High debt-to-GDP ratio remains a risk, especially if central bank support is scaled back

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On Wednesday, the Italian Ministry of Economy and Finance (MEF) released the updated Economic and Financial Plan for the Coming Years (NADEF), which anticipates strong nominal economic growth and a reduction in national debt to 146.1% of GDP by 2024 of the pre-crisis level expected (134.3%) by 2030.

While the recovery of the Italian economy in 2021 was impressive – in August we have revised With a forecast for 2021 raised to 6.1%, the government’s assumptions that growth and inflation will remain very high in the period 2022-24 appear, however, rather optimistic.

Rosy assumptions and expansionary fiscal policies mean that sovereign debt projections may turn out to be confident

Rosy nominal growth assumptions and generally expansive fiscal policies expected until the economy has fully recovered to pre-crisis trend levels of production – the government expects it won’t happen before 2024 – mean the longer-term MEF projections to Debt reduction to GDP ratio may prove sanguine.

For 2021, based on strong nominal economic growth, we have lowered our forecast for the general government deficit from 11.7% previously to 8.5% of GDP, which also translates into a more constructive expectation for a reduction the public debt ratio rose to 153% this year, after a record high of 155.6% in 2020.

We see a decline in the government debt ratio over the 2021-22 period based on assumed high nominal economic growth of 7.7% and 5.2% during the initial recovery. However, there is a risk that an ambitious target by the ministry of reaching pre-crisis debt by 2030 will not materialize by 2024, given the uncertainty about possible changes to EU fiscal rules after the crisis and the government’s expectation that the headline deficit will only decline gradually by 2024 over 3% of GDP remain.

A prudent fiscal stance while maintaining a growth-friendly mix of spending, which is critical to debt sustainability

Scope Ratings expects an average primary balance of -1.8% of GDP in the period 2022-2026, but remains below the average primary surplus of 1.5% in the period 2010-19. In the longer term, a prudent fiscal stance that seeks a return to modest primary surpluses while maintaining a growth-friendly spending mix will prove to be key to ensuring debt sustainability.

The sustainability of Italy’s debt will also depend on the timely and effective delivery of next-generation EU funding and its ultimate growth dividend. Assuming comparatively robust economic growth averaging 1.8% in the period 2022-26 in an economic base scenario, Scope expects a general government debt level of around 153% by the end of 2026, still above the (already) increased 134.6% of GDP before Crisis (from 2019).

A structural upward trend in public debt

The expectation that under favorable economic assumptions the debt ratio will be well above the pre-crisis ratios by 2026 without interrupting the recovery underscores our assessment that Italy’s debt-to-GDP ratio will continue to rise structurally Trajectory. Unless the debt can be substantially reduced in the coming phase of favorable conditions for economic growth, the public debt ratios will inevitably rise in the longer term in view of the substantial debt increases expected in future crises.

High indebtedness remains a major limitation of creditworthiness on the BBB + rating, which we assign to Italy.

A scenario with sustained inflation and an abrupt withdrawal of monetary support is a key risk

Long-term debt sustainability concerns are allayed by today’s accommodative market conditions, supported by the European Central Bank’s policy framework.

The ECB’s bond purchases and the announcement of continued exceptional support even after this Covid-19 crisis have anchored the credit terms of EU member states with the greatest tendency to market stress such as Italy. By the end of 2021, over 25% of Italy’s national debt will have been transferred to the Eurosystem’s combined balance sheet, up from 17% before the crisis.

However, an unfavorable scenario of significantly higher and / or persistent inflation in the euro area represents a weak point that could lead to a more abrupt withdrawal of monetary policy support. Such a scenario could expose heavily indebted countries like Italy to a greater reassessment of sovereign risk in debt capital markets – a latent risk related to debt and deficits that arose during the pandemic.

Scope assessments revised the outlook of Italy’s long-term BBB + credit-worthiness to Stable, from Negative, on August 20th.

You can find a look at all of today’s economic events in our Economic calendar.

Giacomo Barisone is Managing Director of Sovereign and Public Sector Ratings at Scope Ratings GmbH. Dennis Shen, Director of Scope Ratings, contributed to the drafting of this comment.

this items was originally published on FX Empire

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