Feeling Moody’s
Last week the credit rating agency Moody’s downgraded Italy from A3 to Baa2, just two notches above junk status. The decision was heavily criticized by the European Union and the Italian government, currently in the midst of a difficult fiscal consolidation. “We are virtuous, yet they punish us”, complained Prime Minister Monti. Ordinary folk, who feel the tax rises and spending cuts starting to bite, blame the decision on a German-led conspiracy to bring down the country. A look at the numbers seems to suggest there is some truth in these views.
Mirror, mirror on the wall, who is the fairest of them all?
| Country | Debt/GDP ratio | Budget balance (% GDP) | Growth forecast 2012 (%) | Rating
|
Belgium | 99% | -3.1 | 0 | AA3 |
| France | 89% | -4.4 | +0.2 | Aaa |
| Germany | 82% | -1.2 | +0.8 | Aaa |
| Italy | 120% | -2.3 | -1.9 | Baa2 |
| Netherlands | 64% | -5.1 | -0.8 | Aaa |
| Spain | 67% | -6.3 | -1.7 | Baa3 |
| UK | 88% | -7.8 | +0.2 | Aaa |
| USA | 103% | -7.6 | +2.2 | Aaa |
Indeed, Italy’s debt, accumulated over thirty years of almost uninterrupted profligacy, represents a massive burden on its long-term growth prospects. Yet, the budget deficit is a better indicator of short-term performance. Italy fares much better than other countries in this respect: it already has a primary surplus (i.e. before repaying interest on its debt) and expects to balance the budget by the end of next year . This target has required austerity measures which help explain why growth forecasts for this year are negative.
Other countries – look at the UK, Netherlands and France – still enjoy a triple-A status despite a much worse budget deficit, anemic growth prospects and a worrying debt to GDP ratio. Last week the French Court des comptes warned that the country would miss its deficit targets if it didn’t come up with €43bn in savings by next year, yet the markets barely flinched. Ironically, these countries, alongside other triple-A ones like Germany, Denmark and Finland, sell their bonds at basically zero (or in some cases negative) interest rates, while Italy has to pay ever-increasing rates to finance its debt.
As investors flee from the Spanish and Italian markets, northern countries are awash with money. Hence Monti’s request at the latest summit for a mechanism to bring interest rates under control and the opposition from the Netherlands and Finland. It’s not a matter of conspiracy theories, but simple economic calculation: these countries benefit from the current situation. So long as the threat of contagion from a major catastrophe – like a Spanish or Italian meltdown – is not right behind the corner, they have little incentive to end the Eurocrisis.
An inconvenient truth
So, is Moody’s downgrade wholly unjustified? A closer look at the reasons for it shows they do have a point. The agency notes the country’s strengths and recognizes “the current government's strong commitment to structural reforms and fiscal consolidation”. However, it also observes that it is “more likely to experience a further sharp increase in its funding costs or the loss of market access” while “near-term economic outlook has deteriorated, which creates risk of failure to meet fiscal consolidation targets”.
Moreover, it considers “the political climate, particularly as the Spring 2013 elections draw near, a source of implementation risk”. This is probably the key challenge for Italy’s long-term prospects: the country needs years of reforms, something that the population doesn’t seem to understand and the current political parties are unable to deliver. Moody’s assessment may be harsh but is hard to dispute.
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