Fitch Ratings – Frankfurt am Main – 03 May 2024: Fitch Ratings has affirmed Italy’s Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘BBB’ with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Fundamental Rating Strengths and Weaknesses: Italy’s rating is supported by its large, diversified and high value-added economy, eurozone membership, and strong institutions relative to the peer group median. These credit features are balanced against weak macroeconomic and fiscal fundamentals, in particular very high government debt, large fiscal deficits since the pandemic, subdued economic growth potential, all made more challenging recently by a higher-yield environment.
Stable Outlook: The Stable Outlook reflects Fitch’s projection for narrowing fiscal deficits to around 3% of GDP by 2026 with expected increased execution of EU-funded projects providing moderate support to growth and for ongoing broad stability of the coalition, which limits more marked policy risk. However, significantly higher-than-expected spending on construction-related tax credits last year has placed debt on an upward trajectory and increased financing needs, with associated risks of higher yields on new debt issuance and non-compliance with EU fiscal rules.
Superbonus Impacts Fiscal Accounts, Growth: The ‘Superbonus’ tax credit scheme in 2023 has had a large impact on Italy’s fiscal accounts and growth. The cost of the scheme in 2023 was 3.9% of GDP, driving the total fiscal deficit to 7.4% of GDP (2.2% of GDP more than we expected at the last review). In total, since the programme’s launch in 2020, the cost of construction-related tax credits has reached 10% of GDP (EUR219 billion). We expect the impact on the growth to be also large. We believe Istat will revise 2023’s growth of 0.9% to fully reflect the impact the Superbonus-related activity in 4Q23, which was the peak for investments under the scheme.
Debt/GDP on Upward Trajectory: Last year’s Superbonus spending has put the government debt burden on an upward trajectory in our baseline projection as it will feed into debt metrics over the next 10 years as the credits are used. We now expect debt/GDP to increase to 142.3% in 2027 from 137.3% in 2023, from a previously broadly stable path. However, a boost to GDP growth last year means that the ratio rose from a lower starting point (2023 ratio was revised to 137.3% from 140.2% due to growth). Italy’s debt remains one of the highest among Fitch-rated peers, significantly above the ‘BBB’ median at 55% of GDP.
Uncertain Fiscal Path: We expect the fiscal deficit to shrink to 4.7% of GDP this year (the government’s forecast is 4.3%) from 7.4% in 2023 because of the phase-out of ‘Superbonus’ and changes to its accounting from accrual to cash. We see high uncertainty on the fiscal path beyond 2024. Because it is a transition year for the EU’s fiscal surveillance framework, Italy presented only a no-policy-change scenario in its Stability Program in April and it is expected to present the policy path in July. We assume the fiscal deficit will narrow moderately to 3.9% and 3.2% in 2025 and 2026, respectively.
Expected Excessive Deficit Procedure: We expect Italy to be placed under Excessive Deficit Procedure (EDP) this year. Unless the government significantly diverges from the no-policy-change path, Fitch assumes Italy will comply with EDP requirements (minimum 0.5% of GDP adjustment in structural balance). We see less clarity on the required adjustment to the debt trajectory under the new rules, as the size of the adjustment and its horizon will be subject to negotiation with the Commission. We expect Italy to remain eligible for the ECB Transmission Protection Instrument (TPI) as long as Italy makes the adjustment required by EDP.
Fairly Stable Political Position: Public support for the Meloni government remains strong, providing a platform for medium-term economic and fiscal planning. But reduced fiscal space due to larger-than-expected ‘Superbonus’ spending might increase tensions between the coalition parties. The government recently stated that the extension of some of the one-off fiscal measures introduced in 2024 (amounting to 0.7% of GDP) will be its priority. In our view, it could be difficult to implement without offsetting measures given the constraints of the EU’s fiscal rules.
Growth Aided by Fiscal Stimulus: We expect the Italian economy to grow 0.7% in 2025 and 1.3% in 2026, following 0.9% in 2023. The phasing out of the ‘Superbonus’ should be broadly offset by acceleration in investments from Next Generation EU (NGEU) funds and recovery in other investments than construction. Despite large the fiscal stimulus, we see some underlying strength, especially in the export and services sectors. Labour market is also supporting growth. The employment grew to 66.8% in 4Q23 from 66.1% in 2Q23 and unemployment is around its historical low (7.5% in February).
Improving External Finances: Fitch forecasts a widening of the current account surplus to 1.5% of GDP in 2025, from 0.5% in 2023, on an improved energy balance and further strengthening demand for exports. While net external debt, estimated at 38.8% of GDP at end-2023, is well above the ‘BBB’ median of 2.7%, Italy has a positive international investment position, at near 7% of GDP, which we expect to improve moderately by 2025.
Sound Banking Sector Fundamentals: The Italian banking sector has strengthened in recent years. The gross impaired loan ratio, according to Fitch’s definition, slightly improved to near 3% at end-2023, a decade low. Default rates remain low and although we expect an increase, high interest rates will continue to support banks’ performance, despite weak loan demand. Business models are more resilient and capital metrics have improved.
ESG – Governance: Italy has an ESG Relevance Score (RS) of ‘5[+]’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Italy has a high WBGI ranking at the 67th percentile, reflecting its long track of stable and peaceful political transitions, well-established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
– Public Finances: Weaker confidence in the implementation of primary balance improvements necessary to contain risks in the context of Italy’s high debt burden.
– Macro: Signs of weakening of growth potential due, for example, to marked delays in execution of NGEU-led investments and/or failure to implement structural reforms.
– Macro/Public Finances: Persistent deterioration of government financing conditions that exacerbates debt sustainability risks, for example, due to a broader tightening of market conditions or more specifically linked to Italy’s eligibility for the TPI.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
– Public Finances: Medium-term fiscal consolidation that supports a substantial decline in Italy’s government debt/GDP.
– Macro: Increase in medium-term growth potential, for example, due to the implementation of growth-enhancing structural reforms.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Italy a score equivalent to a rating of ‘A-‘ on the LTFC IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the LTFC IDR by applying its QO, relative to SRM data and output, as follows:
– Macro: -1 notch, to reflect Italy’s low GDP growth potential, partly due to adverse demographic trends.
– Public Finances: -1 notch, to reflect very high government debt levels. The SRM is estimated on the basis of a linear approach to government debt/GDP and does not fully capture the risk at high debt levels, notably from possible lasting shifts in market sentiment and long-term interest rates.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LTFC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the LTFC IDR, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
COUNTRY CEILING
The Country Ceiling for Italy is ‘AA’, six notches above the LTFC IDR. This reflects very strong constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch’s Country Ceiling Model produced a starting point uplift of +3 notches above the IDR. Fitch’s rating committee applied a further +3 notches qualitative adjustment to this, under the Long-Term Institutional Characteristics pillar reflecting the sovereign’s membership of the eurozone currency union and the associated reserve currency status. The agency views the risk of imposition of capital or exchange controls within the eurozone as exceptionally low.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Italy has an ESG Relevance Score of ‘5[+]’ for Political Stability and Rights as WBGI have the highest weight in Fitch’s SRM and are, therefore, highly relevant to the rating and a key rating driver with a high weight. As Italy has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Italy has an ESG Relevance Score of ‘5[+]’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as WBGI have the highest weight in Fitch’s SRM and are, therefore, highly relevant to the rating and are a key rating driver with a high weight. As Italy has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
Italy has an ESG Relevance Score of ‘4[+]’for Human Rights and Political Freedoms as the Voice and Accountability pillar of the WBGI is relevant to the rating and a rating driver. As Italy has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Italy has an ESG Relevance Score of ‘4[+]’ for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Italy, as for all sovereigns. As Italy has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
Italy has an ESG Relevance Score of ‘4’ for Demographic Trends. Aging costs will increase significantly over the next 10-15 years, due partly to adverse demographic trends. Accordingly, this has a negative impact on the credit profile, is relevant to the rating and a rating driver.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of ‘3’. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation of the materiality and relevance of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
