Italy: coronavirus and its consequences

The coronavirus pandemic will send Italy into a deep recession in 2020 and the country may even need to draw on additional assistance from the EU. Union Investment’s assessment of Italian government bonds is currently neutral.

Of the countries in the European Union (EU), Italy and Spain are the worst affected by the coronavirus pandemic. However, the number of new infections there – and in other European countries – indicates that the virus is now spreading at a much slower rate. The restrictions on movement introduced on 9 March 2020 have been effective and can now slowly be lifted. Many factories are ramping up production again, and travel between regions has been permitted since 4 May. Shops are allowed to open from 18 May, followed by restaurants and hairdressers on 1 June.

Italy faces a deep recession

The coronavirus pandemic and the measures to contain it will result in a severe recession in Italy. The economists at Union Investment predict that gross domestic product (GDP) will fall by 11.7 per cent in 2020 before returning to growth of 3.4 per cent in 2021. This particularly pronounced slump compared with other countries is due to the fact that the coronavirus outbreak primarily hit Lombardy and other provinces in northern Italy, which are the country’s economic heartland. Moreover, tourism has come to a standstill right across the country and is likely to recover more slowly than other sectors because travel restrictions and warnings are still in place and people will probably remain cautious for some time even after they have been lifted.

The Italian government signed off a new stimulus package of €55 billion on 13 May. This is modest compared with the steps taken in other countries and will by no means make up for all of the loss of revenue and income suffered by companies and consumers. The already high level of government debt means that Rome’s hands are tied. The economists at Union Investment estimate that the economic collapse and increase in spending will push up the budget deficit to 15 per cent in 2020 and it will still be as high as 7.5 per cent next year. As a result, government debt will rise to approximately 165 per cent of GDP.

Additional assistance may be obtained from the EU

In these circumstances, the Italian government may be able turn to Brussels for additional assistance. It is possible that Italy may draw on EU assistance funds, guarantees from the European Investment Bank (EIB) and, in particular, a support programme within the framework of the European Stability Mechanism (ESM). This would enable the European Central Bank (ECB) to buy Italian government bonds without restriction as part of outright monetary transactions (OMTs). But at the end of March, the ECB hugely stepped up its bond buying under the new pandemic emergency purchase programme (PEPP) even without the OMTs being activated. Of the €750 billion volume already announced, the central banks in the Eurosystem have purchased bonds worth €153 billion so far. A country-by-country breakdown of the purchases is not yet available. It is probable, however, that the bonds purchased are mainly from the countries hit hardest by the pandemic. This assumption is supported by buying patterns for the public sector purchase programme (PSPP), which was relaunched at the end of last year. Until the end of 2018, the ECB had, in percentage terms, kept relatively close to the capital key – i.e. the proportion of the ECB’s capital held by the national central banks – but it has deviated from it significantly in recent months. It is now buying far fewer government bonds from Germany and far more from Italy, Spain and France.

ECB significantly increases purchases of Italian government bonds

ECB significantly increases purchases of Italian government bonds
* Pandemic emergency purchase programme, forecast based on purchasing volume in first four weeks; implied stepping up of purchases over the year. ** Including supranational bonds. Sources: Bloomberg, Union Investment, as at 13 May 2020.

Assessment of Italian government bonds is currently neutral

Despite these measures, the spreads of ten-year Italian government bonds over their German equivalents have widened. The fixed-income fund managers at Union Investment currently view Italy neutrally but emphasise the importance of closely monitoring the situation and acting flexibly. The rating agencies are unlikely to exert substantial pressure in the short term, with only Fitch recently lowering the country’s credit rating to BBB-. However, discussions about Italy slipping into the high-yield segment could resurface as the year progresses. Nonetheless, Union Investment’s experts do not believe that this would stop the ECB from continuing to buy Italian government bonds.

Italy’s ability to service its debt will be affected by how credibly it can reduce its deficit in the years ahead. And this depends on overcoming the coronavirus crisis, returning to a path of consolidation in the medium term and obtaining additional financial assistance from the EU. Negative factors in the short term (and concerns about a second wave of the pandemic) are balanced by support in the shape of the ECB’s willingness to make purchases and the appeal of the high yields on Italian government bonds against the backdrop of generally low interest rates.

 

As at 19 May 2020