DBRS Commentary on Italy
Still Resilient Amid Multiple Shocks
Over recent years, Italy has faced multiple shocks: the pandemic, supply-side bottlenecks, and an energy shock, all amid political uncertainty and three different governments. However, none of these have translated into significant economic scarring thus far, contributing to stability in Italy's rating at BBB (high).
Over recent years, Italy has faced multiple shocks: the pandemic, supply-side bottlenecks, and an energy shock, all amid political uncertainty and three different governments. However, none of these have translated into significant economic scarring thus far, contributing to stability in Italy's rating at BBB (high).
In fact, Italy's post-pandemic recovery has been better than expected and growth has been stronger than its peers. Potential GDP growth appears to be improving and the public debt-to-GDP ratio is expected to continue to decline in coming years, although at a more moderate pace compared with the last two years. We foresee a shift to a higher level of economic growth compared with the pre-pandemic period, along with a gradual improvement in the public balance contributing to future debt-ratio declines.
Post-pandemic economic performance has been stronger than Italy's main Eurozone peers, reflecting a sound resilience to lockdowns, the energy shock and high inflation. The real GDP level stood 2.4% higher than pre-covid in Q1 2023 or one percentage point better than that of France, while Germany and Spain's GDP levels remain close or slightly below Q4 2019 level.
Moreover, latest projections from the European Commission (EC) point to an improvement in Italy's potential growth in coming years, in spite of the severe economic downturn during the pandemic and the gas shortage. The EC projects Italy's GDP potential to have increased from a growth rate slightly below zero in the period 2009-2021 to about 0.9% from 2022 to 2027 (Exhibit 2) reflecting both the expected boost from reforms and investments related to Italy's recovery plan and higher employment
Pre-pandemic, the country's economic growth, averaged around 0.3% between 2010 and 2019, which was weaker than euro area peers, and this constrained the improvement in the debt ratio. Therefore, a shift to a higher level of economic performance from the weak growth rate of the past is key to maintain the debt ratio on a declining trajectory in the medium-term.
Although with a high degree of uncertainty, and also depending on the evolution of the new EU fiscal framework, higher output growth should be accompanied by an improvement in public finances. According to the International Monetary Fund (IMF), the primary balance should gradual shift from a deficit of 3.8%1 of GDP in 2022 to a surplus of 2.2% in 2026, a level that is in line with Italy's historical track record (Exhibit 3). Italy's primary surplus from 1992 to 2019 averaged around 2.2% of GDP.
Over the last two years, the public debt-to-GDP ratio has declined materially, by more than 10 percentage points from the peak of 154.9% in 2020. Robust nominal growth, as a result of high inflation, particularly in 2022, has been contributing to this improvement. Future improvements are likely to be slower and dependent on Italy's economic growth, prudent fiscal stance and contained interest costs. Latest projections from the IMF point to a continuation in the debt-to-GDP ratio decline to around 136.9% in 2026 from 144.7%2 in 2022. This would reflect mainly sound real GDP growth benefitting from high public investment, a resilient labour market and dynamic exports.
Future progress on structural reforms, including public sector, justice and competition, will be also positive for growth. According to the IMF, output growth would contribute to the cumulative decline in the debt ratio by around 5.1 percentage points up to 2026, while the primary balance is expected to contribute around 5.2 percentage points cumulatively, on the back of a gradual fiscal consolidation (Exhibit 4).
The impact of real interest rates, except for this year, when it contributes negatively to the public debt ratio by 4.5 percentage points, is expected to place upward pressure on the debt ratio at an average rate of 1.1 percentage point in the 2024-2026 period. Similarly, the stock flow-adjustment (or residual), which would reflect mainly lower fiscal revenues in cash terms, due to past tax incentives for construction, is likely to put moderate upward pressure on the debt ratio in coming years. On the other hand, a continuation of good economic performance along with an improvement in public finances appear sustainable and in line with past experience.
Italy’s high level of public debt and gross borrowing requirements make the country vulnerable to shocks but given these IMF assumptions our expectations are that the rise in interest costs will be met with firm progress on fiscal consolidation, and we foresee Italy complying with the EU fiscal framework when it comes back into force next year. The comfortable average maturity contains the impact of the increase in funding costs.
At the same time, a large share of debt is held by the Eurosystem and EU institutions and that reduces the susceptibility of Italy’s debt to a rapid shift in investor confidence. These factors contribute to underpin our Stable trend on the Italian rating as we take the view that the risks to Italy's sovereign ratings remain balanced for now.
Link to the report:
https://www.dbrsmorningstar.com/research/414277/italy-still-resilient-amid-multiple-shocks
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