Italy’s outlook improves to positive at Moody’s

Investing.com -- Moody’s Ratings has revised the outlook for the Government of Italy from stable to positive today, while simultaneously confirming the country’s long-term issuer and senior unsecured ratings at Baa3. The foreign currency senior unsecured MTN programme and shelf ratings have also been confirmed at (P)Baa3. The local currency commercial paper rating has been affirmed at Prime-3, and the foreign currency other short-term programme rating has been affirmed at (P)Prime-3.

The positive outlook change is due to a better-than-anticipated fiscal performance in 2024 and a stable domestic political environment, which increase the chances of fiscal metrics continuing to improve in line with the government’s medium-term fiscal-structural plan. The positive outlook is also supported by a strong labor market, healthy household and corporate balance sheets, and a robust banking sector. Expected improvements in the net international investment position are likely to support economic resilience and reduce Italy’s susceptibility to event risk.

The Baa3 ratings affirmation takes into account Italy’s large economy and effective institutions and governance relative to rating peers. Italy’s large and wealthy economy, its effective policymaking and institutional capacity, results in a high degree of economic resilience. However, the affirmation also acknowledges Italy’s high debt burden which, along with a gradual weakening debt affordability and structural challenges related to population ageing, remains a constraint on its credit profile.

Italy’s long-term local and foreign-currency bond country ceilings remain unchanged at Aa3. This is typical for euro area countries, reflecting benefits from the euro area’s strong common institutional, legal, and regulatory framework, as well as liquidity support and other crisis management mechanisms.

In 2024, Italy’s fiscal outcome was better than expected, with a deficit at 3.4% of GDP compared with 3.8% budgeted. The main driver of the better fiscal outcome was a decrease in expenditures, helped by strong revenue growth mainly from personal income and other taxes. Domestic political stability increases the likelihood that the government will continue to narrow the deficits and achieve growing primary surpluses.

For 2025 and 2026, revenue growth is expected to align with nominal GDP growth, with direct and indirect taxes supported by the robust labor market and nominal wage growth. Expenditure growth will mainly be driven by increased capital spending under the Recovery and Resilience Facility (RRF), while current spending will increase moderately due to public sector wage increases.

The fiscal deficit is projected to decline further, to just under 3.0% of GDP in 2026, as widening primary surpluses offset gradually increasing interest payments. Italy’s debt affordability indicators will remain strong relative to similarly-rated sovereigns and to Italy’s own history. Interest payments-to-revenue will approach 9.5% by 2030, up from 8.2% in 2024.

Italy’s debt burden is expected to increase in 2025 and 2026 due to so-called stock-flow adjustments of around 2% of GDP per year related to the superbonus. Government debt is expected to reach 138.4% of GDP in 2026 and 2027, up from 135.3% last year. From 2028 onwards, sustained primary surpluses should put the debt burden on a gradual declining trend.

A range of labor market indicators point to enhanced economic resilience to potential future shocks. The unemployment rate was 6% in March 2025 and is expected to remain around this level in the coming years as employment will continue to grow faster than the labor force, reflecting a falling working-age population.

In general, private sector debt is relatively low, an important support factor for economic resilience. Total (EPA:TTEF) credit to households and non-financial corporates was around 95% of GDP in 2024, compared to 158% for the euro area as a whole.

A financially sound banking sector also supports economic resilience. Italian banks demonstrate strong capitalization, improved profitability, ample liquidity, and strong asset quality. The steady improvement in the banking sector’s asset quality has been facilitated by the government’s Garanzia sulla Cartolarizzazione delle Sofferenze (GACS) guarantee program, at the expense of higher contingent liabilities worth 0.4% of GDP as of end-2024.

Moreover, improvements in external liquidity support Italy’s shock absorption capacity. The country’s current account balance improved to 1.1% of GDP in 2024, from 0.1% in 2023, as the effects from the energy price shock dissipated, and the competitiveness position of Italian exporters improved relative to large euro area peers.

The affirmation of the Baa3 ratings takes into account levels of economic as well as institutions and governance strength that are stronger than those of most rating peers. Italy has a large and wealthy economy which, combined with solid policy effectiveness and institutional capacity, results in a high degree of economic resilience.

Italy’s rating also takes into account credit support from the ECB’s credible commitment to use all available tools to respond to sharp rises in interest rates that are not explained by a country’s fundamentals. This limits the sovereign’s exposure to very high levels of liquidity stress.

Italy’s CIS-3 indicates that ESG considerations have a limited impact on the current rating, with potential for greater negative impact over time. This reflects high exposure to social risks and overall robust governance, which supports a general strong capacity to respond to shocks.

Faster fiscal consolidation than currently assumed, leading to a lower debt burden than in current projections would be positive, particularly if efficiency of the tax system increased. Continued implementation of structural reforms after the end of the National Recovery and Resilience Plan period that prospectively lift Italy’s low potential growth rate by starting to address rigidities in the labor market and improve the business environment would also support a higher rating.

Given the positive outlook, a rating downgrade is unlikely in the foreseeable future. However, worse-than-expected fiscal outcomes that lead to a higher debt burden than in the baseline scenario could move the outlook back to stable. Signs of lack of tangible reform momentum could also lead to a return to a stable outlook. Although not the baseline assumption, an escalation of the war in Ukraine involving NATO members would exert downward rating pressure.