Why We Aren’t a ‘Junk’ Country

Why has Moody’s downgrade left investors and international analysts indifferent? Why have the yields of the government bonds that were auctioned yesterday declined despite a double-notch downgrade? And why have the prices of credit-default swaps on Italy fallen instead of increasing? And finally, why did Moody’s announce the downgrade when (the soon-indifferent) Asian markets were still open and a few hours before the opening of European markets? And why just ahead of a crucial government bond auction? Wouldn’t it have been more honest and fair to wait for the closing of European markets for the weekend, as is the norm in these cases?

These were yesterday’s key questions, and one answer among all others was particularly striking. That’s because the answer wasn’t written by an analyst at an Italian bank, but by an analyst at one of France’s most important banks: “The way out of the crisis comes from reliable standards that can reflect the steps each country makes toward more sustainability at the EU level,” the French analyst wrote. Spreads and ratings, therefore, are imperfect standards, which the markets know should be read in context. “The gap between Italian and German bonds doesn’t reflect the progress made by Italy,” the report says.

“Seen from another perspective, credit spreads certify the existence of a considerable European subsidy for reducing public debt that exists even in Germany. The markets, ‘policy makers’ and the media should avoid alarmist tones in order to understand and explain such a complex situation.” What’s striking is that a new approach to rating agencies and the dictatorship of spreads seems to have finally gained ground, rather than the fact that BTPs passed the auction test or that stock markets rebounded.

Our three questions have found a first answer: in a complex crisis like today’s, the markets have started to recognize ratings for what they are: a black-and-white picture of a rainbow. Not only has the world changed, but this is especially true when it comes to the subjection of the markets to old indicators. This change happened after a four-year economic and financial crisis, when the euro and Europe were on the verge of breaking up, governments kept changing at an incredibly fast pace and EU leaders had made enormous efforts to prevent the Greek crisis from turning into a Europe-wide apocalypse.

Of course rating agencies and spreads still matter for the markets, but in a context that seems more realistic and less prophetic. Evidence of this was yesterday's BTP auction and another one that was held a few days before. Spreads and ratings no longer seem to sum up the analyses on the health and future of Italy’s economy. “It’s as if in order to check someone’s health we would only look at cholesterol levels,” wrote the French analyst. “Above 200, it’s a problem. Yes, that’s right. But it’s important to look at the whole situation, from an analytical and therapeutic perspective.”

Factors such as ratings or the difference between the yields of German and Italian bonds are not enough to determine the sustainability of public debt. In other words, they aren’t a good predictor of whether Italy will be able to reduce its debt/GDP ratio, a goal set by the Maastricht treaty and made even more pressing by the Euro Plus Pact and the fiscal compact.

There are economic and financial factors behind spreads. Measuring them is a way of reminding us of the constraints derived from owning one of the largest debts in the world. This year, interest payments will amount to about 85 billion euros, equal to more than five percentage points of the GDP. But this is a black-and-white picture of our rainbow. Many colors went missing, and Moody’s seems unwilling to see them. These colors alone would be enough to spur confidence in what Italy is doing. But rating’s agencies seem to prefer that confidence decreases.

Here are some colors. Moody’s says that public finances have deteriorated, but according to data from the Economy Ministry (the same data that Moody’s should be using), in the first semester of 2012 the state sector deficit dropped to 29.1 billion euros, from 43.9 billion euros a year earlier. In June, the state sector budget surplus was 5.8 billion euros, up from 1 billion euros a year earlier. In light of these figures, analysts believe that the government isn’t lying when it says that it expects a primary surplus equal to 4.9 percent of GDP by the end of year, up from 3.6 percent of GPD estimated in 2012. There is more: several leading economic research centers, including Banca Intesa Sanpaolo, forecast that thanks to these results achieved by our technocratic government, next year we should be in a position to have a 17 billion euro deficit, down from this year’s 32 billion.

Finally, the most important issue when it comes to reducing excessive public debt: independent economists forecast that Italy’s annual borrowing needs will amount to 415 billion in 2013, 40 billion less than the 454 billion euros estimated for this year. Based on current estimates, which were adjusted for the recession, next year Italy will be able to finance its debt at the same level as in the years 2003–07—in other words, before the crisis. Has Moody’s taken these factors into account? Or is the past the only thing that matters? Yesterday the markets showed they were aware of these factors. Here’s the answer to the last question pertaining to the timing of the downgrade: if it had been announced Friday night, probably nobody would have realized it had ever occurred.