Italy is the latest European sovereign to suffer a downgrade, after Moody’s Investors Service cut its rating two notches on rising event risk, and said the outlook remains negative.
The rating agency says that its decision to downgrade Italy’s rating stems from several factors. For one, it is more likely to experience a further sharp increase in its funding costs, or the loss of market access, due to increasingly fragile market confidence, contagion risk emanating from Greece and Spain, and signs of an eroding non-domestic investor base.
Also, the risk of a Greek exit from the euro has risen, Moody’s says, as has the risk that the Spanish banking system will experience greater credit losses than anticipated.
Additionally, Moody’s says that Italy’s near-term economic outlook has deteriorated. It is experiencing both weaker growth and higher unemployment, which heightens the risk that it will fail to meet its fiscal consolidation targets, and could weaken market confidence further. Moody’s is now expecting real GDP growth to contract by 2% in 2012.
At the same time, Moody’s notes that the sovereign’s current rating is supported by significant credit strengths relative to other peripheral economies in the Euro area, including a large and diverse economy that can act as a shock absorber in the current crisis; and, it has made substantial progress on structural reforms that could improve the country’s competitiveness and growth potential over the medium-term.
The negative outlook reflects the view that risks to implementing these reforms remain substantial, Moody’s says. The deteriorating macroeconomic environment, which increases austerity and reform fatigue among the population, adds risk too, it suggests.
Moody’s says that the rating could be downgraded further in the event there is additional material deterioration in the country’s economic prospects or difficulties in implementing reform. A further deterioration in funding conditions would also place downward pressure on Italy’s rating.
Conversely, successful implementation of economic reform and fiscal measures that effectively strengthen the growth prospects of the Italian economy and the government’s balance sheet would be credit positive and could lead to a stable outlook, Moody’s says.