Italy moves away from the “junk bond” and gives a break to southern Europe

Italian bonds recovered this Monday after avoiding the possible downgrade to “junk bond” by the credit rating agency Moody’s. According to the agency, Italy’s cyclical economic outlook in the medium term “continue to benefit from their National Recovery and Resilience Plan.” To this they add that the decrease in risks to the energy supply and the improvement in conditions in the banking sector drive their decision.

Even so, Moody’s emphasizes that Georgia Meloni’s Executive faces numerous institutional challenges that will slow the growth of the transalpine country through reforms and investments. At the same time, they hope that the load Italy’s debt remains “very high”with a forecast of 140% of GDP in the coming years and this “will negatively affect its fiscal strength.”

Following the news, Italian bonds caused 10-year yields to fall 0.04 percentage points to 4.32%, their lowest level since early September. In addition, the Italian risk premium fell by just over 1.7 percentage points this Monday morning, also its lowest level since the end of September.

This Friday’s forecasts from Moody’s would be key, as it would become the first agency to downgrade the Italian credit rating. But it decided not to become the first of the agencies to deal this blow to Rome and strip it of its investment grade status. The company argued that the stabilization of the outlook for the country’s economic strength and the strength of its banking sector. He also mentioned “the dynamics of government debt.”

For this reason, they continue to maintain the rating of Italian sovereign debt at ‘Baa3’, one step above the much feared “junk bond” that would drive investment away from the country. At the same time, reduced its negative outlook in August 2022after the unexpected collapse of the government of former president of the European Central Bank, Mario Draghi, led to early elections in the country.

Rumors of a negative reclassification began to sound the moment the Italian Prime Minister, Georgia Meloni, presented her economic plan for 2024, with a totally expansive stance that aims to pay for it. through debt issuance and the “tax” on electricity companies and banks. This caused Italy’s bond yields on Germany to widen by 210 basis points for the first time since January.

Since coming to power a little over a year ago, Meloni wanted to please foreign investment and distanced himself from anti-EU populist precepts. His first declaration of intentions was to appoint as Minister of Economy Giancarlo Giorgetti, a disciple of Mario Draghi himself. At the same time, he promised to enter the fold of Brussels’ fiscal discipline and only make “punctual” reviews of the Recovery and Resilience Plan.

Giorgetti himself assured that this decision by Moody’s to maintain its rating was “a confirmation” that despite the many economic difficulties that the country is going through, partly due to its dependence on Germany in different aspects of its economy, show that “we are working well for the future of Italy.” At the same time, he expressed his relief after receiving the news: “it filled me with great satisfaction,” she said.

But this is not only a relief for the Government of Italy. The countries of southern Europe, including Spain, They looked closely at the agency’s review qualification since they ran the risk of experiencing the same bad luck. This would cause the European Central Bank to put all its machinery to work to reduce the investment turmoil so that it would not spread to the rest of the surrounding countries.

This task would not be easy for the ECB since it would have to activate its protection shield (ITP) for sovereign debt at the same time as reducing its balance sheet.

Optimistic evaluations

If it had occurred, Moody’s would be the first to lower its credit rating. Its competitors showed completely optimistic opinions about the Italian bond. Both Fitch Ratings and S&P Global upgraded their investment grade ratings.

At the same time, this gives a pump of oxygen to Georgia Meloni, who is currently is dealing with a very volatile economic crisis and a very fragmented government coalition. It is true that Italy managed to escape recession in the third quarter and these prospects could be improving.

Forecasts indicate that the contraction of the transalpine economy will occur in 2025 and should benefit from spending from the European Union Recovery and Resilience Fund. At least this was confirmed by the European Commission this week.

The forecasts are not something to shout about either. The Commission plans that the deficit will be reduced to 4.3% in 2025, a result greater than what the Meloni Executive predicts (3.6%). He also believes that debt to GDP ratio will rise above 140% in the coming years.

What is going to lead Moody’s to keep Italy under scrutiny are public finances. At the same time, the likelihood that it will fail to comply with Brussels’ fiscal rule and that its deficit will remain notably higher than 3% in two years will also be another element they take into account, as it will be another point of contention with the EU.

In any case, the proposed revision of a reform of fiscal discipline, led by Spain, the “frugal” countries (Denmark, Sweden and the Netherlands) and Austria. This proposal from Brussels proposes a spending path subject to the debt of each country, but that a minimum annual adjustment of the deficit is established at 0.5% of GDP for the years in which an imbalance is expected. This change could help Meloni weather the blow of a credit rating downgrade.