October 20, 2017 / 8:11 PM / a year ago

Fitch Affirms Italy at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) LONDON, October 20 (Fitch) Fitch Ratings has affirmed Italy’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB’ with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Italy’s ‘BBB’ rating is supported by a diversified, high value-added economy, with GNI per capita, governance and human development indicators much stronger than the peer group median. Private sector indebtedness is moderate, there is a sustainable pension system, and government yields are low. Set against this are the extremely high level of public debt, a track record of fiscal slippage, relatively high net external debt, low trend GDP growth, ongoing weakness in the banking sector, and political risk. Italy’s rating also reflects the following key rating drivers:- The newly revised Stability Programme further backloads fiscal consolidation, following the pattern of recent budgets and largely in line with Fitch’s expectations at our April review. Fitch forecasts a narrowing in the 2017 general government deficit to 2.2% of GDP, from 2.5% in 2016, two-thirds of which is due to lower debt interest costs. This would equate to an increase in the structural deficit of close to 0.5% of GDP. The 2018 general government deficit target has been eased to 1.6% of GDP from 1.2% (and compares with the 2015 Stability Programme target to balance the budget) and the 2019 target to 0.9% of GDP from 0.2%. The deficit-reducing measures set out in the draft 2018 budget focus on improving tax efficiency and avoidance, and on broad-based central government expenditure cuts, with no activation of VAT safeguard clauses. Fitch forecasts some further slippage relative to targets in 2018 and 2019, with deficits of 1.9% and 1.5% of GDP respectively, which would be broadly neutral on a structural basis. Deficit reduction is expected to fall broadly evenly between revenue and expenditure, with next year’s election constraining a faster adjustment. General government debt is forecast to increase to 132.5% of GDP in 2017, from 132.0% in 2016, partly due to banking sector interventions earlier in the year totalling 0.6% of GDP, and to a low GDP deflator. Thereafter public debt falls only gradually in our medium-term projections, to 128.3% of GDP in 2021 (which assumes an increase in the primary surplus to 2.0% of GDP from 1.5%). This would leave Italy as one of the most highly indebted sovereigns in Fitch’s rated universe, and compares with a ‘BBB’ peer median of 42.3% of GDP.

Economic activity has gained momentum but Fitch continues to view Italy's medium-term growth prospects as weak. We forecast that GDP will rise 1.4% in 2017, up from 0.9% last year, driven by domestic demand. Growth is expected to moderate in 2018 to 1.1%, as a further pick-up in investment to 3.2% only partly compensates for cooling private consumption due to a fall in real wages. Fitch forecasts GDP growth of 0.9% in 2019 as economic slack is steadily absorbed, falling further towards a trend rate of 0.4% in 2021. Italy's economy contracted by an average of 0.5% from 2011-2016 compared with a 'BBB' median growth of 3.1%, and under our projections real GDP in 2019 is still 4% below the 2007 level. The political landscape remains highly fragmented, with risks of weak government, and of populist, Eurosceptic parties influencing policy after elections due by May 2018. Current opinion polls imply a wide split of seats and difficult coalition dynamics, with a possibility of minority government. Electoral reform is being taken forward which increases the degree of proportional representation, introduces a pooled minimum threshold (of 10%) for coalitions, and abolishes bonus seats. This is likely to lower the probability of a non-mainstream party heading the government, while potentially requiring a broader coalition to govern. We continue to view the medium-term prospects for substantial structural reform as weak. The Italian banking sector is challenged by a high level of non-performing loans (NPLs), alongside weak profitability, which adds to downside risks to the sovereign. There has been a recent improvement in aggregate asset quality, with 'Sofferenze', the worst category of NPLs, falling to 9.5% of total loans in August from a peak of 10.9% in April, with the capital provisioning ratio broadly unchanged at 62%. This largely reflects some large, one-off disposals, including as part of state support provided to the sector this year, in addition to the lower (2%) rate of new NPLs reflecting economic recovery and a stabilisation in house prices. Fitch expects a further, albeit more gradual, reduction in the NPL ratio over the next year. More broadly, we view other credit fundamentals of the banking sector as similar to six months ago. Market confidence in the sector has shored up since the beginning of the year, but the Precautionary Recapitalisation of Monte dei Paschi di Siena has added EUR5.4 billion to public debt this year, and payments to Intesa as part of the liquidation of Banca Popolare di Vicenza and Veneto Banca a further EUR4.8 billion. The government expects only a small share of the additional EUR12.4 billion in guarantees extended to Intesa will be called, although the assessment of such expected losses is uncertain. The current account surplus is expected to remain broadly flat at close to 2.5% of GDP this year and next, compared with the 2008-15 average of a 0.9% deficit. Export volumes have been resilient to a 3% appreciation of the real effective exchange rate this year, rising 5%. More generally, Italy's trade competitiveness has been supported by a reallocation of resources towards more productive firms and some unit labour cost adjustment during the downturn, as well as by earlier euro depreciation and reform measures. Nevertheless, net external debt is forecast to fall only modestly, to 51% of GDP in 2019, and compares with a peer group median of -1% (net creditor). SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Italy a score equivalent to a rating of 'A+' on the Long-Term Foreign-Currency IDR scale. In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/-3 notches because in our view conditions justified a 4-notch adjustment to reflect the following:- - Macroeconomic policy and performance: -1 notch, to reflect Italy's very low GDP growth potential. - Public finances: -1 notch, to reflect very high government debt levels. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the risk at high debt levels. - External finances: -1 notch, to reflect: relatively high net external debt, which is not captured in the SRM; and our view that the SRM enhancement across the eurozone for "reserve currency status" overstates the degree of flexibility provided to Italy given its experience of market volatility. - Structural Features: -1 notch, to reflect: a) weakness in Italy's banking sector, including a high level of NPLs, which represents a contingent liability risk to the sovereign; and b) downside political risks that could adversely affect the coherence and credibility of economic policy-making, economic performance, public finances, or financing flexibility. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The following factors may, individually or collectively, result in negative rating action: - Political developments negatively affecting economic and fiscal policies; - A rise in gross general government debt/GDP; and - Adverse developments in the banking sector increasing risks to the real economy or public finances. The following factors may, individually or collectively, result in positive rating action: - A track record of falling gross general government debt/GDP; - A stronger economic recovery and greater confidence in medium-term growth prospects, particularly if supported by the implementation of effective structural reforms; and - Reduction in banking sector risks. KEY ASSUMPTIONS - Our 2017 general government debt forecast incorporates a 0.3% of GDP positive stock-flow adjustment, as the 0.6% of GDP cost of bank interventions earlier this year is partially offset by proceeds from financial transactions such as privatisations. Our forecast does not incorporate any further public recapitalisation of banks. - Fitch's long-run debt sustainability calculations are based on an average primary surplus of 2% of GDP from 2017-2026, GDP growth steadily moderating to a trend rate of 0.4% in 2021, GDP deflator inflation rising to 1.7%, and a gradual increase in marginal interest rates to 4.5%. - Italy remains a member of the EU and the eurozone. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'BBB'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'BBB'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F2' Short-Term Local-Currency IDR affirmed at 'F2' Country Ceiling affirmed at 'AA' Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'BBB' Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'BBB' Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'F2' Contact: Primary Analyst Douglas Winslow Director +44 20 3530 1721 Fitch Rating Limited 30 North Colonnade London E14 5GN Secondary Analyst Alex Muscatelli Director +44 20 3530 1695 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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