October 24, 2014 / 8:05 PM / 5 years ago

Fitch Affirms Italy at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, October 24 (Fitch) Fitch Ratings, London, 24 October 2014: Fitch Ratings has affirmed Italy's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB+'. The issue ratings on Italy's senior unsecured foreign and local currency bonds have also been affirmed at 'BBB+'. The Outlooks on the Long-term IDRs are Stable. The Country Ceiling is affirmed at 'AA+' and the Short-term foreign currency IDR at 'F2'. KEY RATING DRIVERS The Italian economy is in a prolonged slump and growth prospects are weak. GDP is currently close to its 2000 level and 9% below its peak in 2008. It contracted again in 1H14, in contrast to Fitch's previous expectation of a weak recovery, after 0.1% growth in 4Q13. Fitch forecasts GDP to contract by 0.2% in 2014, followed by growth of 0.6% in 2015 and unemployment to remain above 12% until 2016. Nominal GDP growth will also remain very weak over the medium term, and is unlikely to exceed significantly the 1.2% average of the 2005-2013 period. General government gross debt (GGGD) was exceptionally high at 128% of GDP in 2013, compared with the 'BBB' category median of 40%. Fitch forecasts it will peak at 134% of GDP in 2015 and remain above 120% until 2022. This implies a decade-long period of limited fiscal flexibility to respond to potential adverse shocks. A return to GDP growth and maintaining large primary budget surpluses will be key to reducing the debt ratio. The government has revised its target for the general government deficit to 3% of GDP in 2014 (from 2.6% in the April Stability Programme) and 2.9% in 2015 (from 1.8%), little changed from 2013 and 2012. The government estimates that the structural fiscal deficit will widen by 0.3% of the GDP in 2014 and remain little changed in 2015. It argues that an easing in fiscal consolidation is required to prevent a recessionary spiral and to support structural reforms. Inflation has declined further this year to -0.1% in September 2014 from 0.6% in January 2014. Both headline and core inflation (HICP excluding energy and unprocessed food) are at historical lows and below the eurozone average. Persistently low inflation leads to slow nominal GDP growth, increasing the real value of the large public debt stock. Italy's creditworthiness is supported by a large, fairly wealthy, high value-added and diversified economy, with moderate levels of private sector indebtedness and a sustainable pension system. The Italian sovereign has continued to benefit from a significant improvement in financing conditions since mid-2012. Yields of 10-year sovereign bonds declined to 2.3% in 3Q14, a historical low. Furthermore, Italy demonstrated financing flexibility and resilience during the sovereign debt crisis and the average life of GGGD has stabilised at 6.4 years. Italian banks have strengthened their capital during 2014, taking advantage of benign market conditions ahead of the publication of the ECB's comprehensive assessment, by raising EUR10.5bn fresh equity. This limits fiscal contingent risks for the sovereign amid the weak economic environment. Although there is a risk that some Italian banks may need to take further actions to meet capital shortfalls after the results of the comprehensive assessment are published we believe any capital shortfall should be manageable and largely met by private sources . Italian banks have high levels of NPLs and face a challenging economic environment. Italy's current account surplus in 2014-2016 will likely increase from the 1% of GDP recorded in 2013, the first since the global financial crisis. The weaker euro exchange rate could boost extra-eurozone exports, in particular to the US and the UK, the two most dynamic advanced economies, while export demand from emerging economies is unlikely to increase. Domestic demand will remain anaemic, constraining import growth while falling oil prices will improve the economy's terms of trade. However, net external debt is 54% of GDP, well above the 'BBB' category median of 5%. The government of Prime Minister Matteo Renzi is making progress with an agenda of structural and fiscal reforms, which if implemented successfully could have some positive impact on growth over the medium-term. It also aims to introduce further tax cuts, funded by expenditure reductions over the medium term. The victory of the governing Partito Democratico in the European Parliamentary elections in May 2014 is indicative of public support for the government's reform agenda. Nevertheless, there are political risks to implementation. The introduction of the new, ESA 2010, national account methodology resulted in a 4.7pp decline of Italy's GGGD/GDP ratio in 2013. The change is due to an increase in the level of GDP, driven mainly by reclassification of research and development expenditure, while the nominal debt level has not changed compared with the previous, ESA95 accounting rules. This explains why the GGGD/GDP peak is 1pp lower than in Fitch's April 2014 review, despite adverse macroeconomic and fiscal projections. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Factors that may, individually or collectively, result in a negative rating action are: -Reduced confidence that GGGD/GDP will peak in 2015 -A failure of the economy to return to growth -Political turmoil disrupting economic and fiscal policies, or weakening political support for fiscal consolidation over the medium term Factors that may, individually or collectively, lead to a positive rating action are: -GGGD/GDP peaking in 2015 and being placed on a firm downward path thereafter -Sustained and broad-based economic recovery, including an acceleration in nominal GDP growth KEY ASSUMPTIONS Fitch assumes that a GDP contraction of 0.2% in 2014 will be followed by 0.6% growth in 2015 and 1% in 2016. Fitch remains cautious regarding the potential benefits of structural reforms and maintains its view that the growth potential of the Italian economy would not exceed 1% over the medium term even after the currently proposed structural reform measures are implemented. The Italian economy has so far failed to benefit from recent modest fiscal and monetary stimuli, heightening risks surrounding the recovery. Fitch assumes the European Commission will not impose sanctions on Italy during the negotiations on the 2015 budget. Italy's compliance with the new fiscal governance framework is supported by progress in most of the areas mentioned in the recommendations of the EU Council on Italy's national reform programme in June 2014. However, Italy will not meet the recommendation of a declining debt ratio in 2015 or a 0.5% reduction in the structural balance, key pillars of the EU's reinforced fiscal rules, which also have a direct impact on debt dynamics. Fitch assumes the eurozone will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. Fitch also assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term. Contact: Primary Analyst Gergely Kiss Director +44 20 3530 1425 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Ed Parker Managing Director +44 20 3530 1176 Committee Chairperson Paul Rawkins Senior Director +44 20 3530 1046 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Criteria' dated 12 August 2014 and 'Country Ceilings' dated 28 August 2014, are available at www.fitchratings.com. Applicable Criteria and Related Research: Sovereign Rating Criteria here Country Ceilings here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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