Italy’s week of truth

The coming week could turn out to determine the future direction in Italy. The government in Rome is obliged to submit its complete 2019 draft budget to the Commission by Monday. To date, only portions of the budget plan – above all the deficit parameters for the next 3 years and the GDP forecasts underlying these – have become known. In particular, the fact that growth assumptions are higher than consensus estimates gave rise to initial questions upon publication. However, a definitive verdict from Brussels, the investor community and the rating agencies is only on the cards once all planned measures, including additional expenditure and revenue shortfalls, have been released.

At any rate, the European Commission can scarcely be expected to accept Italy’s plan without renegotiations. Even if the 2019 deficit target – 2.4% of GDP – were to appear realistic, it would still be well in excess of the path supposed to lead to a reduction in the public-debt ratio which was mapped out between the previous administration and Brussels. From the investor’s point of view, though, what will be more decisive is whether Brussels regards Rome’s budgetary plans as, at least, a basis for negotiations and whether a compromise in the tussle between the two sides seems a possibility. But neither the Commission nor the pan-populist government would have any interest in allowing the conflict to escalate. It is true that Brussels will continue to hoist the austerity flag for political reasons, but the priority will definitely be to prevent the EMU’s biggest public-sector debtor from getting into dire straits and to prevent a possible conflagration in the European government-bond market.

The rating agencies will be assessing Rome’s budgetary plans as well. Moody’s, in particular, has already made critical comments about Italy’s deficit-widening measures on several occasions, putting the country’s rating on “watch negative” this May. In the light of the developments witnessed over the past few weeks, a downgrade by one notch looks relatively likely and could take place at any time after the draft budget has been published. Departing from the usual custom, the rating decision does not need to be taken on a previously communicated date because Moody’s has already announced that a rating verdict will be reached “by the end of October” on the basis of the reported fiscal numbers. The new draft budget could also prompt S&P to reverse its October 2017 decision to upgrade Italy by one notch. From the market’s viewpoint, above all the pending rating verdicts entail uncertainty. If Moody’s does downgrade Italy by one notch, this could indeed cause short-term unrest, although the move, as such, is being anticipated by parts of the investor community. More serious turbulence would be likely if Italy, contrary to expectations, were to be downgraded more sharply or if Moody’s were indeed to go so far as to hold out the prospect of a non-investment-grade rating for the boot-shaped peninsular.


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