S&P cuts Italy’s outlook to ‘negative’ but affirms credit rating

Italy escaped another rating downgrade after S&P Global Ratings on Friday affirmed its credit rating but lowered its outlook to “negative” from “stable”, noting the government’s policies are “weighing on the country’s economic growth prospects, a critical driver of government debt-to-GDP trajectory”.

S&P left its rating at BBB, or two notches above junk status while the negative outlook signals the rating agency could lower its ratings over the next 24 months.

“In our view, by crowding out investment in the private sector, the government’s economic and budgetary plan risks weakening Italy’s economic growth performance,” S&P said.

“At the same time, in our opinion, the plan represents a reversal of Italy’s previously sustained fiscal consolidation path and partly undoes past pension system reform. As a result, we no longer expect Italy’s government debt to GDP to continue on a downward path.”

S&P forecast a 2019 budget deficit of around 2.7 per cent of GDP, compared with the government’s target of 2.4 per cent.

Italy’s populist Eurosceptic government wants to hike public spending, a move which puts it on collision course with Brussels because of European Union fiscal rules which limit member states’ budget deficits.

Earlier this week the European Commission rejected Rome’s budget in an unprecedented rebuke; Italy’s government was given three weeks to come up with alternative proposals, but ministers have insisted that they will not do so.

S&P’s decision came a week after rival rating agency Moody’s downgraded Italy by one notch, leaving it one step above junk territory.

Moody’s gave Italy a ‘stable’ outlook, bucking investors’ fears that it would leave the outlook as ‘negative’ — a move that would have been widely interpreted as signalling that Italy was on track to fall below the junk threshold.

Two other rating agencies, Fitch and DBRS, are not scheduled to update their ratings until next year.

Fitch rates Italy as two grades above junk with a negative outlook.

DBRS, a less well-known agency whose views are nevertheless taken into account by European Central Bank policymakers, rates Italy as three notches above junk with a stable outlook.

As the third-largest economy in the eurozone and its biggest issuer of sovereign debt, Italy’s position in investment-grade bond indices is vitally important.

Any move towards junk status puts that position at risk, and downgrades could trigger huge capital flows as investors are forced to rearrange their portfolios.

The major indices require Italy to be rated as investment-grade by at least two of the three biggest rating agencies, or by either Moody’s or S&P.

The ECB is not able to buy junk-rated debt as part of its quantitative easing programme, another factor which makes further downgrades for Italy so perilous.

Sovereign credit downgrades have consequences for the capital base of Italy’s banks too.

“The bonds held by the banks could be ineligible as collateral to obtain ordinary funding from the Eurosystem,” said Eric Dor, director of economic studies at IESEG School of Management in France, who warned that “Italy is currently a perfect illustration of the pernicious loop linking the risk of the banks of a country and the risk of the sovereign bonds”.