Italy's Unsolicited Ratings Lowered To 'BBB+/A-2'; Outlook Negative

We are lowering our unsolicited long-term rating on Italy by two notches 
to 'BBB+' from 'A' and the short-term rating to 'A-2' from 'A-1'.
The downgrade reflects what we view as Italy's increasing vulnerabilities 
to external financing risks and the negative implications these could 
have for economic growth and hence public finances. We believe the 
external financing risks are exacerbated by deepening political, 
financial, and monetary problems within the eurozone. 
The outlook on the long-term rating is negative.

LONDON (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services 
said today that it lowered its unsolicited long-term sovereign credit ratings 
on the Republic of Italy to 'BBB+' from 'A'. At the same time, we lowered the 
unsolicited short-term sovereign credit rating to 'A-2' from 'A-1'. We also 
removed the ratings from CreditWatch with negative implications, where they 
were placed on Dec. 5, 2011. The outlook on the long-term rating is negative. 

Our transfer and convertibility (T&C) assessment for Italy, as for all 
European Economic and Monetary Union (eurozone) members, is 'AAA', reflecting 
Standard & Poor's view that the likelihood of the European Central Bank 
restricting non-sovereign access to foreign currency needed for debt service 
is extremely low. This reflects the full and open access to foreign currency 
that holders of euro currently enjoy and which we expect to remain the case in 
the foreseeable future.

The downgrade reflects what we see as Italy's increasing vulnerabilities to 
external financing risks, given the high foreign ownership of its government 
and financial sector debt. It is our view that deepening political, financial, 
and monetary problems within the eurozone are exacerbating the external 
funding constraints on the Italian public and private sectors. 

The downgrade of Italy's ratings reflects our view that the country's external 
financing costs have risen markedly and may remain elevated for an extended 
period of time amid a reduction in cross-border financing of Italian banks and 
the government. We expect that a difficult external financing environment will 
have negative implications for growth performance and hence public finances. 
Looking at BIS data, we note a marked and sustained decline in foreign banks' 
claims on Italian borrowers; this represents a risk to the sustainability of 
Italy's balance of payments, in our view, as it could reduce Italian 
borrowers' capacity to roll over their debt at low interest rates acceptable 
to the borrowers. Consequently we have lowered our external liquidity score 
for Italy (one of the five key factors in our published sovereign ratings 
criteria).  

The lower external score also reflects our view of Italy's substantial 
exposure to short-term external liabilities. Our calculations indicate that 
the ratio of total short-term external debt by remaining maturity exceeds 100% 
of current account receipts. We view current account receipts as an 
appropriate measure of an economy's foreign currency generating capacity. In 
our view, higher interest payments to non-resident creditors in turn will 
require increased domestic savings or lower investment in order to stabilize 
Italy's external debt net of liquid assets, which we estimate at 240% of 
current account receipts at Dec. 31, 2011. 

During 2012 and 2013, we expect the Italian Treasury will likely either pay 
historically high yields at longer maturities or issue debt at lower 
maturities to take advantage of the recent steepening of the yield curve. Over 
time, the latter option would, in our opinion, diminish one of Italy's 
important credit strengths: the relatively long average maturity of its debt 
stock of over seven years, a phenomenon that slows the impact of rising yields 
on the Italian government's budgetary performance.  

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements 
from policymakers lead us to believe that the agreement reached has not 
produced a breakthrough of sufficient size and scope to fully address the 
eurozone's financial problems. In our opinion, the political agreement does 
not supply sufficient additional resources or operational flexibility to 
bolster European rescue operations, or extend enough support for those 
eurozone sovereigns subjected to heightened market pressures. 

We also believe that the agreement is predicated on only a partial recognition 
of the source of the crisis: that the current financial turmoil stems 
primarily from fiscal profligacy at the periphery of the eurozone. In our 
view, however, the financial problems facing the eurozone are as much a 
consequence of rising external imbalances and divergences in competitiveness 
between the eurozone's core and the so-called "periphery". As such, we believe 
that a reform process based on a pillar of fiscal austerity alone risks 
becoming self-defeating, as domestic demand falls in line with consumers' 
rising concerns about job security and disposable incomes, eroding national 
tax revenues. 

In our view, the effectiveness, stability, and predictability of European 
policymaking and political institutions (with which Italy is closely 
integrated) have not been as strong as we believe are called for by the 
severity of a broadening and deepening financial crisis in the eurozone. 
Nevertheless, we have not changed our political risk score for Italy (one of 
the five key factors in our published sovereign ratings criteria). We believe 
that the weakening policy environment at European level is to a certain degree 
offset by a stronger domestic Italian capacity to formulate and implement 
crisis-mitigating economic policies. This reflects our view of the improved 
policy environment under the recently inaugurated technocratic government 
headed by Mario Monti, and our expectation that extensive growth-enhancing 
measures will be implemented during the first half of 2012. 

We believe that plans to deregulate the labor market, including closed 
professions, could help to restore Italian competitiveness, potentially 
enabling Italy to operate steady current account surpluses in a shift that 
could strengthen Italy's creditworthiness. Nevertheless, we expect that there 
could be opposition to some of the current government's ambitious reforms. 
This, we believe, increases the uncertainty surrounding the outlook for growth 
and hence public finances, in the context of a more challenging funding 
environment for Italian banks and the Italian government.

Italy's ratings are also constrained by what we see as the country's very high 
public sector debt and weak economic growth potential. The ratings are 
supported by our view of Italy's wealthy and diversified economy, expected 
primary fiscal surpluses, and sizable private sector savings. 

The outlook on the long-term rating on Italy is negative, indicating that we 
believe there is at least a one-in-three chance that the rating will be 
lowered again in 2012 or 2013. According to our criteria, we could lower the 
ratings if a weaker-than-expected macroeconomic environment and deflationary 
pressures: reduce Italy's per capita GDP; result in Italy's net general 
government debt ratio continuing its upward trajectory; or lead to what we 
would consider a prolonged worsening of financing conditions. We could also 
lower the ratings if we see that the technocratic administration fails to 
implement structural reform measures that we believe are necessary to boost 
growth potential, whether due to opposition from special interest groups and 
other incumbents or if the new government's term is cut short before its 
mandate is fulfilled.  

Conversely, we expect that the ratings could stabilize at the current level if 
structural reforms are fully implemented and shift the Italian economy to a 
higher level of growth, or if we see that other measures--such as significant 
asset sales and privatizations--are taken to substantially reduce the public 
sector debt burden. 


RELATED CRITERIA AND RESEARCH
All articles listed below are available on RatingsDirect on the Global Credit 
Portal. 

Sovereign Government Rating Methodology And Assumptions, June 30, 2011 
Criteria For Determining Transfer And Convertibility Assessments, May 18, 
2009
Standard & Poor's Puts Ratings On Eurozone Sovereigns On CreditWatch With 
Negative Implications, Dec. 5, 2011
Trade Imbalances In The Eurozone Distort Growth For Both Creditors And 
Debtors, Says Report, Dec. 1, 2011
Who Will Solve The Debt Crisis?, Nov. 10, 2011 

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This unsolicited rating(s) was initiated by Standard & Poor's. It may be based 
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