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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Italy’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at BBB+ and affirmed the short-term issuer ratings at S-2 in local and foreign currency. All credit ratings have a Stable Outlook.

Scope’s affirmation of Italy’s BBB+ ratings reflects: i) the supportive European monetary and fiscal policy frameworks under the EU and euro area institutional architecture; ii) the Italian economy’s size (GDP of EUR 2.1trn) and diversification, which, together with a high per-capita income of around EUR 35,000, strong external sector, moderate non-financial private sector debt and financial system buffers, supports economic resilience; iii) a favourable public debt structure with an average cost of funding of around 3.0% and an average debt maturity of around seven years; and iv) the country’s recent political stability given a wide parliamentary majority and the next general elections scheduled for 2027.

Rating challenges include: i) weak public finances, given high government debt of around 137% of GDP and elevated annual funding needs, including bills, of around 24% of GDP, expected to persist into the medium term; ii) structural challenges, which constrain medium-term growth by limiting productivity and labour force participation; and iii) weak demographics, with an ageing and declining working population that will continue to weigh on government finances and growth.

Key rating drivers

Extensive European institutional support. Italy’s BBB+ ratings are underpinned by the extensive European institutional support in the form of EU monetary and fiscal policies. The ECB’s supportive monetary policy has been a primary anchor for Italy’s favourable financing conditions during the pandemic and energy crisis. While the ECB continues its gradual quantitative tightening and policy rates are expected to only decrease gradually, the ECB retains the tools to curtail market volatility and excessive spread rises if needed. As such, the ECB retains flexibility of asset purchases over time, asset classes and jurisdictions when conducting quantitative tightening to respond to market conditions^1,2. In addition, the ECB’s Transmission Protection Instrument (TPI), while untested to date, is a permanent tool that allows the ECB to purchase bonds of member states if it deems that yields and/or spreads reflect unwarranted, disorderly market dynamics³. In Scope’s opinion, the conditions for its activation – compliance with the EU fiscal framework^a, an absence of severe macro-economic imbalances^b, fiscal sustainability^c, and compliance with the reform commitments of the recovery and resilience plans – provide a strong incentive for Italian policymakers to ensure Italian bonds remain eligible under the TPI, thus preserving the reform agenda and gradual fiscal consolidation over the coming years.

European institutional support is further reinforced by the Next Generation EU (NGEU) recovery and resilience facility (RRF). Italy is the largest beneficiary of the programme in absolute terms, set to receive EUR 194.4bn, including EUR 71.8bn in grants⁴. Policy priorities include reforms on the public administration, the judiciary, competition and public procurement, education and research, and active labour market policies. The economic impact will depend on the timing and effectiveness of the investments and the reforms but should be positive overall. The government estimates that the additional investments will result in GDP being 3.4% higher than in the baseline scenario, with the impact of reforms estimated to generate an increase in GDP of 5.6% by 2030 and around 10% in the long term. To date, Italy has received EUR 102bn in grants and loans, amounting to 52.5% of the overall allocation, though spending has been slower with EUR 45.6bn spent to date.

Demonstrated resilience of Italy’s large, diversified economy. The BBB+ ratings are also supported by Italy’s economic resilience driven by its large and diversified EUR 2trn economy, high per-capita income of around EUR 35,000, strong external sector, moderate non-financial private sector debt and financial system buffers. Italy recovered faster than many other large European economies following the pandemic and energy crisis, with GDP now 4.6% above its pre-pandemic level. Scope expects the fading growth dynamics from the phase-out of the house renovation tax credits (Superbonus) to be replaced by increased investment spending under the national recovery and resilience programme (NRRP), with growth weakening slightly to 0.8% in 2024 before returning to its medium-run potential of around 1.0%. Driven by the drop in energy prices, inflation has fallen sharply with HICP headline inflation at 0.9% in June 2024 and core inflation falling to 2.1%. Following a negative terms-of-trade shock in 2022, strong export performance returned the current account to a 0.5% surplus in 2023 with further improvements expected in coming years. The country’s net international investment position is a positive 7.9% of GDP as of Q1 2024, a significant credit strength compared to peers Spain (A-/Positive; -53%) and Portugal (A-/Stable; -72%). In addition, both corporate and household debt is low at around 63% and 38% of GDP respectively, compared to the euro area averages of 104% and 57%. The banking sector also remains robust, with a system-wide CET1 capital ratio of 15.9% in Q1 2024, solid liquidity positions, and non-performing loans remaining low at 2.4% in Q1 2024, down from the 17% peak in 2015.

Commitment to prudent fiscal policy and favourable debt structure. Italy’s BBB+ ratings are supported by the government’s commitment to prudent fiscal policy and its favourable debt structure. The higher-than-expected uptake of the Superbonus tax credits caused the fiscal deficit to remain elevated at 7.4% in 2023 and will exert upward pressure on the debt-to-GDP ratio over the forecast horizon. Looking ahead, Scope expects the deficit to fall to 4.7% in 2024 and 3.9% in 2025, declining to less than 3% by 2028. This gradual consolidation is driven by reforms to make the Superbonus less favourable, as well as the government’s commitment of financing any new policy within the budget to achieve its targets. Scope expects the government to remain committed to fiscal consolidation, including continuous primary surpluses from 2025 onwards. The Excessive Deficit Procedure (EDP) announced by the European Commission will require an average annual fiscal adjustment of around 0.6pps under the EDP’s seven-year adjustment period⁵. The government’s current consolidation path for the structural primary balance over 2025-27 amounts to 0.83pps per annum. At the same time, the implementation of the NRRP will continue to support investment, policy reform and economic growth. Achieving this fiscal consolidation without hampering public investments is critical for reducing, or at least stabilising Italy’s gross financing needs, which are set to remain elevated at around 25% of GDP.

Scope also notes positively that Italy’s solid investor base and favourable debt structure shield the sovereign from market volatility and reduces the immediate impact of higher rates on its funding costs. About 28% of Italian central government securities are held by the Eurosystem as of March 2024, up from 6% in 2014 before the start of the ECB’s asset purchase programmes. In addition, domestic financial institutions and residents hold 43%, with a rising share held by individual retail investors following the successful issuances of BTP Valore bonds. This brings the share of the domestic investor base to above 70%, reducing risks of sudden divestment and capital flight in times of market volatility. Non-residents, which are potentially a less stable source of demand for sovereign bonds than the ECB or residents, therefore hold just 29% of outstanding securities though this share increased by 3pps over the past year and is likely to rise further as the ECB continues its gradual quantitative tightening.

Finally, an adequate cash buffer of about EUR 30-40bn, the long debt maturity of around seven years, the still low but rising average cost of debt of around 3.0% for 2024-26 (up from 2.4% in 2020 but still below the 4%-6% range observed during 2000-12), and continued NGEU loan disbursements support Italy’s funding resilience.

Period of relative political stability. Scope notes that following the September 2022 elections, Prime Minister Giorgia Meloni has a comfortable parliamentary majority, also becoming Italy’s biggest party in the June 2024 European Parliament elections. This implies a low risk of extreme policy outcomes until the next scheduled elections in 2027, with a government that can be held accountable to the implementation of the recovery plan and fiscal consolidation under the EDP.

Rating challenges: weak public finances, structural challenges constraining medium-term growth, weak demographics.

First, public debt will rise to around 143% of GDP over the coming years, about 9pps above pre-Covid levels, even with Scope’s expectation of continued economic growth and gradual fiscal consolidation without contingent liabilities (14.4% of GDP) materialising. The larger-than-expected uptake of the Superbonus tax credits will maintain upward pressure on the ratio until 2026. Scope’s baseline includes economic growth of 0.8% in 2024 rising to about 1% over the medium-term and a reduced fiscal deficit of 4.7% of GDP in 2024, down from 7.4% in 2023, gradually improving to 3.0% in the following years, reflecting no significant additional discretionary spending and a return to primary surpluses in 2025. On this basis, Scope expects the debt-to-GDP ratio to increase from 137% in 2023 to 143% by 2026, remaining stable for the remainder of the forecast horizon, well above the level of Spain (98% expected by 2028) and Portugal (83% by 2028). Italy’s high public debt reduces the country’s fiscal capacity to absorb future shocks, particularly as interest payments rise, which are set to increase from around EUR 87bn in 2024, already up from a low EUR 54.3bn in 2020, to around EUR 105bn by 2027.

Second, the Italian economy has weak total factor productivity, averaging just 0.4% annual growth during the pre-Covid decade compared to 0.8% for the euro area, and remaining broadly unchanged since 2019. Similarly, labour productivity increased by only 1.4% between 2000 and 2023, compared with 18.5% in the euro area, 18.7% in Spain and 27.9% in Portugal. Reasons for the weak productivity dynamics include infrastructure gaps, an inefficient public administration, low investment in both R&D and human capital, and longstanding labour market rigidities. This also dampens medium-term economic growth of around 1% compared with around 1.8% in Spain and Portugal. While the employment rate is near a record high in Q1 2024 (61.6%), it remains around 8pps below that of the euro area (69.9%), with participation particularly weak among women. These challenges highlight the importance of the full implementation of the NRRP, which aims to address Italy’s productivity and labour market challenges.

Finally, Italy’s demographic developments are among the worst in Europe, with the rapidly ageing and declining working population having major economic and fiscal consequences. By 2050, the European Commission projects Italy’s working-age population (aged 20-64) to decrease by about 15% to 29,300 and the number of pensioners to increase by 19% to 17,500⁶. This will cause the old-age dependency ratio (ratio people aged over 65 to those aged 20-64) to peak at around 66% by 2050 from around 41% in 2023, in line with that of Spain (64%) and Portugal (69%) but well above the euro area average of 56%. This trajectory limits Italy’s growth potential and poses a challenge to the consolidation of public finances over the medium term.

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s opinion that risks to the credit ratings over the next 12 to 18 months are broadly balanced.

Downside scenarios for the ratings and Outlooks are (individually or collectively):

1. support from European institutions weakened, increasing refinancing risk on Italy’s high public debt stock;
    
2. the fiscal outlook deteriorated, resulting in a significantly slower fiscal consolidation, or rising debt-to-GDP ratio; and/or
    
3. the medium-term growth outlook weakened due to delays in public investment and/or reforms under the country’s recovery and resilience programme.

Upside scenarios for the ratings and Outlooks are (individually or collectively):

1. a firm downward trajectory in the debt-to-GDP ratio; and/or
    
2. improved medium-term economic growth resulting from an effective implementation of public investments and structural reforms on which EU fund disbursements are conditioned.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘a-’ for Italy. Under Scope’s methodology, the indicative rating receives 1) a one-notch positive adjustment from the methodological reserve-currency adjustment; and 2) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘a’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of Italy’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope identified the following QS relative credit weaknesses for Italy: 1) growth potential and outlook; 2) fiscal policy framework; 3) long-term debt trajectory; 4) social factors; and 5) governance factors. Conversely, Scope did not identify any QS relative credit strengths for Italy. On aggregate, the QS generates a two-notch negative adjustment for Italy’s credit ratings, resulting in final BBB+ long-term ratings. A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

For environmental factors, Italy scores above-average for emissions per unit of GDP, but receives a low score for natural disaster risk, reflecting its exposure to earthquakes, floods, volcanic eruptions, prolonged droughts and wildfires in certain regions. However, the country has set ambitious goals in its National Energy and Climate Plan⁷, including reducing GHG emissions by 43.7% relative to 2005 levels by 2030, achieving a 39% share of its energy consumption by 2030 from renewable sources, as well as improving its energy efficiency. Meeting these targets will require significant investment, underscoring the need to implement the national recovery plan which allocates 39% of its resources to green policies.

For social factors, Italy faces challenges from its ageing population, as reflected by the old-age dependency ratio set to exceed 60% by 2050, one of the highest levels in the EU. This will adversely impact economic growth and pressure public finances. In addition, income inequality, while modest under an international comparison, is high relative to the euro area. Labour force participation is the lowest in the euro area, at around 66.8% of the working-age population in Q1 2024, which also reflects a high rate of undeclared work. Finally, Italy’s labour force inactivity results in a high share of NEETs (people not in Education, Employment or Trainings), at 15.4% as of Q1 2024, which highlights the need for additional measures to address youth unemployment to preserve social stability and ensure economic sustainability.

For governance factors, Scope uses a composite index of five World Bank Worldwide Governance Indicators, according to which Italy scores slightly below euro area peers, with no negative adjustment under the political-risk assessment. Moreover, under the qualitative scorecard, Scope assesses ‘institutional and political risks’ as a relative weakness given its historic highly fragmented political environment, which frequently leads to episodes of political instability. Italy’s record of political instability and paralysis – with 66 governments over the past 75 years – represents a rating constraint. However, after the September 2022 elections, Brothers of Italy’s leader Giorgia Meloni became prime minister supported by a far-right coalition with Forza Italia and the Lega. Together the parties hold a clear parliamentary majority with 228 out of 400 seats. The prospects of significant EU funds to be received over coming years is likely to incentivise the new government to broadly continue with the reforms agreed with the European Commission.

a. Not being subject to an excessive deficit procedure, or not being assessed as having failed to take effective action in response to an EU Council recommendation.
b. Not being subject to an excessive imbalance procedure, or not being assessed as having failed to take the recommended corrective action from the EU Council.
c. Based on the debt sustainability analyses by the European Commission, the European Stability Mechanism, the International Monetary Fund and the ECB’s own assessment.

Rating committee
The main points discussed by the rating committee were: i) credit rating triggers; ii) EU monetary and fiscal policy support; iii) economic growth outlook, including the implementation of the national recovery plan; iv) fiscal outlook and debt sustainability; and v) sovereign peers considerations.

Rating driver references
1. ECB – PEPP Monetary Policy
2. ECB – PSPP Monetary Policy
3. ECB – TPI
4. European Commission – Italy’s Recovery and Resilience Plan
5. Bruegel policy brief – The implications of the EU’s new fiscal rules
6. 2024 Ageing Report - Italy
7. National energy and climate plan – Italy

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Sovereign Quantitative Model Version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation      YES
With access to internal documents                                    NO
With access to management                                            YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings and Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Senior Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 14 July 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.