DBRS Confirms Italy at A (low), Stable Trend

DBRS Ratings Limited has confirmed the Republic of Italy’s long-term foreign and local currency issuer ratings at A (low) and the short-term foreign and local currency issuer ratings at R-1 (low). All ratings have a Stable trend.

The rating is underpinned by the government’s commitment to fiscal consolidation, as reflected in a relatively good budgetary position compared with its Euro area peers, as well as progress in delivering institutional and structural reforms. Italy also benefits from demonstrated debt servicing flexibility, relative low private sector debt, a well-financed pension system, and a large economy. However, these supportive factors are balanced by significant challenges such as the country’s exposure to external shocks, high government debt and low potential growth.

The Stable trend reflects DBRS’s assessment that the risks Italy faces remain fairly balanced as a result of a positive recovery despite the uncertainty on the external environment. If continued progress on the fiscal side were to lead to a significant reduction in the debt-to-GDP ratio, this would likely put upward pressure on the ratings. On the other hand, a weaker political commitment to fiscal consolidation and the reform agenda, or a material downward revision to growth prospects, either due to adverse external shocks or weak domestic demand, could lead to a Negative trend.

Italy’s sovereign ratings reflect a commitment to fiscal consolidation, as mirrored in a budgetary position that remains relatively strong. After easing moderately in 2014, Italy’s fiscal consolidation effort accelerated in 2015 where the deficit declined to 2.6% of GDP from 3.0% of GDP in 2014 and it is further projected to decrease to 2.2% this year supported by the low level of yields on government bonds, further easing in monetary conditions and higher growth.

Nevertheless a deterioration in the structural deficit (from 0.3% of GDP in 2015 to 0.7% of GDP in 2016) is expected as a result of the deactivation of the tax increases that should have been in force since the beginning of the year (valued at 1% of GDP) and of the reduction of the property tax on primary residences and on farmland (0.3% of GDP). At the same time the government has pledged to implement additional corporate income tax cuts in 2017, which it intends to fund with spending cuts. DBRS expects the proposed measures to have a positive impact on household confidence and business sentiment. However, the impact on the economy will depend on a clear identification of the funding for structural tax cuts through detailed spending reductions.

After a three-year recession, Italy's economy has begun to recover (0.8% in 2015) . Real GDP is expected to moderately accelerate in 2016 by 1.3%, supported by a recovery in external demand, improving domestic confidence and modest growth in investment. The recovery is also underpinned by the European Central Bank’s (ECB) expansionary measures, the depreciation of the euro, the fall in oil prices and the less restrictive fiscal policy stance. Low energy prices and an improvement in external competitiveness should sustain the current account surplus at close to 2% of GDP in 2016-17.

The government has made concrete progress in passing institutional and structural reforms. A new constitutional reform is expected to be approved in 2016, and along with the new electoral law is expected to promote government stability over the medium term. The labour market reform has started to produce some positive effects and at the same time the government has been able to pass new bankruptcy laws to facilitate the rescue and turnaround of distressed companies and non-performing loans, and to introduce a new securitization scheme for credit disposal.

Italy continues to benefit from the significant improvement in funding conditions since the end of 2012, supported by low yields and a demonstrated debt-servicing flexibility during the crisis by maintaining a strong domestic investor base, which held 65.4% of government debt in November 2015, compared with 56.7% in 2010. In addition, the average maturity of government debt has remained comfortable at 6.5 years in February 2016, helping to shelter the country against interest rate shocks.

Despite these strengths, Italy faces some challenges. The positive growth is still fragile, uncertainty over geopolitical risks, such as the risk of a British departure from the EU, persistent inward migration, or a slowdown in emerging markets could affect the pace of the recovery.

Although the government projects a rapid decline in the debt to GDP ratio, from 132.6 in 2015 to 119.8% in 2019 that seems quite challenging since it would imply a primary surplus of 3.7% of GDP on average from 2017 to 2019 (if compared with the average of 1.4% of GDP over the last five years). At current growth estimates, DBRS expects government debt to decline gradually this year (132.3 % of GDP) and more sharply in the coming years driven by a structurally high primary surplus and stronger nominal GDP growth. However, risks remain including less fiscal outturns, higher financing costs along with weak inflation. If these risks were to materialise, the prospect that public debt will be put on a firm downward path over the medium term would be lower.

The progress on reforms is encouraging but DBRS remains cautious regarding the full impact of structural reforms. The reforms largely address political and supply-side constraints and seem to be less focused on low demand. This is important, because in Italy low consumption and investment are partly responsible for low potential growth. The supply side measures are positive, but are likely to have only a positive impact on medium term growth.

Italy's growth potential remains weak and the need to improve growth performance remains a fundamental driver of the ratings. Over the last decade, Italy’s economic growth has been flat and a lower than the Euro area average. Total factor productivity growth has been negative and corporates’ profits remain feeble. Fragile growth is largely the result of low productivity of labour and capital, low employment rates and low investment in research and development and education, all of which have led to declining competitiveness.

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

The principal 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.

These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

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

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved
within a twelve month period, while reviews are generally resolved within 90 days. DBRS’s outlooks
and ratings are under regular surveillance.

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Lead Analyst: Carlo Capuano, Assistant Vice President
Initial Rating Date: 3 February 2011
Rating Committee Chair: Roger Lister, Managing Director
Last Rating Date: 25 September 2015

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