Low yields are not forever. In an “issuer comment” on Italy, distributed by Moodys to its subscribers on October 14 and not to be confused with a “rating action”, the agency says that
“rising US treasury yields and euro/dollar currency trends could over time gradually
undermine the Italian government's favourable funding environment”, and this is crucial because “the low funding costs buy time for the government to implement reforms and for growth to accelerate”.
The report, with the title “Accelerated reform efforts amid recession consistent with stable
outlook”, says that the recent credit developments affecting the Italian sovereign “show a mixed picture” but in spite of this the “overall assessment is that these credit developments are consistent with the stable outlook on Italy's Baa2 government bond rating .”
On the negative side, Moodys points out that with second quarter GDP shrinking, Italy continues to lag behind other large euro area countries in terms of economic activity. The cycle has not turned, with weak economic activity reflecting both demand-side weaknesses and long-standing structural impediments to economic growth, particularly with respect to the labour market. Second-quarter economic data showed fairly uniform weakness across the Italian economy. Overall, real GDP contracted by 0.2% quarter-on-quarter (q-o-q), mainly due to a 0.9% q-o-q decline in fixed investment. Services, manufacturing and agriculture sectors all contributed negatively to growth, and while inventories provided a small boost (+0.2 percentage points (pp)), net exports contributed negatively (-0.2pp), with exports increasing only marginally (+0.1%), while imports recorded a stronger growth (+1.0%). Consumption was flat. On the top of this, high-frequency indicators suggest sustained weak economic activity, as reflected in a decline in business confidence since May, and a fall in the composite Purchasing managers' index (PMI) below the no-change 50 mark. In light of Q2 data, Moody’s forecasts that the Italian economy will contract by 0.3% in 2014, versus previous forecast of 0.1% decline, retaining 2015 forecast of 0.5% real GDP growth.
Renzi's “Jobs Act” is described in the issuer comment as an an effort to overcome the labour market's dualism. Moody’s warns that a failure to implement the enabling law of the “Jobs Act” in labour market legislation would be credit negative because it would accentuate both domestic and external threats to Italy's eventual economic turnaround. Domestically, markets could react adversely to an inability to pass key legislation as well as to the deterioration in the overall political climate which would probably accompany such an event. External risks include a global economic slowdown, a more prolonged period of slow
growth and low inflation across the euro area, and an escalation of the Russia/Ukraine crisis which would damage economic sentiment across the continent, including in Italy.
In Moody’s view, recent reform efforts in Italy are important, “as they begin to address some of the major structural rigidities that are weighing on the country’s rating”. However the Jobs Act “alone does little to move Italy from a centralized to a decentralized wage-bargaining process, or to increase wage-setting flexibility, which was one of the key elements of Spain's recent labour market reforms”.
As for the debt-trajectory, Moody’s highlights that the major factors weighing on Italy's government rating are “the economy's return to recession and an unfinished reform
agenda”. Measures related to the latter include judicial reforms, aimed at improving court efficiency and facilitating corporate restructuring, as well as initiatives to foster competition, especially in the retail and broader service sector, and efforts to
strengthen the anti-corruption legal framework.
These concerns, adds Moody’s, are mitigated by Italy's strong fscal position, with many years of consolidation having led to a significant primary budget surplus which provides a stabilizing factor in a debt sustainability analysis, in part by supporting Italy's favourable funding costs. Moody’s expects debt-to-GDP to peak at below 134% in 2015, and interest payments to remain below 11% of revenues. Due to Italy's favourable funding costs, the government's debt affordability as measured by the interest-payments-to- revenue ratio is - despite the high debt-to-GDP ratio - only slightly above the mean for other Baa-rated sovereigns.
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