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Fitch cuts Italy outlook on political uncertainty, weak growth

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Ratings agency Fitch cut its outlook for Italy on Friday, saying weak growth, high debt and the uncertain outcome of a planned referendum posed risks to the euro zone's third-largest economy.

Fitch said political uncertainty ahead of the vote on constitutional reform which could decide Prime Minister Matteo Renzi's future had increased since its last review, with polls now suggesting its outcome is too close to call.

The agency left unchanged Italy's BBB+ rating, but said downside risks had increased, noting that Renzi has indicated he could resign in the event of a "no" vote.

"Even in the event of a 'yes' vote, Italy would face elections by May 2018, with populist and Euroskeptic parties currently performing well in opinion polls," Fitch said.

Potentially voter-pleasing budget measures that Renzi unveiled last week include Rome's latest upward revision to the deficit target, continuing a "pattern of slippage against fiscal targets since 2013", Fitch said.

The budget risks setting up a tussle with the European Commission, whose rules require governments to make progress every year towards balancing their books or achieving a surplus.

The Commission says Rome needs to curb the deficit to rein in public debt, which as a proportion of GDP has risen to be the euro zone's second-largest after Greece's, and which Fitch forecast would peak at 133.3 percent of GDP in 2017.

Italy's banking sector and its 200 billion euros ($217.6 billion) of bad loans pose another risk to the economy, Fitch said, while the outcome of two alternative rescue plans for Banca Monte dei Paschi di Siena is uncertain.

European rules on state aid to banks would limit the options available if these were to fail, Fitch said, "which could have negative implications for the broader banking sector".

Fitch expects economic growth, which ground to a halt in the second quarter, to start again in the third, although it revised down its forecast for GDP growth to 0.8 percent in 2016, in line with the government's recently trimmed forecast.

"Weak growth makes it harder to reduce government debt, bank NPLs (nonperforming loans) and unemployment, and risks increasing support for populist political parties," Fitch said.

In August, DBRS, the last of the four main ratings agencies that ranks Italy in the "A" band, said it was placing its rating under review with negative implications.