“Typically, developed sovereign bond market passive funds track benchmarks that require issuing governments to be rated investment-grade,” said Morningstar. “his means that a downgrade of Italy to junk would turn the funds into forced sellers at the worst possible time. Given the large weight of Italy in these indexes, it is easy to imagine a situation where downside pressure to prices is magnified by the sheer volume of bonds that these passive funds–and active funds unable to invest in non-investment-grade debt–would have to shed and, thus, the cost that investors would have to bear.”
Italy argued that the increased spending plan was necessary to bolster growth, which will eventually push down debt, and the higher deficit will subsequently fall as a result, according to the Associated Press.
“Besides, a downgrade to junk would also mean that the European Central Bank may be technically barred from coming to the rescue, which would add fuel to the anti-euro rhetoric of this Italian government,” according to Morningstar.
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