LONDON (MNI) – Fitch ratings warned Thursday that if Italy were to
lose market access for its debt, which is not Fitch’s base scenario, the
country’s credit rating could be lowered to the low investment grade
category.

Fitch said it believed the new technocratic government led by Mario
Monti “will prove itself to be credible in pursuing fiscal and
structural economic reform”.

Fitch currently rates Italy at A+ with a stable outlook. S&P rates
Italy A and Moody’s A2 — both in line and also stable outlooks.

Following is the full text of Fitch’s report, entitled “Italy – The
Challenge Ahead”:

The dramatic rise in Italian bond spreads and yields reflect a loss
of confidence in the European policy response to the systemic crisis of
the Eurozone. As Fitch previously warned, Italy’s (‘A+’/Negative) high
public debt burden and weak growth performance rendered it especially
vulnerable to the intensification of the Eurozone crisis. Nonetheless,
there is a window of opportunity for the new Italian government to
generate a positive surprise that would, if supported by European policy
action including intervention by the ECB, break the negative market
dynamics and shift bond yields towards a more sustainable level.

In Fitch’s opinion, the new ‘technocratic’ government led by Mr
Mario Monti will prove itself to be credible in pursuing fiscal and
structural economic reform and has the potential to remain in office
until the general elections scheduled in April 2013. The first test of
the new government is securing broad parliamentary and public support
for the government and its fiscal and economic reform programme.

However, Italy is likely already in recession and the downturn in
activity across the Eurozone has rendered the task of the new government
much more difficult. Sustaining political and public support for
structural reforms and austerity will be challenging in the face of
rising unemployment. Convincing investors that the reforms will be
effectively implemented and will boost economic growth over the medium
term will be equally if not more challenging.

The policy priorities of the new government are expected to focus
on additional fiscal measures that would begin to lower the debt burden
from 2012 as well as strengthen the credibility of the balanced budget
target for 2013. Of more significance for positively shifting growth
expectations that are at the heart of the current crisis of confidence
will be measures to reform public administration and reduce public
spending, liberalise the economy, and make the labour market more
flexible.

The crisis of confidence that has enveloped the Eurozone and Italy
has driven Italian bond yields to levels that, if sustained, would place
public debt on an unsustainable path. Fitch has previously highlighted
that the duration and maturity of the Italian treasury debt (five and
seven years, respectively) means that it could absorb an elevated
marginal cost of funding for a prolonged period before the budgetary
burden became unsustainable. Moreover, Italy’s treasury debt redemption
profile over the remainder of this year and into January is moderate –
around EUR31bn of Treasury bills mature that are likely to be
refinanced, albeit at a high cost – and cash deposits stand at around
EUR36bn. However, more than EUR36bn of medium-term bonds mature in
February and EUR193bn over the whole of next year. It is therefore
imperative that Italy retains market access.

It remains Fitch’s judgement that European and international policy
institutions would intervene to prevent a self-fulfilling liquidity
crisis for any systemically important sovereign, including Italy.
However, the emphasis on ‘private sector involvement’ (PSI) and the
subordination of private creditor claims under the Greek PSI
restructuring underscore that under such a scenario, the risks to
bondholders would remain elevated even as short-term credit risk is
lowered by external support.

Italy’s sovereign ratings are premised on it retaining market
access. In the event that the Italian government loses market access –
not Fitch’s base case – the ratings would be lowered, likely to the low
investment grade category.

–London Bureau; Tel: +442078627492; email: ukeditorial@marketnews.com

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