From Fitch's press release on Italy's downgrade (emphasis mine):
Fitch Ratings-London-08 March 2013: Fitch Ratings has downgraded Italy's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'BBB+' from 'A-'. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the Short-term foreign currency IDR at 'F2' and the common eurozone Country Ceiling for Italy at 'AAA'.
KEY RATING DRIVERS
The downgrade of Italy's sovereign ratings reflects the following key rating factors:
- The inconclusive results of the Italian parliamentary elections on 24-25 February make it unlikely that a stable new government can be formed in the next few weeks. The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession.
- Q412 data confirms that the ongoing recession in Italy is one of the deepest in Europe. The unfavourable starting position and some recent developments, like the unexpected fall in employment and persistently weak sentiment indicators, increase the risk of a more protracted and deeper recession than previously expected. Fitch expects a GDP contraction of 1.8% in 2013, due largely to the carry-over from the 2.4% contraction in 2012.
- Due to the deeper recession and its adverse impact on headline budget deficit, the gross general government debt (GGGD) will peak in 2013 at close to 130% of GDP compared with Fitch's estimate of 125% in mid-2012, even assuming an unchanged underlying fiscal stance.
- A weak government could be slower and less able to respond to domestic or external economic shocks.
The 'BBB+' rating reflects:
- The rating remains supported by the relatively wealthy, high value-added and diverse economy with moderate levels of private sector indebtedness.
- Italy has progressed substantially over the past two years with fiscal consolidation. Public sector deficit was 3% of GDP in 2012, a result of 2.3pp fiscal consolidation in structural terms, according to the recent estimate of the European Commission.
- The fiscal measures already adopted should be sufficient to deliver a further narrowing of the budget deficit in 2013 despite the continuing recession. Fitch expects the deficit in 2013 to be around 2.5% of GDP. In structural terms, this would be close to the constitutional requirement of a balanced budget.
- Low contingent fiscal risks from the banking sector; an underlying budgetary position close to that necessary to stabilise the government debt to GDP ratio; and sustainable pension system underpins confidence in the long-term solvency of the Italian state.
- The Italian sovereign has demonstrated its financing flexibility and resilience during the crisis reflecting a strong domestic investor base and average duration of 4.74 years.
3 year chart of the 10-year Italian Government Bond Yield (courtesy of Bloomberg.com)
5 year chart of EUR/USD (courtesy of Bloomberg.com)
Annalisa Piazza, economist at Newedge Group, is worried that political instability in Italy could hurt its ability to tap the European Stability Mechanism for aid if there is another debt crisis (via CNBC.com and Sky.com).
The Mysterious Power of ECB Backstop (WSJ - March 8, 2013)
ECB Chief Plays Down Italy Fears (WSJ - March 7, 2013)
Did the ECB Just Warn Italian Voters Against Berlusconi? (Bloomberg View - February 22, 2013)