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Italy’s Rating Cut by Fitch as Election Threatens Gridlock

Italy’s credit rating was cut one level by Fitch Ratings as an inconclusive election in February produced political paralysis that threatens the country’s ability to respond to a recession and the European debt crisis.

The rating company lowered Italy’s government bond rating to BBB+ from A- with a negative outlook, according to a statement released late yesterday. That’s three levels above junk and one higher than Spain, according to data compiled by Bloomberg.

“The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession,” Fitch said. “The ongoing recession in Italy is one of the deepest in Europe.”

Outgoing Prime Minister Mario Monti helped calm the European debt crisis by taming Italy’s budget deficit and implementing reforms aimed at shoring up the country’s finances. Under Monti and prior to the election, Italy’s 10-year bond yield had fallen by almost half from a euro-era record 7.5 percent in November 2011. Monti’s departure coupled with the divided parliament produced by last month’s vote fueled concern Italy may reignite debt crisis contagion.

“Fitch’s decision was not surprising,” Finance Minister Vittorio Grilli said today in a speech at a conference in Cernobbio, Italy. The downgrade “is based on a combination of economic and political uncertainty.”

Dwindling Impact

Italian 10-year bonds were little changed yesterday at 4.6 percent before the cut, which triggered a decline in bond futures.

Investors are paying less attention to the views of ratings companies and relying more on their own analysis. Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December.

Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by Standard & Poor’s. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974.

Fitch also cited risks of “sustained deterioration in fiscal funding conditions with adverse implications for financial conditions for the private sector and public debt dynamics.”

Ratings Impact

Italy’s long-term debt is rated Baa2 by Moody’s Investors and BBB+ by Standard & Poor’s, according to data compiled by Bloomberg.

“In recent years, the impact of rating agencies hasn’t been very strong because they often acknowledged a situation already discounted by markets more than looking forward,” Grilli said today. “Markets expect the next government to go ahead with reforms” and the Rome-based Treasury will strive to shield Italy from any financial turmoil at the next auctions of government bonds, he said.

The downgrade “raises the risk from a market’s perspective of moves by Moody’s,” said David Schnautz, a fixed-income strategist at Frankfurt-based Commerzbank AG. “Moody’s is the one to watch -- at Baa2, there is only 1-notch left within investment grade.”

Italian government bonds returned 20 percent last year, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. That’s almost four times the 5.9 percent return on Spanish debt and dwarfs the 4.5 percent return on German bunds, the indexes show.

Debt Needs

Italy, bearer of the euro’s second-biggest debt relative to gross domestic product, needs to sell more than 30 billion euros of bonds and bills a month.

The Feb. 24-25 vote produced a split parliament, and sent the country’s 10-year bond yield up 41 basis points the day after the election, the biggest increase in 14 months. Democratic Party leader Pier Luigi Bersani and his allies failed to win a majority in the Senate, leaving former Prime Minister Silvio Berlusconi and comic-turned-politician Beppe Grillo with blocking minorities.

The political deadlock rattled markets as investors were betting on a government strong enough to tackle the country’s fourth recession since 2001, while maintaining fiscal rigor.

The political uncertainty produced by the vote “is part of a normal democratic process,” the Finance Ministry said in a statement last night. “We reaffirm the confidence that Italy will find the political solutions and will therefore continue the undergoing reform process.”

Limited Effect

ECB President Mario Draghi said this week that the effect of Italy’s vote on financial markets was limited as Monti’s economic reforms will survive the political impasse. “After some excitement after the elections, markets have now reverted back more or less to where they were before,” Draghi told reporters in Frankfurt on March 7. “Much of the fiscal adjustment Italy went through will continue going on automatic pilot.”

The euro region’s third-biggest economy shrank 2.4 percent last year as the country’s budget deficit narrowed to match the European Union limit of 3 percent.

Italy will probably contract again this year and unemployment will continue rising to reach 12 percent next year, European Commission forecasts released on Feb. 2 showed.

Fitch said yesterday it expects Italy’s GDP to fall 1.8 percent this year as public debt peaks at almost 130 percent, up from 127 percent in 2012.

-- With assistance from Sonia Sirletti in Cernobbio. Editors: Dan Liefgreen, Andrew Davis

To contact the reporter on this story: Lorenzo Totaro in Rome at ltotaro@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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