Italy Update Q4 2017

Capital International Group
January 22, 2018

As the threat of populist revolt throughout Europe recedes, the familiar mix of economic stagnation, toxic debt and governmental dysfunction in Italy has investors concerned again. Europe’s third biggest economy is due to hold its next parliamentary elections in early 2018 and will test the country’s unsure relationship with the single currency, its huge debt and a perturbed banking system still trying to rid itself of decade old toxic holdings. According to government officials, March has been touted as the most likely month for the elections. Parliament set the stage for the vote in October by passing an electoral law that resolved differences between the lower house and the Senate and, importantly, will encourage parties to build alliances. The electoral law effectively gives the green light for parties to fight for seats as coalitions. This has upset some, most notably the anti-establishment, Eurosceptic Five Star Movement, who called it a coup d’etat by mainstream forces. Five Star has completely ruled out any pre-election pacts. The opinion polls currently indicate that Five Star is neck and neck with the ruling center-left Democratic Party of Prime Minister Paolo Gentiloni. Nevertheless, both narrowly trail a possible center right coalition of the Forza Italia party of ex-premier Silvio Berlusconi, the Eurosceptic and anti-migrant Northern League and the smaller, far right Brothers of Italy. That bloc won the regional elections in Sicily in early November. However, none of these three groups appears to have enough support to win a parliamentary majority on their own. Both the Five Star and the League have softened their opposition to the euro as Italy overcomes the longest recession in the nation’s history. Five Star’s candidate for the premiership, Luigi Di Maio, has called a referendum on Italian membership of the Eurozone a last resort to force reforms of the European Union. However, pulling Italy out of the euro would require cross-party political backing as well as difficult and longwinded legislative process. Even before calling a referendum, a constitutional amendment would be necessary.

However, between now and the elections, some very difficult decisions will have to be made. First up is the budget law for 2018. The budget, which has to be approved by parliament by the end of the year, is supposed to lower the structural deficit. Italy’s debt is the second highest in the Eurozone after Greece, at more than 130% of gross domestic product. The European Commission called the debt a major source of vulnerability for Italy and has been overseeing the country’s pledges to reduce spending. An election victory for Five Star, in addition to raising questions about Italy’s euro membership, would fuel doubts over the sustainability of the country’s debt. Gentiloni, whose party has a very small majority, is also overseeing state intervention to help Banca Monte dei Paschi di Siena SpA, Italy’s oldest bank, as well as Banca Popolare di Vicenza SpA and Veneto Banca SpA. Government measures imposed on Monte Paschi and the two Veneto banks have defused a major source of financial and political stress in the Eurozone for the past two years. However, the underlying issues remain, including cronyism, with many banks too entwined with unions, foundations and politicians. The losses inflicted on savers will no doubt feature heavily in the election campaign, with controversy fueled by a parliamentary investigation into the sector’s troubles. As his government draws to an end, Gentiloni may try to push through parliament a controversial bill giving citizenship to immigrants’ children born in Italy.

If Five Star are victorious, Matterella could give its candidate, Di Maio, the deputy speaker of the lower house, an exploratory mandate to try to form a government. But Five Star would have a difficult time finding allies, although League leader Matteo Salvini has made overtures to it. A possible scenario is a grand coalition with the Democratic Party (PD) and Berlusconi’s Forza Italia. Who would lead such a coalition is uncertain. PD leader and ex-premier Matteo Renzi, who is touring Italy by train for two months, is under attack inside his party and seeking to smooth relations with the rest of the center-left. Berlusconi is vying with Salvini for leadership of the center-right and is banned from running for office after a 2013 tax-fraud conviction.

Concerning the financial markets and the impact these upcoming elections are having on them is the prospect of a hung parliament, Five Star’s inexperience at national level and a possible referendum on Italy’s membership of the Eurozone. Five Star’s program for government includes overhauling banks and breaking up the European Stability Mechanism and the troika that oversaw bailouts from Greece to Iceland. Add to that worries about how Italy could suffer from an end to the European Central Bank’s quantitative easing program. At the time of writing, the FTSE MIB had gained 17.73% year to date, following global indexes higher. However, as we get closer to the elections we can expect more volatility, which could affect other markets in the region also.

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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