Italy’s Debt Constrains Ratings; Resilient Economy, Prudent Policies, Domestic Investors Curb Risks

Public debt will remain high at around 140% of GDP over the coming years, about 6pp above pre-Covid levels, partly offsetting other credit-positive factors captured in Scope Ratings’ affirmation of Italy’s BBB+/Stable Outlook long-term credit ratings on 14 July.

Scope expects Italy’s debt-to-GDP ratio to decline to around 142% in 2023, from 144.4% in 2022, and to stabilise around 140% by 2028 (Figure 1), well above the level of Spain (110% expected by 2028) and Portugal (88% by 2028).

Such high public debt reduces the country’s fiscal capacity to absorb future shocks, particularly as interest payments rise. The government’s interest burden is set to increase from around EUR 75bn in 2023, up from a low EUR 57.3bn in 2020, to around EUR 90-EUR 100bn by 2026. In a stressed scenario, assuming slightly lower growth and primary fiscal balances, debt would again exceed 150% of GDP, above our baseline forecasts for Greece (142%), which would imply the highest public debt level in Europe.

Figure 1 – Public debt-to-GDP trajectories for selected euro area countries, 2018-28F (%)

Italy is Benefitting From Slowing Albeit Continued Economic Growth

However, Italy is benefiting from continued, if slowing, growth, the favourable impact from inflation on the country’s stock of debt, and gradual fiscal consolidation assuming contingent liabilities equivalent to about 16% of GDP do not materialise on the government’s balance sheet.

Scope’s baseline is for economic growth of 1.2% in 2023, 0.8% in 2024 and about 1% over the medium term, down from the pandemic rebound of 7.0% in 2021 and 3.7% in 2022 when Italy outperformed other large euro-area economies.

The government has so far shown commitment to prudent fiscal policies, reflected in a targeted deficit reduction to 4.5% of GDP in 2023, down from 8.0% in 2022, gradually improving to 3.0% in the following years, reflecting no significant additional discretionary spending and a return to primary surpluses in 2024. Achieving the ambitious budgetary targets is critical to ensure risks to Italy’s debt sustainability remain under control. A key milestone will thus be the presentation of the budget for next year in the autumn.

Another Supportive Development is the Stronger-than-expected Resilience of Italy’s Bond Market

Another supportive development is the stronger-than-expected resilience of Italy’s sovereign bond markets, despite the rapid turnaround of monetary policy in the past year. Italy’s solid investor base and favourable debt structure shield the country from market volatility and the immediate impact of higher interest rates on its funding costs.

Over 30% of Italian central government securities were held by the Eurosystem in March 2023, up from 5% in 2014 before the start of the ECB’s purchases programmes. Domestic financial institutions and private investors held another 42%, which increases the share of the domestic investor base to above 70%, reducing risks of sudden divestment and capital flight in times of market volatility.

Attractive returns and the focus of the Italian Treasury’s funding strategy towards the retail market have supported strong demand for government bonds from domestic households and corporates, which have increased their holdings by EUR 97bn since the beginning of 2022, more than offsetting the decline in foreign investors’ holdings over the same period, though they have ticked higher since February.

Finally, an adequate cash buffer of about EUR 25-EUR 30bn, the long public debt maturity of around seven years, the low if rising average cost of public debt of around 3.0% for 2023-25 – up from 2.4% in 2020 but below the 4%-6% range during 2000-12 – and expected Next Generation EU funds support Italy’s funding resilience.

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Giulia Branz is an Associate Director of Sovereign and Public Sector ratings at Scope Ratings GmbH. Alvise Lennkh-Yunus, Executive Director at Scope Ratings, and Alessandra Poli, Analyst at Scope Ratings, contributed to authoring this commentary.