Fellow ratings agency Moody's cut Italy's credit rating by a notch last week over the populist government in Rome's plans for larger deficits despite the high public debt load.
The hard-right League and anti-establishment Five Star Movement, ruling in coalition, have refused to change their big-spender programme, which forecasts a public deficit of 2.4 percent of GDP in 2019. The former, centre-left government had pledged to keep next year's deficit to 0.8 percent of GDP in a bid to ease Italy's vast public debt, which amounts to a phenomenal €2.3 trillion.
The new plan went down like a lead balloon with Brussels, which on Tuesday rejected it outright, accusing Rome of “openly and consciously going against commitments made” and requesting a revision.
Italy's government won a supporter across the Atlantic, however, as US President Donald Trump expressed his approval of Prime Minister Giuseppe Conte.
…I agree with their stance 100%, and the United States is likewise taking a very hard line on illegal immigration. The Prime Minister is working very hard on the economy of Italy – he will be successful!
— Donald J. Trump (@realDonaldTrump) October 25, 2018
Erik Nielsen, head economist at UniCredit, says S&P will likely lower Italy's outlook but keep its credit rating at BBB. Others, like Matthieu Groues, head of strategy at Lazard Freres Gestion, think the agency will follow in Moody's footsteps.
The downgrade from Moody's — from Baa2 to Baa3 — came as international financial watchdogs sound the alarm over Italy's economic choices.
Baa3 is still an investment-grade rating, but it's only one step above “junk” which many big investment funds are barred from holding. The agency's decision to give Italy a stable outlook, however, appeared to soothe skittish markets.
Photo: Filippo Monteforte/AFP
“By proposing a budget heavy on debt-fuelled spending, the country started clashes both with the European Commission and with the market,” said Fidelity International analysts Andrea Iannelli and Alberto Chiandetti. “Neither has confidence in Italy's projection that its economy will grow at a rate of 1.5 per cent, or that its current debt path is politically and financially sustainable.”
Since mid-May, when negotiations to form the coalition began, Milan's stock exchange has lost 22 percent. The closely-watched “spread” — or difference between yields on ten-year Italian government debt compared to those in fiscally conservative Germany — has more than doubled, widening from 150 points to 309 points.
The banking sector, which holds €372 billion worth of the country's sovereign debt according to the central bank, has been the hardest hit, losing 36 percent on the Milan stock exchange.
'A shared solution'
Rome has until November 13th to present a revised budget to Brussels, and faces a heavy fine if it fails to do so.
European Central Bank chief Mario Draghi said Thursday he was “confident” an agreement could be reached. In the meantime, the Commission insists it wants to avoid all-out war with the populists.
“It's very important for the channels of communication to remain open… and I'm not going to be the one to close them,” Economic Affairs Commissioner Pierre Moscovici told AFP on Wednesday. “We need to find a shared solution because Italy is a country at the heart of the eurozone” and “I can't see an Italy without Europe,” he said.
Photo: Gerard Cerles/AFP
“Let me be clear, Italy is not a problem. Let us not confuse political tactics with the facts,” Italian Finance Minister Giovanni Tria assured on Thursday. “We are convinced that Europe can benefit from our strategy,” he told journalists in Paris, reiterating that Italy did not pose “a threat to the eurozone.”
“Since we want to stay in the euro, our only path is a contained, responsible deficit next year to give the proper boost [to the economy] and ensure our capacity to reduce our debt,” he said. As one of the founding members of the EU, Tria stressed that “we Italians also built this house. If Italy grows, Europe as a whole gains stability and can profit from it.”
Tria said that Italy had entered “a phase of dialogue ” with the European Commission. But the leaders of Italy's coalition parties, League head Matteo Salvini and Five Star chief Luigi Di Maio, refuse to budge.
“We open the little letters from Brussels because we have been brought up well. We read them, we reply to them, but we won't change a comma of the finance law,” Salvini said. “The Italian economy is healthy”, and this budget “will make it even stronger and will create jobs,” he insisted.
Tria has signalled his concern for the country's banks, should the spread remain high. Salvini shrugged off those fears on Thursday, saying that should banks or businesses run into difficulty, the government was ready to help.