Italy’s rising risk is warning of an existential eurozone shock
Its risk score plunged the most of any country worldwide in Euromoney’s country risk survey in Q3 2016, highlighting how eurozone investors must remain on their toes.
ByECR - Jeremy Weltman,Thu Oct 20, 2016
Falling more than three points since June, to 55.9 from a maximum 100 allotted in the survey, Italy has careered down 10 places in Euromoney’sglobal risk rankings, below Spain, to 51st, its lowest level in three years:
The economy is weak, the banks in crisis, and prime minister Matteo Renzi has staked his all on a political reform to deliver the nation from decades of unstable coalitions and government ineffectiveness.
It is no wonder Italy’s capital access has tightened, not least with such low political risk scores (see chart, below).
Eyes fixed on December showdown
A referendum on the constitutional reform bill to be held on December 4 could prove to be another pivotal moment, not just for Italy, which would then be odds on for a credit rating downgrade. It could potentially impair other eurozone assets reeling from the aftershock.
Several eurozone countries are now improving, but concerns over Greece, Portugal and Italy continue to weigh on the region’s prospects, with economic growth vulnerable to Brexit-related setbacks and political risks stemming from elections next year in the Netherlands, France and Germany.
The fact Renzi has got this far is testament to his determination to enact real change to a system of ‘perfect bicameralism’ granting equal powers to the Senate, making it too easy to routinely block legislation from the lower house.
By diluting the power and size of the upper chamber, with fewer senators, less ability to bring down a government or overturn national budgets, and more regional representation, the referendum should improve the functioning of the political system.
What is promised
Increased centralization at the federal level encapsulated in the referendum goes hand-in-hand with the July 2016 reforms of the electoral system, which saw a reduction in parliamentary representation for smaller parties.
“The reform is also proposing streamlining the power of the regions, reducing local powers and increasing the degree of federalization,” says one of ECR’s expert survey contributorsConstantin Gurdgiev, a professor of finance at the Middlebury Institute of International Studies.
“If it is passed, it is threatening to reduce the autonomy of some of the northern regions, fuelling further centrifugal forces within Italy and potentially disrupting growth and enterprise-centric policies in the north.”
Partly for that reason, public approval is not guaranteed. The ‘yes’ side is leading in the majority of recent opinion polls, but not by a comfortable margin, with a significant share of undecided voters influencing the outcome when the status-quo effect will come into play.
Economy on its knees
Although there are many positives from the reform bill, from the point of view of improving policymaking, its opponents are invariably concerned it will hand the government too much power.
Many might also utilize this opportunity to deliver a verdict on the government’s patchy economic record.
GDP growth ground to a halt in the second quarter. The unemployment rate is stuck at just over 11% (harmonized). The sovereign debt burden is a whopping 135% of GDP, propped up by the European Central Bank’s implicit asset purchase guarantee.
Just-released forecasts inEuro Zone Barometer, a monthly survey of experts’ predictions, point to real-terms GDP growth of just 0.8% in 2017, with domestic demand forecasts downgraded, and only minor improvements to the deficit and debt situation foreseen.
Risk indicators of the economic-GNP outlook, employment/unemployment and government finances all score less than five out of 10 in Euromoney’s survey.
It is clear those forecasts might become worse, too, depending on how the political scenario unfolds, and what lies in store in terms of Brexit harming European trade and confidence, among other possible extraneous factors.
Prospect of snap elections
Renzi has softened his stance on vowing to resign if the referendum is defeated, but in all likelihood Italy could be heading for snap elections in 2017 in a country where few governments last a full term – and where would that leave the banking crisis?
With the anti-establishment Five Star Movement (M5S) led by Beppe Grillo challenging the Democratic Party’s narrow lead in the opinion polls, and taking control of mayoral seats in Rome and Turin, the prospect of an alternative Eurosceptic coalition gaining power is at least raising the possibility of another serious eurozone crisis down the line.
In principle, M5S favours continuing membership of the European Union, but does wish to see a referendum on the euro, and is supported in that aim by Matteo Salvini’s far-right Northern League, and other Eurosceptics in parliament.
A plebiscite might not ultimately reject membership of the single currency, but it could spur increased volatility of key assets, and not just Italian 10-year sovereign bonds, which have already edged out to 1.4%, widening the gap to Spain.
If the markets sense any realistic prospect of the eurozone losing one of its members, or of the EU splitting further apart, who knows what could happen to the currency, bonds and equities with the region still mired in a fiscal-macro crisis.
At the very least, Italy’s rising risk is sending out a sombre early warning sign.
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