With the coronavirus having spread throughout Italy, and with the country’s already worrying debt profile, Kames Capital’s Nick Chatters asks how the ratings agencies will view its credit rating which is already hovering perilously close to junk status.
Fixed income manager, Chatters says: ‘GDP growth in Italy has been broadly on a falling trajectory since the start of 2018, with growth falling into negative territory at the end of 2019 and its manufacturing and services sectors following the overall Eurozone picture of decline throughout the past two years, with signs of stabilisation more recently.
‘But Italy is different to the average Eurozone market regarding its debt position, which is currently north of 135% of GDP. This level, while high on a relative basis, is more acute in Italy than other indebted nations like Greece or Portugal, given the level of yield spread that the government must pay to refinance, along with the large nominal amount of debt. However, the debt profile is elongated enough such that the requirement to refinance is drawn out over a long period.’
Chatters highlights that much of the volatility in Italy in the past few years has been a function of its politics as it has moved through an evolving theme of populist, nationalist and socialist agendas involving a mixture of regional and national political parties.
He says: ‘Generally, the widening of spreads is related to the success of the Lega and Five Star parties, which have sought to battle the EU for more expansionary fiscal policy than is acceptable under the stability and growth pact.’
Recently this tension has been reduced, as the vote of no confidence called by Matteo Salvini-led Lega backfired leaving them out of a new ruling coalition and the conversation has now moved on.
But, with the coronavirus worsening the fiscal position, the likelihood it could be downgraded to junk has surfaced again.
The issue with the Eurozone fiscal response is that Italy can’t afford it, says Chatters. ‘Despite the ECB pouring over €1 trillion worth of QE into Eurozone bond markets this year. The current government is more fiscally sensible than in the past and it is also aware that the market will punish it if it tries to push through irresponsible spending plans, however the macro data will be significantly hit by the virus.’
The Italian government has also announced significant fiscal and liquidity measures in line with other Eurozone governments. The pandemic fiscal package will be waived under the stability and growth pact rules, but that doesn’t mean that Italy can afford it with debt to GDP of 135%.
However, Chatters says: ‘The debt sustainability is not the issue, with the term structure they have – it’s more of a market confidence issue.
‘On the plus side, the ECB’s Pandemic Emergency Purchase Programme package is significant, and affords the ECB the ability to support member countries as its sees fit, without worrying about breaching individual-country exposure limits. Furthermore, the ECB has been explicit within the PEPP programme (and through its external commentary) that it will not allow an isolated blow-out in Italy to potentially infect the wider Eurozone.’
Chatters points out that the ECB stimulus although significant, is now broadly in the price of its debt. He believes in the short term, the rating review by S&P on 24th April will be the first significant flash point as the agency already has a BBB rating / negative outlook on Italy, with Moody’s review following on 8th May.
He says: ‘Over the medium term, the overwhelming driver will be the horrific growth and debt trajectory, which means it looks seems increasingly likely the ratings agencies will decide to downgrade the sovereign.’