Research Update:

Ratings On Italy Affirmed At

'BBB/A-2'; Outlook Remains Negative
Primary Credit Analyst:
Frank Gill, London (44) 20-7176-7129; frank.gill@standardandpoors.com
Secondary Contact:
Marie-France Raynaud, Paris +33 (0)1 44 20 67 54; marie-france.raynaud@standardandpoors.com
Table Of Contents
Overview
Rating Action
Rationale
Outlook
Key Statistics
Related Criteria And Research
Ratings List
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Research Update:
Ratings On Italy Affirmed At 'BBB/A-2'; Outlook
Remains Negative
Overview
We are affirming our 'BBB/A-2' long- and short-term sovereign credit
ratings on the Republic of Italy.
The affirmation reflects our view of Italy's wealthy and diversified
economy, as well as our expectation that the government will make some
progress on important structural and fiscal reforms.
The outlook on the long-term rating remains negative, reflecting our view
of risks to the public sector balance sheet from weak real and nominal
growth prospects.
Rating Action
On June 6, 2014, Standard & Poor's Ratings Services affirmed its unsolicited
'BBB' long-term and 'A-2' short-term sovereign credit ratings on the Republic
of Italy. The outlook on the long-term rating remains negative.
Rationale
The ratings are supported by our view of Italy's wealthy and diversified
economy and the country's relatively strong international investment position.
We believe this reflects Italy's traditionally elevated private-sector savings
rate, buttressed by a gradually improving current account.
The ratings are constrained by our assessment that economic growth prospects
remain weak in real and nominal terms. In our view, Italy's modest growth
prospects reflect only tentative progress by the past three governments in
reforming Italy's domestic labor and product markets, which we regard as less
flexible than those of Italy's key trading partners. The ratings on Italy are
also constrained by the high net general government debt burden and what we
consider to be an impaired monetary transmission mechanism, which has led to
tighter credit conditions for Italy's private sector.
The government of Prime Minister Matteo Renzi, of the Democratic Party (PD),
assumed office in February 2014. It is pursuing fiscal, electoral, judicial,
political, labor, and other economic reforms. Although the government's policy
intentions, as specified in the 2014 Stability Programme (Documento Di
Economia e Finanza 2014), are encouraging, we consider it too early to assess
how much of the program the government will be able to implement and over what
time period.
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We project that gross general government debt will peak at 132% of GDP this
year (excluding European Financial Stability Facility guarantees) and then
gradually decline to below 130% of GDP by 2017. This baseline projection
assumes that:
Average government borrowing costs will remain close to 4%;
The government will maintain a primary budgetary surplus of over 2% of
GDP; and
Receipts from the sale of minority stakes in public companies will
approach 0.3% of GDP in both 2014 and 2015.
We expect that the recent decision to cut the personal income tax (PIT) burden
on low wage earners, at a cost of 0.7% of GDP for 2014 and 1% of GDP
(cumulative) for 2015, will lower the tax burden on labor in a progressive
manner that will support demand. That said, our understanding is that more
than half of the sources of financing for this measure during 2014 are
nonrecurring.
We consider Italy's weak nominal and real GDP prospects to be the main source
of risk to our fiscal projections for Italy. In particular, we see the
rigidities and cost pressures weighing on the profitability of Italy's private
sector as a weakness. These include:
A wage bargaining process organized at the national, rather than the firm
level, which contributes to wage rigidity, regardless of underlying
productivity trends;
High nonwage employment costs, including elevated judicial, legal, and
other administrative fees, and high severance costs;
A wholesale cost of energy substantially higher than that of peers,
partly due to Italy's dependence on imported oil and natural gas for
power generation, but also reflecting market dominance by incumbent
utility monopolies and the absence of sufficient electricity
interconnections with its neighbors;
Incentives created by tax and labor laws for companies to remain small;
and
Low internal labor mobility, partly because the property rental market is
underdeveloped, but also because incumbent professions such as notaries
and lawyers levy high transaction and business fees for buyers and
sellers of residential property.
Although Italy's corporate sector appears to have preserved considerable
pricing power, as demonstrated by consistently high value-added deflators, it
has done so to a considerable extent by increasing manufacturing abroad, and
by substituting capital for labor, via layoffs of temporary employees and cuts
to worker hours. The resulting rise in underemployment and unemployment has,
in turn, depressed consumer spending and corporate investment. Ultimately,
these pressures on the profitability of the private sector weigh on GDP, which
is the sum of value added (profit margins) in the economy.
At the end of 2013, the volume of economic activity in Italy remained 8% below
the previous peak levels in 2007 and unemployment was higher than its previous
peak, which it reached in the late 1980s. Although employment increased
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Research Update: Ratings On Italy Affirmed At 'BBB/A-2'; Outlook Remains Negative
slightly during the first few months of 2014, we anticipate that unemployment
will continue to rise toward 13% during 2014 as discouraged workers re-enter
the jobs market, before starting to decline next year.
In light of only modest structural reforms implemented since the onset of the
turmoil in the eurozone and our expectations of subdued growth in employment
this year and next, we are projecting that real and nominal GDP growth between
2014-2016 will average 0.9% and 1.9%, respectively. By contrast, the
government expects real and nominal GDP growth of 1.2% and 2.4%, respectively.
Given our lower growth projections for 2014 and 2015, we are forecasting
higher general government deficits (2.9% of GDP for 2014, and 2.7% of GDP for
2015) compared to the Italian government's targets (2.6% of GDP for 2014 and
1.8% of GDP for 2015).
The government's steps to keep the deficit from rising this year include
extending the freeze on public sector wages announced last year. At the same
time, we estimate a slight increase in primary expenditure (government
spending excluding interest payments) for 2014. We understand that the
government plans to make permanent primary expenditure cuts worth almost 1% of
GDP in 2015, in order to meet its fiscal objective, but these have yet to be
fully articulated.
As a consequence, in our view, most of the projected improvement in the
budgetary position relies on the government's higher nominal GDP projections
and on lower expected interest payments as a percentage of GDP. The rest of
the consolidation projected for this year and next appears to be based on the
government's expectation that domestic demand, and thus indirect tax receipts,
will recover.
Most metrics of cost competitiveness indicate that an internal devaluation,
comparable to what has occurred in eurozone trading partners Ireland and
Spain, has yet to take place in Italy. Although, in our view, Italy did not
experience an inflationary construction boom before 2008, wages consistently
increased above underlying productivity both before and after 2008. As a
result, according to Eurostat data, as of the fourth quarter of 2013,
economywide nominal unit labor costs in Italy were still 16.6% above 2005
levels. Combined with weak external demand and a large capital goods and
consumer durables component in Italy's export basket, this may partly explain
why Italian volume export growth during 2012 and 2013 averaged only 1.1%. It
may also explain weak growth performance in the nontradeables sector, which
makes up the bulk of the Italian economy. That said, an external adjustment
has been occurring. In 2013, Italy posted a current account surplus of 1.0% of
GDP, the first current account surplus since Italy joined the eurozone in
1999. Since the end of 2011, much of the improvement in Italy's current
account has stemmed from declining merchandise imports.
European Central Bank (ECB) actions have helped reduce financing tensions for
many eurozone members, including Italy. Partly as a consequence, nonresidents
have started to buy Italian government debt again. We view this positively,
and our economic projections are based on the assumption that ECB monetary
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Research Update: Ratings On Italy Affirmed At 'BBB/A-2'; Outlook Remains Negative
policy will remain supportive. The domestic financial sector (including
state-owned Cassa Depositi e Prestiti), moreover, has a considerable exposure
to the sovereign.
In March 2014, credit to the nonfinancial sector was contracting by an
estimated rate of just under 3% a year, according to data released by the
Banca d'Italia. However, in an important development, quarterly credit to the
nonfinancial corporate sector rose for the first time this year. Nonperforming
loans (NPLs) remain high at an average 15.9% in December 2013, according to
Banca d'Italia data, but performance varies materially among banks.
Significantly, the increase in bad debts has slowed during 2014. Over the past
two years, the supervisory authority has pressed Italian banks to book more
than 60 billion of specific and generic loan-loss provisions. This has
improved the system's specific NPL coverage ratio to 42% from 40% at the end
of 2011. We estimate that generic provisions also improved, representing 0.7%
of net customer loans at the end of 2013, up from 0.6% in 2011. We also note
that midsize and larger Italian commercial banks have successfully raised
capital on the international markets, indicating to us that the sovereign's
contingent liabilities are diminishing.
Outlook
The negative outlook reflects our belief that there is at least a one-in-three
chance that we could lower the ratings, either this year or in 2015. According
to our criteria, we could lower the ratings if we conclude that the government
cannot implement policies that would help to restore growth and keep debt
indicators from deteriorating beyond our current expectations.
Sustained delays in addressing some of the rigidities in Italy's labor,
services, and product markets--which have been holding back growth--could also
cause us to lower the ratings. Under our criteria, a downward revision of our
assessment of Italy's institutional and governance effectiveness, for example,
could lead us to lower the rating by one notch or more, depending on the
severity of the circumstances.
On the other hand, we could revise the outlook to stable if the government
implemented reforms to the labor, product, and service markets that we
considered sufficient to trigger a sustainable increase in Italy's economic
growth.
Key Statistics
Table 1
Republic of Italy - Selected Indicators
2007 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f
Nominal GDP (US$ bil) 2,127 2,307 2,111 2,057 2,199 2,013 2,072 2,136 2,100 2,146 2,190
GDP per capita (US$) 36,535 39,338 35,782 34,758 37,047 33,895 34,711 35,674 34,973 35,640 36,248
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Research Update: Ratings On Italy Affirmed At 'BBB/A-2'; Outlook Remains Negative
Table 1
Republic of Italy - Selected Indicators (cont.)
Real GDP growth (%) 1.7 (1.2) (5.5) 1.7 0.4 (2.4) (1.9) 0.5 1.1 1.2 1.0
Real GDP per capita growth
(%)
1.4 (1.9) (6.1) 1.4 0.2 (2.4) (2.3) 0.2 0.8 0.9 0.7
Change in general government
debt/GDP (%)
1.1 4.2 6.5 5.3 3.3 3.7 6.1 2.0 1.6 2.2 2.0
General government
balance/GDP (%)
(1.9) (3.0) (5.8) (4.8) (3.7) (3.0) (3.0) (2.9) (2.7) (2.4) (1.9)
General government
debt/GDP (%)
103.3 106.1 116.4 119.3 120.5 125.2 131.9 132.1 131.0 130.3 129.7
Net general government
debt/GDP (%)
99.7 102.7 112.0 114.1 116.7 121.3 127.6 128.4 127.3 126.7 126.1
General government interest
expenditure/revenues (%)
10.8 11.2 9.9 9.7 10.5 11.3 10.6 11.0 11.5 11.4 12.0
Oth dc claims on resident
non-govt. sector/GDP (%)
95.6 100.7 106.5 118.0 118.0 119.3 116.1 116.8 117.8 118.7 119.9
CPI growth (%) 2.1 3.5 0.7 1.7 2.9 3.3 1.3 0.7 0.8 0.8 1.2
Gross external financing
needs/CARs +use. res (%)
209.3 224.0 233.2 223.1 207.4 208.7 212.1 214.0 196.0 193.8 191.6
Current account balance/GDP
(%)
(1.3) (2.9) (1.9) (3.4) (3.0) (0.3) 1.0 1.6 1.9 1.9 1.6
Current account balance/CARs
(%)
(3.6) (8.3) (6.6) (10.8) (8.9) (0.7) 2.9 4.5 4.9 4.9 3.9
Narrow net external
debt/CARs (%)
230.0 192.0 277.0 249.4 196.1 223.6 244.8 237.5 236.4 225.2 218.0
Net external liabilities/CARs
(%)
83.1 54.0 87.5 65.4 44.6 57.6 71.5 70.2 72.7 69.8 69.6
Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition
of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior
year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is
defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus
public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative
number indicates net external lending. CARs--Current account receipts.
The data and ratios above result from S&Ps own calculations, drawing on national as well as international sources, reflecting S&Ps independent
view on the timeliness, coverage, accuracy, credibility, and usability of available information.
Related Criteria And Research
Related Criteria
Sovereign Government Rating Methodology And Assumptions, June 24, 2013
Methodology For Linking Short-Term And Long-Term Ratings For Corporate,
Insurance, And Sovereign Issuers, May 7, 2013
Criteria For Determining Transfer And Convertibility Assessments, May 18,
2009
Related Research
Sovereign Defaults And Rating Transition Data, 2013 Update, April 18,
2014
Ratings On Italy Affirmed At 'BBB/A-2'; Outlook Remains Negative, Nov.
29, 2013
S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating
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Research Update: Ratings On Italy Affirmed At 'BBB/A-2'; Outlook Remains Negative
The Sovereign Guarantors, Nov. 2, 2011
In accordance with our relevant policies and procedures, the Rating Committee
was composed of analysts that are qualified to vote in the committee, with
sufficient experience to convey the appropriate level of knowledge and
understanding of the methodology applicable (see 'Related Criteria And
Research'). At the onset of the committee, the chair confirmed that the
information provided to the Rating Committee by the primary analyst had been
distributed in a timely manner and was sufficient for Committee members to
make an informed decision.
After the primary analyst gave opening remarks and explained the
recommendation, the Committee discussed key rating factors and critical issues
in accordance with the relevant criteria. Qualitative and quantitative risk
factors were considered and discussed, looking at track-record and forecasts.
The chair ensured every voting member was given the opportunity to articulate
his/her opinion. The chair or designee reviewed the draft report to ensure
consistency with the Committee decision. The views and the decision of the
rating committee are summarized in the above rationale and outlook.
Ratings List
Ratings Affirmed
Italy (Republic of) (Unsolicited Ratings)
Sovereign Credit Rating BBB/Negative/A-2
Transfer & Convertibility Assessment AAA
Additional Contact:
SovereignEurope; SovereignEurope@standardandpoors.com
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