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Italy is still Europe’s main political tail-risk

By Jeremy Weltman
30 Aug 2017

Europe’s investor prospects are superficially safer due to economic recovery, but elections in Germany and in Italy, especially, present tail-risks. This is a manifestation of deeper uncertainty urging a fresh approach to risk management.

The eurozone risk outlook has generally eased this year.

Risk scores for 11 of the 19 members of the eurozone improved in the first half of this year in Euromoney’s country risk survey, as analysts became more confident in the region’s economic prospects.

GDP increased by 0.6% in the second quarter, after a 0.5% rise through January to March, according to Eurostat, pushing the annual rate of expansion higher to 2.2%.

Ultra-loose monetary policy and robust global trade growth are finally delivering results, and the region’s unemployment rate fell to 9.1% (harmonized) in June, on a steady downward trend.

Upgraded economic forecasts in the latest Euro Zone Barometer survey put the region on course for the strongest pace of expansion since the sovereign debt crisis in 2010.

Yet ECR expert Constantin Gurdgiev believes there is a sense of complacency since the French elections and the rebound for Angela Merkel in the polls for September’s elections in Germany.

Germany’s total risk score has fallen sharply, more than any other country in Europe this year, highlighting uncertainty over the forming of a coalition, although it does not just reflect pure political risk.

There are structural concerns and reputational damage to the car industry to factor. In fact, Germany’s political risk is only marginally down on year-earlier levels, and has improved a little this year with the diminishing threat from the right-wing populist and Eurosceptic party, Alternative for Germany.

Still, political risk is a prominent feature of Europe’s investor landscape, Gurdgiev believes.

Immediate concerns centre on what will happen in Italy.

“The political landscape is confused, with the Five Star Movement (M5S) rising to the top of the opinion polls six months ago, but then losing the local elections in June,” says Norbert Gaillard, an independent sovereign credit risk expert, and another of Euromoney’s survey contributors.

Gaillard notes the fact a recent poll published by Corriere della Sera indicated a coalition composed of Silvio Berlusconi’s Forza Italia, North League – a regional party seeking independence for Padania – and the national-conservative Brothers of Italy could win the next general election ahead of Beppe Grillo’s populist-Eurosceptic M5S, and Matteo Renzi’s Democratic Party.

That would result in a remarkable comeback for Berlusconi as prime minister, or a kingmaker in parliament, which could mean harsher relations between Italy and Germany, and the same if North League came to power.

Gaillard has been concerned by the political situation in Italy for years, and he is not alone.

Italy’s political risk score has worsened in Euromoney’s survey during the past five years, with the country still scoring fewer than half the points available for corruption and government stability, and institutional risk barely much higher:


“I am afraid that the next Italian government will have a populist roadmap,” says Gaillard. “This is the major threat to the stability of the eurozone and the euro currency.”

Gurdgiev concurs, stating: “There is little comfort in the contest between Berlusconi and Renzi, as the former is highly capable of taking a populist stance, and Renzi is alienating scores of his Democratic Party (PD) voters by sticking to the same ideological ground and policies that led to the split of his party in the first place.”

A regional election will be held in Sicily in November, with the M5S on course for victory there.

This would mark a milestone for the party going into the general election, with PD slightly behind M5S in the national opinion polls, but both broadly even on around 27% each.

Holistic approach

Italy’s predicament opens up a wider discussion about the changing nature of the political landscape in Europe since the global financial crisis a decade ago and the austerity required to address huge sovereign debt burdens with populism on the march.

Citing research from Sweden’s Timbro, Gurdgiev says: “Hungary, Poland and Slovakia are flashpoints of political opportunism and populism.”

Then there is Brexit, the fact Dutch politics is split between the mainstream and opposition dominated by Eurosceptic populists, the influence of the far-right in Austria and Switzerland, and the secessionist movements in Belgium and Spain, led by Catalonia’s push for constitutional independence.

The Timbro research suggests populism is no passing phase, but a long-term threat to liberalism in Europe, with around a fifth of the electorate – some 55.8 million people – now voting for a left-wing or right-wing populist party.

Nine European countries, including seven EU member states, have populist parties in government.

Gurdgiev notes this is a manifestation of what is described as the new “volatile, uncertain, complex and ambiguous world”.

His recent paper, Millennials’ Support for Liberal Democracy is Failing. An Investor Perspective, suggests the deeper uncertainty environment invalidates the core policy strategies designed for stabilizing democratic systems, namely institutional consolidation and harmonization.

It also means investors cannot rely on traditional risk-management approaches to mitigate the effects of deep uncertainty.

Gurdgiev cites added protection from systemic deep uncertainty by tilting towards high environmental, social and governance-rated portfolios, and to gold and more liquid crypto-currencies.

At the very least, it explains why political risk scores remain heavily marked down since the crisis began, and why political risk matters as much as, if not more than, real economy factors.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.

By Jeremy Weltman
30 Aug 2017