Italy Downgraded on Deflation, Debt Concerns by S&P

The agency based its ratings on the country’s growth prospects which it chopped from previous projects of 1% real and 1.9% nominal growth for 2014 through 2017 to new projections for real growth of just 0.5% and nominal growth of 1.2%. S&P said:

We expect the Italian economy to exit recession in early 2015, although we forecast only a modest GDP recovery of about 0.2%, compared with our previous forecast of 1.1% for next year. Compared with the government’s view, we forecast weaker recovery in private consumption and gross fixed capital formation. We believe that consumption will be constrained by a difficult labor market situation, with unemployment at a historically high level, and gradual budgetary consolidation. At the same time, we expect investment activity to remain subdued due to uncertainty regarding the outlook for demand, including weaker economic growth prospects in Italy’s main trading partners in Europe and the rest of the world, and a challenged monetary transmission mechanism that impedes a faster improvement in credit conditions. Our forecast also reflects our view of Italy’s weak domestic fundamentals, including its difficult business environment and competitiveness challenges.

S&P now expects general government debt to peak at 133% of GDP in 2016 and net debt to rise to 127% of GDP. The agency expects general government debt to rise to €2.256 trillion by the end of 2017 which is €80 billion higher than S&P’s previous forecast.

The ratings agency also said the Italian government’s ability to raise revenues is “relatively limited.” The country’s implied tax rate on labor is 42.3%, the second-highest in the European Union, and S&P does not think the country’s plan to reduce the tax burden and making the necessary spending cuts has enough detail.

And the deflation story is even more depressing:

[T]he European Central Bank (ECB) is undershooting its medium-term price stability target of close to, but lower than, 2% for the eurozone as a whole. The harmonized indices of consumer price inflation (CPI) in Italy showed an inflation rate of 0.2% in October, year on year, while core CPI was 0.6% year on year. In this context, restoring fiscal buffers could prove difficult.

S&P said it would consider raising its ratings if the Italian government implemented fully its planned reforms to labor, product, and service markets that would lead to an increase in the country’s economic growth and put the budget deficit and government debt level on downward path.

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