Goldman Sachs on why Italian budget crisis could get worse

The Italian budget crisis could get
worse.
Reuters/Max
Rossi

• Italian stocks and bonds rebounded a little on Monday
  after ratings agency Moody’s left the country’s debt with an
  investment grade rating.
• The bounce is likely to be short-lived, however, as
  investors simply don’t think Italy’s fiscal path is
  sustainable.
• The government wants to increase the budget deficit,
  and implement a large scale fiscal stimulus.
• Goldman Sachs’ Silvia Ardagna thinks the situation
  could get worse.

Italian assets are showing signs of a nascent recovery this week,
boosted by ratings agency Moody’s leaving the country’s
government debt at investment level.

Moody’s downgraded Italian debt to a Baa3 rating, placing it
one notch above junk status — the point at which investments
effectively become speculative bets — but also reaffirmed the
country’s outlook as stable, upgrading it from negative
previously.

This was interpreted by markets as a reasonably good result, with
many having feared that Italy could be moved into junk status.

Monday saw Italian assets across the board climb, and while the
country’s stock market has
slipped as part of a global sell-off on Tuesday, yields on
the country’s benchmark 10-year bonds continue to fall off their
recent highs, reflecting a renewed appetite for Italian assets
from investors.

The comeback, however, looks set to be shortlived and assets
could drop below even the multi-year lows witnessed last week.
That’s according to Goldman Sachs economist Silvia Ardagna, who
wrote this week that Italy’s “market situation may need to get
worse before it gets better.”

Ardagna’s rationale is fairly straightforward. The Italian
government does not want to take a backward step in the
imposition of its new budget, which has led it to clash with
Brussels.

The budget proposes
increasing both Italy’s overall government debt and its deficit
in the short run, pushing the deficit as high as 2.4% of GDP
over the coming years. This means Italy will fall foul of a
previously mandated maximum deficit level of 0.8% of GDP.

Brussels has repeatedly asked the coalition government to
reconsider its plans, but Rome is refusing to budge, and will
need a serious motivation to do so.

One such motivation could be a further adjustment lower in
markets.

“Financial market participants understand there is value in
correctly pricing not just the ‘end game,’ but also the path to
that ‘end game’ and the risks around it,” Ardagna wrote to
clients in a note earlier in October, before reiterating the
point on Monday.

“From this perspective, our view is that market tensions would
need to intensify in order to exert sufficient pressure on the
Italian political system to trigger a change in the policy path
and the political rhetoric around it.

“On that basis — and even if Italy does ultimately remain part of
the Euro area — the market situation may need to get worse before
it gets better,” she added.

Get the latest Goldman Sachs stock price here.