threat of junk inspires no funk for Italy

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Dear reader, 

Italians are, by and large, a confident bunch. Ask them whether Moody’s is likely to downgrade the country’s debt to junk and they respond with a unanimous “noooo”. Plus an eye-roll, just to underline how far-fetched this all is. 

They may be too sanguine. The credit rating agency is expected to publish its review of Italian sovereign debt on Friday. It rates Italy at Baa3, one notch above junk. It placed the country on a negative outlook last year. 

My contacts reckon I should relax. Moody’s is already a notch more bearish than peers S&P and Fitch, which have confirmed their ratings in recent reviews. A downgrade would widen the gap further, which would be unusual. 

On top of that, the Italian economy is hardly fragile. It has survived a lot of shocks. Last year’s high energy prices are unlikely to be repeated this year. The country is protected from widening spreads by the European Central Bank, which is determined to nip in the bud any inkling of a run on the country’s debt. Observers think Moody’s would be foolish to bet against the bank. 

Certainly, investors in Italian debt do not appear to be panicking. The cost of 10-year debt, at 4.4 per cent, is a mere 177 basis points above the equivalent German bond. That spread, anxiously watched by Italians, has in the past five years breached the 300bp mark. 

Indeed, the spread has come down about 15 per cent since early October. Risky securities the world over are benefiting from hopes that inflation is under control and interest rates have peaked. That is a relief for fragile corporates and sovereigns. These stand to suffer the most distress from rates that are higher for longer. 

Proseccos all round, then? Not quite. Tightening bond yields should not deflect attention from Italy’s underlying fragility. 

The country labours under a staggering debt load of more than 140 per cent of gross domestic product. Its ability to coast along blithely is a testament to the power of the ECB guarantee, which keeps rates at a manageable level. Indeed, at 4.4 per cent, Italian debt yields are roughly comparable to those in the UK, where debt is a more manageable 98 per cent of GDP. 

The downside, of course, is that Italy lacks an urgent incentive to tackle the problem. 

Take, for instance, Prime Minister Giorgia Meloni’s budget law for 2024. She has promised €24bn in tax cuts and spending increases, largely to the least well-off. This has widened government budget deficit forecasts to 4.3 per cent for 2024.

Even this may be too rosy. Italy has pencilled in 1.2 per cent GDP growth next year. Independent economists think it will be about half that. Lower growth would reduce tax receipts and increase the deficit. 

Another sign that Italy is fiddling while Rome drowns in debt is the lack of progress on privatisations. Some are included in the government’s longer-term budget calculations, yet any talk of trying to flog off bigger assets quickly gets scotched. 

The country’s farraginous bureaucracy makes it hard to hit the spending milestones in the EU’s Recovery and Resilience Facility. That imperils part of the €191bn the country is set to receive from the EU. This is glumly unsurprising. 

None of this means Italy is toast. As Moody’s itself highlights, the economy is big and diversified, and its citizens wealthy. Private households have relatively little debt, at 42 per cent of GDP compared with an average of 57 per cent for the eurozone as a whole. And they are happy to lend some of their wealth to their cash-strapped government. Indeed, between January and July this year, households soaked up 75 per cent of Italy’s net bond supply, says Barclays. 

Italy will continue tiptoeing along a financial precipice so long as politicians, central banks and rating agencies collaborate to prevent it tumbling into the abyss. For this reason, it is hardly surprising that the threat of a downgrade has done so little to hold the country’s feet to the fire.

Other things I enjoyed this week

I thought this Big Read on the woes — and turnaround hopes — at UK bank Barclays was great.

This detailed explainer mapping the fentanyl supply chain was a real eye-opener.

As a relative outsider, I find the English obsession with class a constant fascination. This FT Weekend piece, about how bullies make up the game and forget to share the rules, was a great read.

Have a good week,

Camilla Palladino
Lex writer