Italy Stands Out to Moody’s as Only Country Risking Junk

Italy is the only country that could lose its investment-grade rating at Moody’s Investors Service, the company said on Tuesday.

(Bloomberg) — Italy is the only country that could lose its investment-grade rating at Moody’s Investors Service, the company said on Tuesday.

In a report surveying how nations have dealt with downgrades to junk over the past three decades, the euro zone’s third-biggest economy was highlighted as a prominent candidate for such a status adjustment. Moody’s didn’t give a view on the likelihood of that happening.

“Italy is currently the only Baa3-rated sovereign with a negative outlook,” wrote analysts including Kelvin Dalrymple and Scott Phillips. “Sluggish growth and higher funding costs may further weaken Italy’s fiscal position.”

The remarks are a reminder of how the easier ride Italy has enjoyed in bond markets this year could yet be derailed. The premium paid by its 10-year yield over the safer German one has traded in a tight range over the past month and is currently at 187 basis points, down from 250 basis points in late 2022. The spread was little changed on Tuesday.

The recent bullishness stems from a quieter period in politics, the Italian government’s stated aim for fiscal prudence, and the European Central Bank’s anti-fragmentation backstop. While the bond-buying tool has never been used, it has offered a big support to peripheral countries since its announcement in mid-2022, as investors expect the ECB to step in if there’s a big market stress.

Moody’s, whose next credit assessment on Italy is due May 19, rates it at Baa3, one notch above junk. The outlook on that has been negative since August — a notably pessimistic appraisal of the country whose fractious coalition led by premier Giorgia Meloni took office almost exactly six months ago. 

By contrast, S&P Global Ratings just last week reaffirmed its own view of Italy at a level one notch higher — BBB with a stable outlook. Fitch Ratings has a similar view and will release its next assessment on the country on May 12.

“The Italian macro outlook for 2023-24 does not look as bleak as initially expected and Meloni has so far avoided a strong confrontation with the EU,” said Evelyne Gomez-Liechti, a rates strategist at Mizuho International Plc. “But the widening tone is likely to remain until Moody’s and Fitch report their decisions.”

Moody’s analysts wrote that Italy faces “heightened risks” around the implementation of crucial reforms aimed at reinvigorating its growth potential, citing measures including those linked to the receipt of European Union Recovery Fund money. 

Any eventual downgrade to junk would hit national pride, and bring the country into unchartered territory with a designation that makes its bonds less attractive to investors. 

Such a move wouldn’t affect its participation for ECB bond-buying programs: government debt is eligible so long as at least one of four major rating agencies judges Italy to be investment grade. 

Meloni’s right-wing coalition has been careful not to rock the boat. Its recently presented budget, keeping the deficit and debt on a downward path, alongside plans to keep investing in the economy, was welcomed by analysts. 

Italy’s borrowings exceed 140% of output however, while growth remains historically sluggish. Also hanging over the outlook is heightened scrutiny over its struggle to allocate and spend money from the European Union’s Recovery Fund. It risks not completing some projects needed to unlock money by a 2026 deadline. 

Moody’s said that 28 countries have become fallen angels since 1995. Of those, only 12 managed to claw back investment-grade ratings, with the time taken ranging from around three to 14 years and the process involving “major transformations” including institutional improvements and stronger government finances.

The comments follow a downbeat view from Goldman Sachs Group Inc. on Monday. Its strategists recommended shorting Italian bonds versus Spanish peers, and forecast the spread over Germany will jump to 235 basis points by the end of the year.

S&P’s assessment on Friday was more sanguine.

“The stable outlook reflects our expectation that Italy’s government debt to GDP will decline in 2023-2026, as economic growth picks up next year, supported by EU investments, external demand, and stabilizing terms of trade,” the ratings company said. “This assessment is balanced against the risk of a reversal in the delivery of critical reforms.” 

–With assistance from Alessandra Migliaccio and Zoe Schneeweiss.

(Adds detail on ECB tool, date of Fitch’s next review and analyst comment from fifth paragraph onwards)

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