S&P Downgrades Italy; Euro, Futures Tumble
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.
Italy Unsolicited Ratings Lowered To 'A/A-1' On Weaker Growth Prospects, Uncertain Policy Environment; Outlook Negative
- 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.
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.
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.
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.
Futures not happy:
Neither is the Euro: