Fitch has decided to keep the outlook and BBB rating unchanged for Italy’s long-term debt, confirming analysts’ expectations and the relatively calm mood of the spread in the past week. The stable outlook, according to the agency, “reflects Fitch’s projection that the debt-to-GDP ratio will stabilize in the coming years at levels similar to the end of 2022 (similar to the level expected in our previous review), with an expected increase in the execution of EU-funded projects providing moderate support to growth, and the ongoing stability of the ruling coalition limiting risks of more pronounced policy shifts.”
However, Fitch added, “the significant loosening of fiscal targets has weakened the deficit adjustment path, with related risks of higher yields on new debt issuances and the possibility of non-compliance with EU fiscal rules.”
In September, Fitch had slightly revised Italy’s growth upwards, just below the government’s targets in the Def (Economic and Financial Document) update, while in October, the agency estimated a 1.3% decrease in Italy’s debt/GDP ratio to 140.3% in 2022, with stabilization expected at 140% by the end of 2025. Now, however, the agency’s projected debt for the end of 2025 will gradually increase to 141%, “as the increase in debt service costs and adjustments to cash flow will offset the 1.7 percentage point improvement in the primary surplus.”
The Italian spread closed the session awaiting Fitch, essentially stable at 185.34 points, a level similar to the beginning of the week. The fear of a potential worsening of the outlook was not highly anticipated by investors, also due to the fact that the gap between Fitch’s rating and the junk threshold is two notches. Over the last month, the yield on the Italian 10-year government bond has decreased by over 19 basis points, reflecting growing expectations of the end of the rate hike cycle by the ECB and the Fed.
For the Italian government, maintaining the debt above the “junk” threshold, which characterizes issuers at a higher risk of default, is important to keep interest expenses on public debt under control. Exiting the “investment grade” area means losing significant investment flows from funds, reducing demand for Italian securities and contributing to rising yields. The most delicate appointment will be on November 17, when Moody’s will express its opinion, whose Baa3 rating is just above the “junk” level.
Last October 20, S&P had expressed its opinion, maintaining the BBB rating with a stable outlook.
The Possibility of the Infringement Procedure and the ECB Variable
“There is a significant risk that Italy will enter an Excessive Deficit Procedure after the EU fiscal rules return, as its fiscal deficit will not fall below 3% of GDP until 2026 according to government plans,” warned Fitch. “We assess that the probability of this resulting in Italian government bonds losing access to the ECB’s Outright Monetary Transactions (OMT) is significantly lower,” meaning the shield against spread presented last year to avoid an disorderly exit from expansive monetary policies. According to Fitch, “the possibility that Italy’s adjustments during the procedure may constitute an effective action is a key element according to the OMT rules.”
The Macroeconomic Scenario and Government Forecasts
In October, both household and business confidence continued to decline, suggesting a possible slowdown in the Italian economy in the coming months, as noted by Istat in its November 10 update. The uncertain international context and internal challenges contribute to creating an atmosphere of uncertainty and concern for the country’s economic growth. According to preliminary estimates, Italian GDP remained stable in the third quarter compared to the previous three months, showing better performance than Germany but lower than that of France and Spain; the acquired growth of GDP in 2023, added Istat, is currently 0.7%.
In the details of public finance projections, the Meloni government revised upward the estimates of interest expenses as a percentage of GDP between the April Def and the September Nadef. For 2023, the percentage was updated from 3.7% to 3.8%, for 2024 from 4.1% to 4.2%, for 2025 from 4.2% to 4.3%, and for 2026 from 4.5% to 4.6%. This indicator reflects the proportion of national production allocated to repaying Italian state creditors: its increase entails a decrease in resources available for other current expenses and investments, potentially making the threat of a possible financial default more realistic. In practice, as the government itself emphasized, the upward revision of one decimal would be fully manageable. The fear that has been looming for months, however, is that the cost of debt service may turn out to be higher than expected, due to the possible economic slowdown combined with the gradual withdrawal of monetary policies that have supported the purchase of government bonds by the ECB. According to Fitch’s latest update, Italy’s interest expense will be 3.9% in 2023 (one decimal higher than the government’s forecast), and then reach 4.3% of GDP in 2025.
