Scope affirms Italy's BBB+/Stable long-term credit ratings
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Scope Ratings GmbH (Scope) has today affirmed the Republic of Italy’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at BBB+ and affirmed the short-term issuer ratings at S-2 in local and foreign currency. All Outlooks are Stable.
Summary and Outlook
Italy’s BBB+/Stable rating benefits from: i) supportive European monetary and fiscal policy frameworks under the EU and euro area institutional architecture that provide a strong incentive for Italian policymakers to preserve the reform agenda and gradual fiscal consolidation over the coming years; ii) the Italian economy’s size (EUR 1.9trn of GDP) and diversification, which, together with a high per-capita income of around EUR 32,000, a positive net international investment position driven by a strong external sector, moderate non-financial private sector debt and financial system buffers, supports economic resilience; iii) the government’s prudent fiscal policy, which should result in sustained primary surpluses from 2024, and its solid investor base and favourable public debt structure, with an average cost of debt of around 3.0% over 2023-25 and an average debt maturity of around seven years, which mitigates the impact of rising financing costs; and iv) the country’s recent political stability given a wide parliamentary majority and the next general elections scheduled for 2027.
Rating challenges include i) weak public finances, given high government debt above 140% of GDP and elevated annual funding needs close to 25% of GDP, set to persist into the medium term; ii) structural economic bottlenecks, which constrain medium-term growth by limiting productivity and curbing employment growth and labour force participation; and iii) weak demographics, with an ageing and declining working-age population weighing on public finances and economic growth.
The Stable Outlook reflects Scope’s opinion that risks to the credit ratings over the next 12 to 18 months are broadly balanced.
The ratings/Outlooks could be upgraded if there is, individually or collectively: i) a firm downward trajectory in the debt-to-GDP ratio; and/or ii) improved medium-term economic growth resulting from an effective implementation of public investments and structural reforms in line with the national recovery plan. Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) support from European institutions weakened, increasing refinancing risks on Italy’s high public debt stock; ii) the growth outlook weakened, for example, due to delays in public investment and/or reforms under the country’s national recovery plan; and/or iii) the fiscal outlook deteriorated, resulting in an upward trajectory of the debt-to-GDP ratio.
The first driver underlying Scope’s affirmation of Italy’s BBB+/Stable rating is the extensive European institutional support the country benefits from via EU monetary and fiscal policies. The ECB’s supportive monetary policy has been a primary anchor for Italy’s favourable financing conditions during the pandemic and energy crisis and will continue to provide support and stability as the normalisation of its monetary policy takes hold. While monetary policy has tightened significantly over the past 12 months via the end of net asset purchases (March 2022), the 400bp increase of its policy rates since July 2022, and the reduction of its Public Sector Purchase Programme since March 2023, the ECB retains the tools to curtail market volatility and excessive spread rises if needed.
Specifically, reinvestments of its Pandemic Emergency Purchase Programme (PEPP), which will continue until at least 2024, allow the ECB to purchase around EUR 50bn of Italian securities each year, about 10% of estimated gross financing needs in 2024. Reinvestments could be higher, however, as they are flexible across time, asset classes and jurisdictions1,2. Moreover, the ECB’s Transmission Protection Instrument (TPI), while untested to date, is a permanent tool, unlimited in scope and unbound to the capital key that allows the ECB to purchase bonds of member states if it deems, at its own discretion, that yields and/or spreads reflect unwarranted, disorderly market dynamics. In Scope’s opinion, the conditions for its activation – compliance with the EU fiscal frameworka, an absence of severe macro-economic imbalancesb, fiscal sustainabilityc, and compliance with the reform commitments of the recovery and resilience plans – provide a strong incentive for Italian policymakers to ensure Italian bonds remain eligible under the TPI, thus preserving the reform agenda and gradual fiscal consolidation over the coming years3.
European institutional support has been further reinforced by the Next Generation EU (NGEU) recovery fund. Italy is the largest beneficiary of the programme in absolute terms, set to receive up to EUR 191.5bn (about 10% of average 2021-26 GDP), including EUR 68.9bn in grants under the Recovery and Resilience Facility, supplemented by EUR 14.4bn in React-EU initiative grants4. Italy’s National Recovery and Resilience Plan comprises 132 investment programmes and 58 reforms. It revolves around three objectives: digitalisation and innovation, ecological transition, and social inclusion. Policy priorities include reforms on the public administration, the judiciary, competition and public procurement, education and research, and active labour market policies. The economic impact will depend on the timing and effectiveness of the investments and the reforms but should be positive overall. The government expects a 3.4pp cumulative boost to GDP by 2026 from the investments. This compares with the Fiscal Council’s estimatesd ranging from 1.5-2.8pp depending on the efficiency of the investments, whereas the European Commission estimates an impact of 1.5-2.5pp by 2026. Including the impact of reforms, the government estimates GDP to be 11.5pp higher by 20505,6.
These estimates critically depend on the timely implementation of the plan. While Italy has achieved targets according to plan until 2022, receiving disbursements of EUR 21bn in April and September 2022, following EUR 24.9bn in pre-financing in 2021, the government is still waiting for the European Commission to issue its preliminary assessment on the projects related to the third payment request made in January 2023 for EUR 19bn. The initial deadline of Q1 2023 has been postponed three times to April, June and now September this year. In addition, Italy should receive a fourth payment of another EUR 16bn in December this year, provided the agreed 53 targets and 32 milestones are successfully implemented in line with its National Recovery and Resilience Plan7.
A revision of the national recovery plan, currently under discussion with the European Commission ahead of a 31 August deadline, could help Italy overcome some of the bottlenecks in the next four years, foster continued ownership of the plan by the new government, and optimise the allocation of resources to ensure selected projects are indeed growth-enhancing, which is vital for the sustainability of Italy’s government debt in the medium run. Sustained delays of reforms and investments, including a low absorption of EU funds, would be credit negative, as the impact of the plan on economic growth would be lower, challenging the government’s fiscal consolidation efforts. Scope also stresses that the endorsement of the European Commission is needed to ensure continued eligibility of Italian securities under the TPI, which critically supports Scope’s BBB+/Stable rating assessment.
The second driver underpinning Italy’s BBB+/Stable rating is the country’s economic resilience driven by its large and diversified EUR 2trn economy, high per-capita income of around EUR 32,000, strong external sector, moderate non-financial private sector debt and financial system buffers. The economy’s performance has surprised on the upside over recent years, growing at 7.0% in 2021 and 3.7% in 2022, and is expected to grow around 1.2% in 2023. Italy has thus outperformed other large euro area economies over 2021-22, also thanks to its ability to significantly diversify its gas import sources since Russia’s war in Ukraine. The country reduced its dependency on Russian gas to around 10% from about 40% before the war. The higher-than-expected growth was also achieved despite delays in the deployment of NGEU-recovery funds to date, providing some upside for coming years.
Still, for 2024, Scope expects growth of around 0.8%, below the government’s forecast of 1.5% and the Banca d’Italia’s 0.9%, before converging towards its potential of around 1%. Scope’s lower growth forecast is mostly on account of the expectation of a more adverse impact of higher interest rates on consumption – despite record employment exceeding pre-Covid levels – and investment. Moreover, investments will also be affected by the phasing out of bonuses for building renovations and energy efficiency, while the government’s fiscal consolidation, resulting in the withdrawal of supportive measures that in 2022-23 helped counter the negative effects of high inflation on households and businesses, is also expected to drag growth. However, in the absence of an additional shock, and assuming interest rates are currently near their peak, Scope expects average growth of around 1% over 2023-28, about 0.8pps above the average during the pre-Covid 2010-19 decade. This also reflects the expected positive economic impact from the NGEU recovery funds and associated reforms. A key risk for the economic outlook is therefore higher- and stickier-than-expected core inflation, resulting in significant additional policy rate increases that curb demand leading to a euro area wide recession8,9.
Following the negative terms-of-trade shock, Scope expects Italy to return to a current account surplus in 2023, thanks to its external competitiveness, supporting its net foreign creditor position. The country’s net international investment position is a positive 3.5% of GDP as of Q1 2023, a significant credit strength compared to peers Spain (A-/Stable; -61%) and Portugal (A-/Stable; -81%). In addition, both corporate and household debt is moderate at around 67% and 41% of GDP respectively, compared to the euro area averages of 105% and 57%. The banking sector also remains robust, with a system-wide Tier 1 capital ratio of 17.3% of risk-weighted assets in Q4 2022, solid liquidity positions, and non-performing loans down at 2.4% in Q4 2022 from the 17% peak in 2015.
The third key credit strength supporting Italy’s BBB+/Stable rating is the government’s commitment to prudent fiscal policy as well as its solid investor base and favourable debt structure. Following the reclassification of the accounting treatment of tax credits, which increased the 2020-22 fiscal deficits by a cumulative 4.4% of GDP, the 2022 fiscal deficit was 8.0% of GDP, slightly below the 9.0% in 2021 and the 9.7% of 2020. Looking ahead, Scope expects the government to reduce the deficit to around 4.5% of GDP in 2023 and 4.0% in 2024, converging to around 3% of GDP afterwards. This gradual consolidation is driven by the government withdrawing support measures for the Covid-19 and energy crises, as well as its commitment of financing any new policy within the budget to achieve its targets. Given the rising interest expenditure, from about 3.6% of GDP in 2021 to 4.5% by 2026, these targets imply sustained primary surpluses, which Scope expects from 2024 onwards to rise gradually to 1.5% of GDP by 2026, broadly in line with the pre-Covid levels (1.7% of GDP in 2019) but below the government’s target of 2%. Achieving this fiscal consolidation without hampering public investments is critical for reducing, or at least stabilising Italy’s gross financing needs, which are set to remain elevated at around 25% of GDP.
Scope also notes positively that Italy’s solid investor base and favourable debt structure shields the sovereign from market volatility and an immediate impact of higher rates on its funding costs. Over 30% of Italian central government securities were held by the Eurosystem as of March 2023, up from 5% in 2014 before the start of the ECB’s purchase programmes. In addition, domestic financial institutions and private investors held another 42%, which increases the share of the domestic investor base to above 70%, reducing risks of sudden divestment and capital flight in times of market volatility. So far, Italy’s creditor base has proven resilient to the shift in monetary policy. Attractive returns and the focus of the Treasury’s funding strategy towards the retail market have supported strong demand for government bonds from domestic households and corporates, which have increased their holdings by EUR 97bn since the beginning of 2022, more than offsetting the decline in foreign investors’ holdings over the same period. Moreover, foreign investors appear to be returning since February 2023. Finally, an adequate cash buffer of about EUR 25-30bn, the long debt maturity of around seven years, the still low but rising average cost of debt of around 3.0% for 2023-25 (up from 2.4% in 2020 but still below the 4%-6% range observed during 2000-12), and the expected NGEU loan disbursements of EUR 23bn support Italy’s funding resilience10.
Finally, Scope notes that following the September 2022 elections, Prime Minister Giorgia Meloni has a comfortable parliamentary majority, although without exceeding the two-thirds threshold needed to change the Constitution. In Scope’s opinion this configuration suggests a low risk of extreme policy outcomes and relative political stability until the next scheduled elections in 2027. In addition, the prospect of significant EU funds should incentivise the government to broadly continue with the implementation of the recovery plan while the risk of a potential market (over)-reaction should compel the government to preserve its prudent fiscal policy.
Despite these credit strengths, Italy’s ratings are challenged by several credit weaknesses:
First, public debt will remain high at around 140% of GDP over the coming years, about 6pp above pre-Covid levels, even with Scope’s expectation of continued economic growth, the favourable impact from inflation, and gradual fiscal consolidation without contingent liabilities (about 16% of GDP) materialising on the government’s balance sheet. Scope’s baseline includes economic growth of 1.2% in 2023 before declining to about 1% over the medium-term and a reduced fiscal deficit of 4.5% of GDP in 2023, down from 8.0% in 2022, gradually improving to 3.0% in the following years, reflecting no significant additional discretionary spending and a return to primary surpluses in 2024. On this basis, Scope expects the debt-to-GDP ratio to decline to around 142% in 2023, from 144.4% in 2022, and to stabilise around 140% by 2028, well above the level of Spain (110% expected by 2028) and Portugal (88% by 2028). Italy’s high public debt reduces the country’s fiscal capacity to absorb future shocks, particularly as interest payments rise, which are set to increase from around EUR 75bn in 2023, already up from a low EUR 57.3bn in 2020, to around EUR 90-100bn by 2026. Under Scope’s stressed scenario, assuming slightly lower growth and primary balances, debt again exceeds 150% of GDP. The high debt burden, elevated gross financing needs (25% of GDP), and rising interest expenditure thus constitute a major rating constraint and underscore the need for a multi-year fiscal consolidation strategy without curbing investments.
Second, the Italian economy has weak total factor productivity, averaging just 0.4% annual growth during the pre-Covid decade compared to 0.8% for the euro area. Similarly, labour productivity increased by only 3.7% between 2000 and 2021, compared with 19.3% in the euro area, 15.3% in Spain and 22% in Portugal. Reasons for the weak productivity dynamics include infrastructure gaps, an inefficient public administration, low investment in both R&D and human capital, a low-skilled workforce as measured via PISA and DESI indices, large skill-mismatches, and longstanding labour market rigidities.
Third, medium-term economic growth is hampered by persistent labour market rigidities. While employment and participation rates are at record high levels in May 2023 (61.2% and 66.3%, respectively), they remain almost 10pp below those of the euro area (Q1 2023: 69.5% and 74.7%, respectively). Participation is particularly weak among women, with 43.6% of the total population aged 15-64 inactive in 2022, against a 25.4% inactivity rate for men. In addition, still elevated structural unemployment of 7.6% as of May 2023% – the third highest in the euro area after Spain (12.7%) and Greece (10.8%) – and persistently high youth unemployment of around 18% as of 2022 further constrain Italy’s growth potential. These challenges highlight the importance of the full implementation of the national recovery plan, which aims to address Italy’s productivity and labour market challenges.
Finally, Italy’s demographic developments are among the worst in Europe, with the rapidly ageing and declining working population having major economic and fiscal consequences. By 2050, the European Commission projects Italy’s working-age population (aged 20-64) to decrease by about 15% and those aged 80 and above to increase by 73%. This will cause the old-age dependency ratio (ratio people aged over 65 to those aged 20-64), already the second highest in the euro area, to increase to around 66% by 2050 from around 41% in 2022, in line with that of Spain (64%) and Portugal (69%) but well above the euro area average of 56%. This trajectory, combined with net emigration of the younger segments of the population, will have a significant impact on the financing of Italy’s pension system and further limit its growth potential, complicating the consolidation of public finances over the medium term.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s CVS, which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating, which was approved by the rating committee, of ‘bbb+’ for Italy. Italy receives a one-notch uplift to this indicative rating via the reserve currency adjustment under the sovereign methodology. As such, the ‘a-’ final indicative rating can be adjusted under the qualitative scorecard by up to three notches depending on relative qualitative credit strengths or weaknesses against a peer group of countries.
For Italy, the QS signals relative credit strengths against indicative sovereign peers for the following qualitative analytical category: i) monetary policy framework. Relative QS credit weaknesses are signalled for: i) growth potential of the economy; ii) fiscal policy framework; iii) debt sustainability; iv) social factors; and v) governance factors.
Combined relative credit strengths and weaknesses generate a one-notch downside adjustment via the QS and signal a BBB+ sovereign rating for Italy. The results have been discussed and confirmed by a rating committee.
Factoring of Environment, Social and Governance (ESG)
Scope explicitly factors in ESG issues into its rating process via the Sovereign Rating Methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) and 20% weighting in the qualitative scorecard (QS).
For environmental factors, Italy scores above-average for emissions per unit of GDP, but receives a low score for natural disaster risk, reflecting its exposure to earthquakes, floods, volcanic eruptions, prolonged droughts and wildfires in certain regions. However, the country has set ambitious goals in its National Energy and Climate Plan, including reducing GHG emissions by 33% relative to 2005 levels by 2030, achieving a 30% share of its energy consumption by 2030 from from renewable sources, as well as improving its energy efficiency. Still, meeting these targets requires significant investments and a clear definition of all policy measures to be implemented, underscoring the need to implement the national recovery plan, which allocates 37.5% of its resources to green policies.
For social factors, Italy faces challenges from its ageing population, as captured via the old-age dependency ratio set to exceed 60% by 2050, one of the highest levels in the EU. This will adversely impact economic growth and pressure public finances, including due to higher healthcare spending. In addition, income inequality, while modest under an international comparison, is high relative to the euro area, leading to an increasing risk of poverty, including in-work poverty. Labour force participation is the lowest in the euro area, at around 65.5% of the working-age population, which also reflects a high rate of undeclared work. Finally, Italy’s labour force inactivity results in a high share of NEETs (people not in Education, Employment or Trainings), at 16.6% as of Q1 2023, which highlights the need for additional measures to address youth unemployment to preserve social stability and ensure economic sustainability.
For governance factors, Scope uses a composite index of six World Bank Worldwide Governance, according to which Italy scores slightly below euro area peers. Moreover, under the qualitative scorecard, Scope assesses ‘institutional and political risks’ as a relative weakness given its historic highly fragmented political environment, which frequently leads to episodes of political instability. Italy’s record of political instability and paralysis – with 66 governments over the past 75 years – represents a rating constraint. However, after the September 2022 elections, Brothers of Italy’s leader Giorgia Meloni became prime minister supported by a far-right coalition with Forza Italia and the Lega. Together the parties hold a clear – although not a two-thirds – parliamentary majority with 228 out of 400 seats. The prospects of significant EU funds to be received over coming years is likely to incentivise the new government to broadly continue with the reforms agreed with the European Commission.
a. Not being subject to an excessive deficit procedure, or not being assessed as having failed to take effective action in response to an EU Council recommendation.
b. Not being subject to an excessive imbalance procedure, or not being assessed as having failed to take the recommended corrective action from the EU Council.
c. Based on the debt sustainability analyses by the European Commission, the European Stability Mechanism, the International Monetary Fund and its own assessment.
d. Estimates based on a model comparable to the one used by the government; with an alternative model, the Fiscal Council estimates an impact of 2.9 pp of GDP by 2026.
The main points discussed by the rating committee were: i) credit rating triggers; ii) EU monetary and fiscal policy support; iii) economic growth outlook, including the implementation of the national recovery plan; iv) fiscal outlook and debt sustainability; and v) sovereign peers considerations.
Rating driver references
1. ECB – PSPP Monetary Policy
2. ECB – PEPP Monetary Policy
3. ECB – TPI
4. European Commission – Recovery and Resilience Plans Italy
5. Ministry of Finance – Document of Economics and Finance 2023 (DEF)
6. Fiscal Council – Hearing as part of the consideration on DEF 2023
7. Italian Government: Italia Domani, the National Recovery and Resilience Plan
8. Bank of Italy – Economic Bulletin April 2023
9. Bank of Italy – Financial Stability Report
10. Ministry of Finance’s Treasury Department – Q3 Issuance Programme
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation YES
With access to internal documents NO
With access to management YES
The following substantially material sources of information were used to prepare the Credit Rating(s): public domain, the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Alvise Lennkh-Yunus, Executive Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 29 July 2022.
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