Frankfurt am Main, April 26, 2013 -- Moody's Investors Service has today affirmed Italy's Baa2
long-term government bond ratings, and is maintaining the
negative outlook. In addition, Moody's has also affirmed
Italy's Prime-2 short-term debt rating.
The key factors for maintaining the negative outlook are:
1.) Italy's subdued economic outlook as a result of weak
domestic and external demand (especially from its EU trading partners)
and a slow pace of improvement in unit labour costs relative to other
peripheral countries.
2.) The negative outlook on Italy's banking system,
which is characterised by weak profitability, a deterioration of
asset quality and restricted access to market funding, and which
indirectly raises the cost of funding for small and medium-sized
enterprises (SMEs).
3.) The elevated risk that the Italian sovereign might lose investor
confidence and, ultimately, access to private debt markets
as a result of the political stalemate and the resulting uncertainty over
future policy direction, as well as contagion risk from events in
other peripheral countries.
The key factors behind the affirmation of Italy's Baa2 rating are:
1.) Low funding costs, which, if sustained, buy
time for the government to implement reforms and for growth to resume.
2.) The government's primary surplus, which increases
the likelihood that Italy's debt burden will be sustainable,
despite the expectation of low medium-term growth in nominal GDP.
3.) Economic resiliency, which is supported by the country's
large diversified economy, the relatively low indebtedness of its
private sector and the likely availability of financial support,
if needed, from euro area members given Italy's fiscal consolidation
progress in recent years and Italy's systemic importance for the
euro area.
RATINGS RATIONALE
RATIONALE FOR MAINTAINING THE NEGATIVE OUTLOOK
The first factor underpinning the negative outlook is Moody's view
that Italy's medium-term growth rate will continue to be
anaemic as a result of the growing risk that the current recession will
extend beyond the first half of 2013. Moody's has now lowered
its forecast for Italy's 2013 GDP growth to -1.8%
from its previous forecast of -1.0%, and predicts
growth of only 0.2% for 2014. Italy's economic
outlook remains weak due to a number of factors. Firstly,
low consumer and investor confidence, in part reflecting the inconclusive
election outcome and uncertain political prospects, together with
rising unemployment, are weakening domestic demand. Moreover,
credit remains constrained and expensive, particularly for SMEs
which are Italy's engine of growth. Indeed, close to
one third of Italian firms cannot meet their operational expenses as they
are short of liquidity, according to Confindustria, the Italian
business federation. Lastly, external demand remains weak
as a result of the combination of weak growth in Italy's euro area
trading partners and its weak competitiveness, with unit-labour
costs continuing to fall more slowly than in other euro area peripheral
economies.
The prospects for an improvement in the medium-term growth outlook
are limited given that further progress on structural reforms has been
undermined by the political paralysis induced by the elections of 24-25
February. The elections resulted in no single party winning either
the lower or upper house, thereby prolonging political uncertainty
and raising the possibility of new elections. Despite the ongoing
efforts to form a government, without firm consensus and a clear
mandate, the prospects of further economic reform look poor.
In its absence, the growth of the Italian economy will remain constrained
by its impaired competitiveness.
The second factor that supports the negative outlook is the country's
weak banking system. Many domestic banks have weak core profitability,
high and growing levels of non-performing loans, and are
largely reliant on central bank funding to replace maturing debt.
The exposure to the Italian corporate sector is high, especially
to the SME sector, which is facing increasingly severe pressures
from weak domestic demand and constrained credit. While the system
has continued to build capital levels (with a system-wide Tier-1
ratio of 10.3%), doubtful and non-performing
loans are also increasing across the system, and a further economic
shock would likely cause a material rise in bank impairments and a reduction
in capital.
In time, Moody's expects that the banking sector will have
selected and limited needs for recapitalisation or restructuring,
which may include injections of capital from the government or the imposition
of losses on creditors. Given that second-tier banks are
at greater risk of needing such re-capitalisation than the first-tier
banks, Moody's estimates that the total size of bank re-capitalisation
expenses is not likely to be material to Italy's sovereign credit
profile. Weakness in the banking system is additionally compounding
to the weak economic outlook as the banking sector's high cost of
funds and capital is being passed on to its borrowers, particularly
SMEs, in the form of higher lending rates.
The third factor underlying the negative outlook relates to Italy's
elevated susceptibility to loss of investor confidence, as a result
of the political stalemate in the wake of the inconclusive parliamentary
elections, as well as the continuing risk of contagion from potential
credit events in other euro area peripheral countries. The political
paralysis stemming from the inconclusive elections, and the resulting
uncertainty over the future commitment to reform increase the probability
that investors will conclude that Italy's high debt burden is no
longer sustainable, resulting in rising yields. In such a
scenario, the government would be likely to seek support from euro
area peers via the European Stability Mechanism (ESM) and, potentially,
the European Central Bank (ECB) -- although this option would be
considerably complicated by the domestic political stalemate, since
any external support would inevitably require a credible commitment by
the Italian government to further reforms.
Moody's notes that a shock to investor confidence could also be
triggered by events elsewhere in the euro area. While the impact
of events in Cyprus on yields of other peripheral countries has been surprisingly
benign to date, those events have served as a timely reminder that
the euro area authorities' 'muddle-through' strategy,
based on reactive policy-making with forward progress largely induced
by shocks, tends to heighten the potential for financial market
volatility. In Moody's view, contagion risk among euro
area countries remains elevated, given policymakers' apparent
willingness to countenance Cyprus's potential exit from the euro
area, and the signalled intention to move further in the direction
of routinely bailing-in private creditors. Wider progress
on institutional reforms remains slow and halting, with little clarity
on what further agreement will be forthcoming on the planned banking union,
and further fiscal integration no longer being discussed. In such
an environment, Moody's continues to believe that despite
Italy's recent successful tapping of the market overall appetite
to invest in peripheral banks and sovereigns will remain fragile.
RATIONALE FOR AFFIRMING THE Baa2 RATING
The first two factors underlying Moody's affirmation of Italy's
Baa2 rating are represented by the strong fundamentals that support the
sovereign's debt sustainability; i.e.,
the government's reasonably low current cost of funding, which
buys time for further economic reform to take effect and for growth to
start to materialise, and the government's primary surplus.
Both are currently supporting factors for Italy's debt sustainability,
despite the weak outlook for nominal GDP growth over the medium term.
Italy's debt remains affordable in light of its relatively low funding
costs: the yield on its 10-year government bonds is currently
at around 4%, significantly below its five-year historical
average yield of 4.8%; and the government's interest
-to-revenue ratio was around 11.5% in 2012,
which is not particularly high compared to other sovereigns in the Baa
rating category.
Moreover, Italy has over the years implemented significant fiscal
consolidation, which led to a decrease of the headline general government
budget deficit to 3.0% of GDP in 2012. The primary
surplus increased to 2.5% of GDP in 2012, which is
one of the highest among all Baa-rated sovereigns. This
primary surplus offers the prospect of an eventual reversal in the government's
debt trajectory -- if sustainable and large enough to compensate
for Italy's subdued economic growth, the government's
high debt stock with its associated interest burden, and a potential
risk in its borrowing costs. We expect that Italy's debt-to-GDP
ratio would likely peak within the next two years at a level below 133%
in a scenario in which modest economic growth resumes, fiscal consolidation
is implemented according to the authorities' plans, funding
costs do not increase and no contingent liabilities crystallize.
The third factor underpinning Italy's Baa2 rating is the country's
economic resiliency, supported by the relatively low indebtedness
of the private sector, the economy's large size and its significant
diversification. Italy is the third-largest economy in the
euro area, its bond market is the largest in the monetary union.
Europe's core banks, insurers and retail investors have significant
exposures to Italy, making core European economies susceptible to
the potential emergence of stress in Italy's government debt market.
If needed, Italy's systemic importance to the euro area therefore
represents a strong case for support by core European countries.
WHAT COULD MOVE THE RATING UP/DOWN
Moody's would consider downgrading Italy's government debt rating
in the event of additional deterioration in the country's economic prospects,
a decrease in its primary surplus and/or a need for a significant recapitalisation
of banks by the government. A deterioration in the sovereign's
funding conditions would also put downward pressure on Italy's rating.
More specifically, should Italy's ability to access to public
debt markets become constrained and the country were to require external
assistance, Moody's would likely downgrade Italy's sovereign
rating, possibly by more than one rating notch.
Given the negative outlook on the Baa2 rating, an upgrade is currently
unlikely over the medium term. However, the rating agency
would consider moving the outlook on Italy's sovereign rating to
stable in the event that further economic and labour market reforms were
successfully implemented and led to an effective strengthening of the
growth prospects of the Italian economy. Moreover, a sustained
reversal of the upward trajectory of Italy's general government
debt-to-GDP ratio against the backdrop of a resumption of
growth, which would make public-sector finances less vulnerable
to volatile funding conditions, would be credit positive.
METHODOLOGY
The principal methodology used in this rating was Sovereign Bond Ratings
published in September 2008. Please see the Credit Policy page
on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the rating action on the support provider and in relation to each particular
rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides certain regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
in each case where the transaction structure and terms have not changed
prior to the assignment of the definitive rating in a manner that would
have affected the rating. For further information please see the
ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
support from the primary entity(ies) of this rating action, and
whose ratings may change as a result of this rating action, the
associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
if applicable to jurisdiction: Ancillary Services, Disclosure
to rated entity, Disclosure from rated entity.
This rating was initiated by Moody's and was not requested by the rated
entity.
This rated entity or its agent(s) participated in the rating process.
The rated entity or its agent(s) provided Moody's access to the
books, records and other relevant internal documents of the rated
entity.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Dietmar Hornung
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Bart Jan Sebastian Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's affirms Italy's Baa2 government ratings and negative outlook
