Analisi

Overview

Rating Action

On Oct. 23, 2020, S&P Global Ratings revised its outlook on Italy to stable from negative and affirmed its unsolicited 'BBB/A-2' long- and short-term foreign and local currency sovereign credit ratings.

Outlook

The stable outlook balances the consequences of the pandemic on public finances at the national level against the extraordinary policy response by the ECB, which has stepped up quantitative easing to lower yields, ease financial conditions, and support asset prices and demand, as well as by the EU, which established a new Recovery and Resilience Fund set to disburse up to 12.5% of GDP in loans and grants to Italy over the next four years.

Downside scenario

We could lower the ratings if our projections of an economic recovery followed by gradual fiscal consolidation fail to materialize, or should rising contingent liabilities from the extensive guarantees provided by the central government crystallize on its balance sheet on a large scale.

Upside scenario

We could raise the ratings if we see Italy's economy performing better than our current prognosis, for example via the implementation of pro-growth structural and fiscal reforms, and the effective deployment of resources available to Italy from the newly created Recovery and Resilience Fund. Under this scenario, Italy's budgetary performance would likely improve over the next two to three years, supporting a higher rating.

Rationale

Between 2015 and 2019, Italian nominal GDP growth averaged just below 2%, the lowest pace of all advanced economies with the exception of Switzerland and Japan. Despite anemic growth, by operating recurrent primary surpluses between 2015 and 2019, the Italian government managed to stabilize public debt at about 133% of GDP last year. Over the same period, the private sector continued to deleverage, with total household, corporate, and financial sector debt ending first-quarter 2020 at 172% of GDP (compared with 236% of GDP in the U.S. and 290% of GDP in the euro area), the lowest of all major advanced economies. Including financial sector debt, Italian private debt has declined by more than public debt has increased since the global financial crisis.

The pandemic has disrupted this equilibrium. Intermittent lockdowns and protracted economic uncertainty have elevated household sector savings rates to multiyear highs (19.3% on a calendar and seasonally adjusted basis as of second-quarter 2020 versus the long-term average of 10.1%), while corporates have had to increase their borrowing to manage a severe squeeze on cash flows. In response, public sector dissaving has risen rapidly, with Italy's primary government budgetary deficit set to deteriorate during 2020 by roughly the same amount that private savings are increasing. We estimate that the economy will contract by about 9% this year, before recovering by 6.4% next year, based on our assumption that an effective treatment or vaccine against COVID-19 is widely available no later than second-half 2021 or the effects of the pandemic otherwise soften. Recent recurrences of COVID-19 outbreaks in Italy and its trading partners imply downside risks to that forecast.

To mitigate the economic consequences of the pandemic, the Italian government has enacted fiscal stimulus measures at the national level worth an estimated 6.1% of GDP for 2020, including €16.6 billion or 1.0% of GDP on a short-term work scheme (Cassa Integrazione), the expansion of which almost certainly prevented the economy from undergoing an even deeper recession this year. In its 2021 draft budget, the government has extended the work scheme, and added new stimulus via increases in spending on health and education, and support for small and midsize enterprises (SMEs).

Fiscal stimulus is also forthcoming at the supranational level. Italy, which has traditionally been a net contributor to the EU budget, will be the major beneficiary of the newly created EU Recovery and Resilience Fund. In principal, this could mean the receipt of as much as 12.5% of GDP in loans and grants between 2021 and 2023 (or an estimated 4.3% of GDP net future repayments). Should the funds be fully deployed, Italy's capital account surplus would likely average at least 1.4% of GDP over 2021-2023.

Italy's creditworthiness benefits from its membership in the Economic and Monetary Union (EMU). Since we last published on Italy on April 24, 2020, the ECB has ramped up its response to COVID-19 by increasing its pandemic emergency purchase program (PEPP) to €1.35 trillion, or 11.3% of euro area GDP, on top of asset purchase program (APP) purchases this year of an estimated €360 billion, or 3.0% of GDP.

As a result, we expect that most of the Italian sovereign debt newly created this year as a consequence of the pandemic will be purchased by the ECB under pre-existing and new initiatives. In our view, that commitment means that the Italian government will be able to finance itself at nominal rates of about 0.8% on average this year compared with the 2.5% average borrowing rate on its existing debt stock. In nominal terms, and absent a significant deterioration in borrowing costs, Italy will pay less to service its total debt stock this year and into 2021-2023, than it paid in 2019.

Institutional and economic profile: Italy's EMU and EU memberships mitigate the economic and budgetary impact of the pandemic

For 2020, we project a 8.9% drop in GDP, followed by a recovery of 6.4% in 2021 and 2.3% in 2022. Even our relatively constructive forecasts of Italy's national accounts would mean that Italian GDP would not return to pre-pandemic figures until 2023. This unprecedented drop in economic output has elicited an unprecedented policy response at the national and EU levels. The ECB has stepped up quantitative easing (government bond purchases) to lower yields, ease financial conditions, and support asset prices and demand.

The change in fiscal policy has been even more profound. At the national level, Italy has moved quickly to introduce measures to prevent productive businesses from bankruptcy and workers from dismissal due to a temporary, albeit outsized, liquidity shock. Since the spring, the government has announced COVID-19-specific expenditure measures worth just under 5% of GDP under the decree law "Cura Italia," including: the expansion of Italy's short-term work scheme (Cassa Integrazione); child-care support; subsidies on rent for SMEs; deferrals on corporate, personal, and value-added tax (VAT) obligations as well as on firms' social security payables; and increases in expenditure on medical equipment and health staff. The draft budget for 2021 includes additional stimulus measures, including increases on expenditure for education, health, and SMEs worth an additional 1.5% of GDP.

On top of direct fiscal support, the Italian government is providing indirect stimulus by underwriting credit to firms and households. Of these measures, only about 0.2% of GDP represent so-called "below the line" transactions that require upfront financing. We consider the remainder--whether guarantees or other liquidity measures--to be contingent liabilities totaling a maximum envelope of about €600 billion or 33% of GDP, which has so far not been fully utilized. These include:

At the supranational level, the fiscal response has been equally powerful. On July 21, the 27 EU member states approved the establishment of a €750 billion Recovery and Resilience Fund, endowed with the ability to borrow in financial markets to finance (and in effect mutualize) lending and transfers to those member states hit hardest by the pandemic, Italy included.

After Germany, Italy is the most open economy in the G7, with exports totaling 32% of Italian GDP. Italy remains the seventh-largest exporter in the world and is a diversified and wealthy economy, with no single export category exceeding 4.5% of the total. The economy's openness, and its sizable current account surplus, make it sensitive to global developments, including this year's synchronized global recession.

SMEs dominate the Italian economy, accounting for an estimated 78% of all employment versus 67% on average in the EU--an apparent economic vulnerability. In comparison with other European economies, Italy lags on digitalization, ranking 25th in the EU in the Digital Economy and Society Index, published by the European Commission in June 2020. According to the report, only 74% of Italians are regular internet users, and the number of information and communications technology graduates is well below the EU average. In this regard, Italy's low starting point may open up an opportunity for the government to invest heavily in digital infrastructure and training.

Italy's weak economic growth performance pre-dates the pandemic, reflecting its rigid labor market, an ageing population, a high tax burden, a large gray economy, as well as administrative, judicial, and bureaucratic burdens on business and job creation, and anti-competitive product and service sector regulations.

Several factors could lend momentum to a gradual recovery beyond 2021. These include:

Prime Minister Giuseppe Conte heads a coalition between Movimento Cinque Stelle (M5S) and Il Partito Democratico (PD), a center-left party. Positive public perceptions of Conte's management of the public health crisis have supported his personal approval ratings. Nevertheless, while the government is not required to call elections until March 2023, intra-coalition dynamics remain complex, and Italian politics continue to be fluid. Sept. 21 regional elections were, in the end, a stalemate, with both PD and Lega holding on to key seats. In what can be construed as a victory for M5S, Italians approved of the ballot initiative to downsize the upper and lower houses of parliament from 630 and 315 members to 400 and 200, respectively. With a smaller parliament, pressure is now on the coalition to formulate a new electoral law.

Flexibility and performance profile: Private surpluses, public deficits

Given the anticipated fallout from the pandemic on household and company incomes, we expect the retraction of fiscal stimulus over the next three years to be back-loaded and gradual.

For 2020, the general government deficit is set to deteriorate to approximately 11% of GDP compared with 1.6% in 2019 as the economy contracts by 9% this year, the cost of COVID-19-specific measures will total close to 5% of GDP, and indirect tax receipts decline. We project a 2021 general government deficit of 7.0% of GDP, in line with government targets, with nearly all of the narrowing of the budget next year due to a cyclical recovery in tax receipts, as the labor market slowly improves. Under our estimates, Italy won't operate a primary budgetary surplus until 2024.

Despite rising government debt to GDP, one key component of public expenditure, interest expenditure to GDP, continues to decline. Reflecting the ECB's extraordinary policy interventions, for 2020, we estimate interest payments at 3.4% of GDP for 2020 versus over 5% of GDP in 2012. Given that the Italian Treasury continues to refinance maturing debt with an average rate of 2.53% at a rate of about 0.7%, we think interest expenditure to GDP will continue to decline over the next few years toward 3.0% of GDP by 2022.

Since the ECB launched its quantitative easing program in March 2015, the Italian Treasury has improved the government debt profile in several ways:

As a result, the lag between rising borrowing costs and increasing government interest expenditure has lengthened. We estimate that a 100-basis-point increase in Italy's average funding costs would increase its interest expenditure in the first year by 0.1% of GDP compared with the base year, and by 0.3% of GDP in the second year.

Under our projections, net general government debt is set to reach a record 149.8% of GDP at the end of 2020, before stabilizing at about 147.1% of GDP in 2021. Indirect fiscal costs are also on the rise, including those from the government's provision for up to 33% of GDP in direct and indirect guarantees to SMEs and other businesses, alongside debt moratoria (though we understand the take up on guarantees so far has been a fraction of the total on offer).

Our estimates of gross and net general government debt exclude guarantees extended to the European Financial Stability Facility (see "S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors," published Nov. 2, 2011).

The Italian economy has been operating current account surpluses averaging 2.5%-3.0% of GDP since 2016. Last year, in dollar terms, Italy's external surplus was the eighth highest in the world. As a consequence, as of fourth-quarter 2019, Italy became a net external creditor to the rest of the world.

Italian public and private claims on the rest of the world exceed the world's financial claims on Italian residents. Levels of private debt (household plus corporate) are the lowest in the G7 and the lowest in advanced Europe at about 109.6% of GDP (at end-2019 according to Banca d'Italia) or less than half of levels in the Netherlands (250%). We estimate that, including financial sector debt, overall private debt levels in Italy have declined by 48 percentage points of GDP, or even more than public debt has increased (27 percentage points), since the onset of the 2008 global financial crisis.

We expect Italy's net external creditor position will continue to increase over the next half decade. Moreover, we project that Italy will continue to operate current account surpluses of about 2%-3% of GDP over our forecast period. During 2020, we expect a sharp decline in goods and services exports (including tourism) to be offset by a proportional contraction in imports (including tourism, given that Italy is one of the largest importers of tourism services in the world), and lower energy prices. We calculate Italy's net energy imports are equivalent to 2.5% of GDP; savings, due to a near 50% correction in the price of oil, should exceed 1% of Italian GDP this year. This implies that Italy will continue to operate a current account surplus this year of about 2.5% of GDP compared with 3.0% last year.

We see Italy's membership in the euro area as a credit strength. To fight the pandemic's disinflationary consequences, the euro area monetary authority has launched a new APP, the pandemic emergency purchase program. It currently has an envelope of €1.35 trillion, or 11.3% of euro area GDP. We expect the ECB to further expand this envelope over the coming months. By the end of 2020, we project that Banca d'Italia's holdings of Italian government securities will approach one-quarter of the stock outstanding, compared with 5% of the stock before the ECB launched quantitative easing in March 2015. Italian commercial bank claims on the central government--including holdings of domestic government securities and other central government exposures--have increased during 2020 by an estimated €67 billion or 4.1% of GDP, to 27% of all central government financial obligations, according to data published by the Banca d'Italia.

Up until August of this year, progress on NPL reduction had been steady, but the economic standstill combined with the moratorium on mortgage payments will almost certainly weigh on asset quality. We believe, however, that the decline in NPL levels, together with the resolute ECB monetary policy measures, including with respect to the banking sector, have been supportive of monetary transmission in Italy.