Italy Politics November 2016

Italy

Italy: Renzi's referendum increases economic and political uncertainty

With its slow-growing economy, fragile banking system and high public debt load, Italy is preparing to vote on 4 December in a referendum to confirm or reject Prime Minister Matteo Renzi’s constitutional reform. Polls published in recent days confirm the slight lead of the “No” camp—as well as a high proportion of undecided voters—which could increase political instability. Renzi has stated that he will step down if the reform fails and a potential transitional government or, in an extreme case, early elections could lead to political instability and policy inaction. This, in turn, could translate into a period of high volatility in financial markets and increase the dangers posed by high public debt and a weak banking system.

The constitutional reform aims to reduce the power of the Senate, which currently has the same powers as the lower house of Parliament. The Senate would no longer vote on all legislation or on confidence motions regarding government. In addition, a number of functions previously granted to regional authorities would be returned to the central government. If the reform is approved, therefore, it should create a more efficient decision-making system, greatly simplifying the currently cumbersome relationship between the two chambers. Renzi always presented the constitutional reform as a key part of his program to transform Italy and make it a more efficient country. The problem he faces, however, is that his own party is divided on the constitutional reform, while the opposition is united against it. The “No” camp thus includes a wide ideological spectrum embracing the extreme right and left, along with centrists. The reasons for the "no" vote range from suggestions that it gives too much power to the Prime Minister, through to assessments of the reform as too timid.

Renzi has repeatedly made his political future conditional on a win for the “Yes” vote and stated that he would resign if he is defeated, though a number of analysts are skeptical as to whether he would actually do so. If he does, a new government supported by a similar parliamentary majority would likely be formed, but it would be a government of short duration, focused mainly on carrying the country over to the scheduled May 2018 elections. This would inevitably lead to a stalling in the adoption of structural reforms, the implementation of which has already been largely paralyzed for months since Renzi has sought to avoid negative consequences for the referendum vote. The greatest risk to the economic recovery, though it is unlikely, would be the calling of an immediate early election won by the populist, protectionist and statist Five Star Movement. This could result in a referendum on the euro, the adoption of a battery of protectionist measures as well as in an increase in public spending.

The challenge ahead for any post-referendum government will be to implement bold pro-market economic reforms to restart the stagnant Italian economy. Italy desperately needs to downsize its weighty public sector and reduce its heavy debt load, but to do so requires a stable government going forward.

FocusEconomics panelists see the economy increasing 0.8% in 2016, which is unchanged from last month’s forecast. For 2017, panelists also expect the economy to expand 0.8%, which is also unchanged from last month’s projection.


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