DBRS Correction: DBRS Downgrades Republic of Italy to A (low), Negative Trend

DBRS has issued a correction to the Republic of Italy press release it issued on 6 March 2013. The corrected version, below, notes the appropriate application of DBRS’s long-term and short-term mapping scales (available on www.dbrs.com) by amending the trend on Italy’s short term foreign and local currency debt to Stable from Negative. The corrected press release is as follows:

DBRS Ratings Limited (DBRS) has today downgraded the ratings on the Republic of Italy’s long-term foreign and local currency debt to A (low) from A, and confirmed the Negative trend on both ratings. In addition, DBRS has confirmed the Republic of Italy’s short term foreign and local currency debt at R-1 (low) with a Stable trend.

The rating action reflects DBRS’s assessment that there has been a marked deterioration in Italy’s credit profile and outlook. Two factors underpin the downgrade: (i) political uncertainty following the February 24-25 elections, which has called into question the government’s ability to approve structural reforms needed to boost long-term productivity; and (ii) the effect of the protracted recession on the public debt ratio, which rose to 127% of GDP in 2012. The Negative trends reflect the risk that on-going political uncertainty amid a low growth environment will delay debt stabilization.

The Italian elections ended in a stalemate and negotiations to form a new government are likely to be prolonged. DBRS believes that the differing policy views of the largest parties will result in uncertainty over the future direction of economic policy if and when the new government is sworn in. DBRS is further concerned that the incoming government may not receive a sufficiently strong mandate to promote growth and maintain the reform momentum while continuing the fiscal consolidation effort.

The outlook for the Italian economy has also deteriorated, with GDP contracting by 2.4% in 2012 and set to decline by 1.0% in 2013. The combination of fiscal tightening (3.5% of GDP in 2012-2013), on-going tensions in financial markets and tight lending conditions are affecting economic activity via the income and confidence channels as firms and consumers put their investments and spending plans on hold.

Weaker growth coupled with a fiscal consolidation plan which is substantially skewed to the revenues side is resulting in material fiscal slippage with government debt rising to 127% of GDP in 2012, up from 120.7% in 2011. DBRS expects the public debt to continue to rise in 2013-14 to over 128% of GDP despite the large primary surplus, as nominal GDP is likely to continue to underperform the average cost of servicing the debt. The large government refinancing needs (around EUR 270 billion still due by end of 2013, or 17% of GDP) makes Italy highly sensitive to changes in market sentiment and thus exposes the sovereign to higher borrowing costs.

Improving Italy’s weak growth performance remains a fundamental driver of the rating. Over the last decade Italy’s economic growth was persistently below the Euro zone average, while total factor productivity growth has been negative and potential growth is estimated to have stalled. Weak growth is partly the result of low productivity, low employment rates, low investment in R&D and education, all of which led to declining competitiveness. Against this backdrop, the Italian government introduced in 2012 a number of reforms aimed at boosting productivity and potential growth. DBRS believes that the broad range of structural reforms, whilst a positive step in the right direction, will take time to have an impact on economic activity and is subject to implementation risks. Furthermore, the current lack of a stable government will likely reduce the momentum towards the adoption of further and deeper reforms.

The rating of A (low) balances these credit challenges with a number of strengths, which include the strong commitment by the government to reduce government borrowing, as reflected in a budgetary position that remains relatively strong and compares favourably with the Euro zone average. Italy recorded a primary surplus of 2.5% of GDP in 2012, estimated to rise to 3.2% of GDP in 2013 and 3.3% in 2014. Italy also benefits from a wealthy and diversified economy, solid corporate and household balance sheets and a track record of pension reforms that, under a positive scenario for output and employment, support the long-term sustainability of public finances.

In addition, Italy benefits from Euro zone membership. As the third largest economy in the Euro area, and being therefore important to its stability, DBRS believes that the European Stability Mechanism (ESM) and the European Central Bank stand prepared to provide conditional financial assistance if bond yields were to rise significantly. However, DBRS believes that the unsettled political environment and the considerable austerity fatigue prevailing in the country further increase uncertainty over the government’s ability to negotiate the strict conditions for European support.

The economic outlook and prospects for debt stabilisation will continue to weigh on Italy’s ratings. The ratings could be downgraded if: (i) political instability, weakening growth prospects or higher funding costs delay debt stabilization, or (ii) structural reforms are reversed. The ratings could stabilise if political negotiations result in a government with a cohesive parliamentary majority committed to deliver the economic and fiscal policy measures needed to stabilize the debt ratio and boost the country’s medium term economic growth potential.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include IMF, European Commission, Eurostat, Banca d’Italia, ISTAT, Ministero dell’Economia e delle Finanze, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 3 February 2011
Most Recent Rating Update: 16 November 2012

For additional information on this rating, please refer to the linking document under Related Research.