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Rating Action:

Moody's affirms Italy's Baa2 rating, maintains negative outlook

Global Credit Research - 06 Oct 2017

London, 06 October 2017 -- Moody's Investors Service, ("Moody's") has today affirmed Italy's long-term issuer ratings at Baa2. The outlook remains negative. Italy's senior unsecured bond and MTN program ratings were also affirmed at Baa2/(P)Baa2, while the Commercial Paper and other short-term ratings were affirmed at Prime-2/(P)P-2. The senior unsecured shelf was also affirmed at (P)Baa2.

The key drivers for the decision to affirm Italy's ratings at Baa2 are as follows:

1. The government has managed to stabilize the banking sector. While restoring the sector to health will take time, the tail risk of a deeper banking crisis with significant impact on the sovereign's balance sheet has been reduced with the government's actions on the weakest banks earlier this year;

2. The Italian economy is currently seeing stronger growth, after six years of very weak outturns, with the recovery now being increasingly broad-based. Moody's believes that the near-term outlook for growth is now stronger than the rating agency had expected earlier. This should help to stabilize public finances and prevent a further increase in the public debt ratio over the coming years.

At the same time, the downside risks to Italy's creditworthiness remain elevated, leading the rating agency to maintain the negative outlook on the Baa2 rating. Despite the recent improvement, Italy's growth prospects are likely to remain moderate over the medium-term. Also, there remains considerable uncertainty regarding the policy priorities of the next government and the pace of fiscal and growth-sustaining reforms for the coming years. A stabilization of the rating at the current Baa2 rating would require a clearly outlined strategy for structural reforms and a fiscal policy path that offers assurance of a significant and sustained reduction in the public sector's indebtedness.

Italy's long-term local currency and foreign-currency bond and deposit ceilings are unchanged at Aa2. The short-term foreign currency bond and deposit ceilings also remain unchanged at P-1.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION OF THE Baa2 RATING

FIRST DRIVER: GOVERNMENT ACTIONS HAVE MANAGED TO STABILISE THE BANKING SECTOR

The government's precautionary recapitalisation of the country's third largest bank, Banca Monte dei Paschi di Siena S.p.A. (MPS, long-term bank deposit rating at B1 stable, senior unsecured debt rating at B3 negative; baseline credit assessment at caa1) and the resolution of two other smaller banks in mid-2017 have significantly reduced the risk of a deeper banking crisis in the country. The cost to the government of its latest banking interventions has been relatively small so far, with total capital provision of €10.2 billion (0.6% of 2017 GDP), which are already accounted for in the public debt ratio. The government has also extended guarantees on bonds and loans, with a nominal value of €31.1 billion (1.8 % of GDP). In total, the government has set aside up to €20 billion for recapitalization and provision of guarantees to banks.

In addition, reforms of the mutual and cooperate banking groups are under way to improve governance and allow the entry of private capital. Reforms enacted in 2015 and 2016 aim to improve the speed and efficiency of insolvency and foreclosure procedures. The formation of new non-performing loans is slowing down and the improving market conditions have allowed some banks to dispose of portfolios of non-performing loans on their balance sheet, although a broad-based cleaning up of the balance sheets of the banking sector will likely take considerable time. Moody's focus has shifted away from the risk of a systemic banking crisis towards the question of when the banking sector will be able to make a substantial positive contribution to Italy's growth.

SECOND DRIVER: STRONGER AND BROAD-BASED ECONOMIC RECOVERY WILL LIKELY SUPPORT STABILISATION OF ITALY'S FISCAL METRICS

The Italian economy is growing at a faster pace than was expected at the time the negative outlook was assigned in December last year. Importantly, the broad-based nature of the recovery provides some assurance that growth can be sustained over the near-term; in contrast to the past two years the recovery is no longer driven solely by private consumption. Productive investment is increasing at robust rates, helped by tax incentives but also the strengthening euro area and global recovery. With financing conditions now back in line with those in other euro area countries, capacity utilization in the manufacturing sector at the highest level since Q3 2007 and a continued recovery in the euro area, investment should continue to expand.

Employment growth has been positive for some time, helped by tax incentives for hiring but possibly also reflecting the lagged effect of labour market reforms implemented from 2012 onwards. This has been supporting household consumption. Another encouraging sign is the performance of exports, which have been growing at robust rates since Q3 2016. In sharp contrast to its performance in the early years of monetary union, when the country was systematically losing market share, Italy is now maintaining its export market share, which bodes well for a continuation of the export recovery under way. Moody's now expects real GDP growth of 1.5% for both 2017 and 2018.

The somewhat better economic performance should also support the government's ongoing efforts to consolidate its finances. The general government budget deficit for 2017 will likely be in line with the revised target of 2.1% of GDP. While the government clearly emphasizes support for growth over fiscal consolidation, such a deficit outcome would nevertheless be an improvement from a deficit of 2.5% last year and 2.6% in 2015. As a result, Moody's expects the debt ratio to stabilise this year at around 130% of GDP. The government targets a further deficit reduction to 1.6% of GDP for next year. However, the precise measures for achieving the target will only be clarified in the upcoming 2018 budget, to be presented by 15 October.

RATIONALE FOR NEGATIVE OUTLOOK

Notwithstanding recent signs of stabilization of some of Italy's credit metrics, the sovereign's balance sheet is highly leveraged and vulnerable to an economic or financial shock. The negative outlook reflects the risk that government policy to date and in prospect will not sustainably address this vulnerability.

In Moody's view, Italy has a limited window of opportunity in particular to turn around the debt trend, before interest rates start to rise. The country has a relatively poor track record of implementing structural reforms. The positive impact of a number of reforms implemented over the past several years remains unproven and there is considerable uncertainty around the authorities' capacity and willingness to press ahead with further structural reforms. Repeated revisions to fiscal targets have dented the government's fiscal credibility.

In this context, it will be important to assess whether the medium-term policy priorities of the next government following the upcoming general elections will ensure that the reform momentum will be sustained. Moody's will assess whether the new government's fiscal plans are sufficiently clear and credible to engineer a clear and significant downward trend in the debt-GDP ratio; and whether its broader reform plans are likely to enhance economic resiliency. The latest opinion polls suggest that the elections will most likely result in a hung parliament, with no party or grouping gaining a majority to form a government

WHAT COULD MOVE THE RATING UP

The negative outlook signals that an upgrade is unlikely in the near future. Italy's key vulnerability is the government's very high debt burden. Moody's would consider stabilizing the Baa2 rating if there was a high level of confidence that the debt ratio would be put onto a sustained downward trend. This would require a reorientation of fiscal policy towards achieving higher primary surpluses than the current 1.5% of GDP on a sustained basis.

The outlook could also be stabilized and the rating ultimately upgraded if a more ambitious programme of structural reforms were to be implemented by the next government, which would result in a sustainably stronger growth performance of the Italian economy.

WHAT COULD MOVE THE RATING DOWN

The rating would be downgraded if policies enacted or anticipated proved insufficient to firmly place the public debt ratio on a sustainable, downward trajectory in the coming years. A failure to articulate and present a credible structural reform agenda which Moody's concludes will enhance economic resiliency by strengthening growth would also put downward pressure on the rating.

GDP per capita (PPP basis, US$): 36,403 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 0.9% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 0.5% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -2.5% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 2.5% (2016 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 03 October 2017, a rating committee was called to discuss the rating of the Government of Italy. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, have not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

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 credit rating action on the support provider and in relation to each particular credit 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 credit rating action, and whose ratings may change as a result of this credit 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.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

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.

Kathrin Muehlbronner
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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