shelved or delayed because of opposition within the governing
coalition and in parliament.
The government projects that its fiscal consolidation program will result in
a cumulative fiscal consolidation of about €60 billion, overall, with the
largest savings projected in 2012 and 2013 (see "Italy Delivers", http://www.mef.gov.it/documenti/open.asp?idd=27880).
However, we think that the government's projection of a €60 billion savings
may not come to fruition for three primary reasons:
First, as described below, we view Italy's economic growth prospects as
weakening;
Second, nearly two-thirds of the projected budgetary savings in the crucial
2011-2014 period rely on revenue increases in a country already carrying a high
tax burden; and
Third, market interest rates are anticipated to rise.
We have adopted a revised base-case macroeconomic scenario, which we view as
consistent with the downgrade and negative outlook. Compared with the May 2011
base case, the revised base-case scenario assumes that annual real GDP growth
will be 0.6 percentage points lower over the 2011-2014 forecast horizon because
of more sluggish growth in exports, investment, and public- and private-sector
consumption. Since May 2011, financial conditions in Italy have tightened and
the pace of economic recovery of its principal global and eurozone trading
partners has slowed. We also note that our revised base case is broadly similar
to the downside (downgrade) scenario we published in May 2011.
We have also adopted a revised downside scenario, consistent with another
possible downgrade. The revised downside assumes a mild recession takes hold
next year, with real GDP declining by 0.6%, followed by a modest recovery in
2013-2014. The economic main drivers in our revised downside scenario are
tighter financial conditions, with higher interest rates on government bonds, as
well as weaker trajectories for private-sector consumption and exports.
We have also adopted a revised upside scenario, which, if it occurred, would
be consistent with our view of a revision of the outlook to stable. Our revised
upside scenario assumes that financial conditions will gradually improve, along
with the trajectories for GDP growth, exports, and investment. For details of
the revised base case and alternate scenarios, see our analysis on Italy,
published Sept. 19, 2011.
Under all three scenarios, we expect that Italy's net general government debt
burden will remain the key rating constraint for the foreseeable future.
We project that such net debt will be 117% of GDP at year-end 2011, up
from 100% of GDP in 2007.
Under our revised base case, the net debt burden would fall only slightly to
115% of GDP by 2014, a similar rate to the May 2011 downside scenario.
Our macroeconomic analysis also illustrates Italy's main credit weakness:
Even under pressure, Italian political institutions, incumbent monopolies,
public-sector workers, and public- and private-sector unions impede the
government's ability to respond decisively to challenging economic conditions.
For example, union opposition to the privatization of Alitalia in 2008 ended
prospects for a takeover by Air France. Moreover, resistance in parliament in
July 2011 led the government to drop proposals to liberalize professional
services from its legislative agenda. Nontariff barriers to foreign direct
investment (FDI) are, in our view, the key reason behind Italy's relatively low
inbound FDI stock. At about 16% of GDP, it is less than one-half that of either
France or Spain (36% and 43% of GDP, respectively) and lower than that of
Germany (27%), despite Italy's potential efficiency gains from economic scale
within Europe's common market.
With elections due in 2013, and the government's parliamentary position
tenuous, it is unclear what can be done to break the deadlock between these
political institutions and the government. As a result, we believe that Italy
remains vulnerable to heightened fiscal, economic, and financial downside
risks.
As noted above, the application of three elements of our recently updated
sovereign ratings criteria--economic structure, external, and monetary--did not
materially change our view from May 2011, when we revised the outlook on Italy
to negative. We continue to score Italy as a high-income sovereign with a
diversified economy and few external imbalances, albeit one with what we see as
weak growth prospects.
In addition, we view both household and corporate balance sheets as
relatively strong, which should enable the government to tap local savings on a
scale that could permit a more gradual fiscal adjustment than for some of its
southern European neighbors. As of year-end 2010, Italy's nonbank sector remains
in a substantial net external creditor position, while the public sector's net
external liability is equivalent to €804 billion (52% of GDP). We note that
Italy's current account deficit has widened recently, to more than 10% of
current account receipts, but we expect this to unwind.
We expect the government, given its tight fiscal position, will provide only
limited direct assistance to the banking system in the near term, and we still
expect most of the Tremonti bonds, which provided four banks' Tier I capital
during the 2008-2009 recession, to be repaid this year.
Outlook
The negative outlook reflects Standard & Poor's view of risks to the
Italian government's fiscal targets over 2011-2014, as well as the uncertainties
on the timely implementation of growth-enhancing reforms. In our view, these
risks would stem from weaker output growth than we currently assume in our
revised base case. In addition, political gridlock could contribute to delayed
policy responses to new macroeconomic challenges and result in significant
fiscal slippage.
If one or more of these risks materializes, Italy's net general government
debt could increase from its already high level. In that event, we could lower
the long- and short-term ratings again. We could also lower the ratings if,
against our expectations, the current account deficit remained higher than 10%
of current account receipts beyond 2013. This would occur if Italy's trade
balance did not improve or if the income deficits continued to widen because of
rising refinancing costs.
On the other hand, if the government manages to gather political support for
implementing growth-enhancing structural reforms, which in turn increase
prospects for a material reduction in the net public debt burden in the medium
term, we could affirm the ratings at the current level.
As is typical, ratings on issues and issuances dependent on these long- and
short-term ratings may be revised as a result of today's rating action.
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