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Italy Politics May 2018

Italy: Further political uncertainty on the horizon

On 28 May, President Sergio Mattarella met with Carlo Cottarelli, a former IMF director, and gave him the task of forming a caretaker government to calm political and market turbulence, approve the budget and lead the country to early elections in 2019. After reaching a coalition agreement in mid-May following complex negotiations, the League and the Five Star Movement (M5S) proposed a list of ministers to the president. However, on 27 May Mattarella refused to appoint Paolo Savona, a Eurosceptic economist proposed by the coalition, as Italy’s new finance minister. This led to the collapse of the coalition agreement and prompted the M5S to threaten to impeach the president. The conflict has notably increased political uncertainty in Italy and the chances of snap elections. While Cottarelli has been given the opportunity to form a government, it is unlikely he will secure the parliamentary majority he needs, since the Five Star Movement and the League hold an absolute majority, and the two political parties have announced they will not support the proposed government. Therefore, the likeliest scenario is early elections later this year.

Whether a short-term technocratic government is formed, or early elections are held quickly, political uncertainty will continue to weigh on Italy’s economy. If Cottarelli can garner a parliamentary majority and form a stable caretaker government, then this could calm markets. However, this situation seems unlikely, and the political scenario will continue to be marked by a high degree of uncertainty. Given recent polls, new elections would most likely confirm a populist parliamentary majority, leading to a situation similar to the current one. Political uncertainty, combined with Italy’s colossal public debt and already sizeable fiscal deficit, could cause financial distress, especially at a time when the European Central Bank is preparing to reduce its monetary stimulus.

Although the economy firmed up in 2017, underpinned by solid investment and export growth, Italy was the EU’s growth laggard, and its growth potential remains low, weighed down by longstanding problems including sluggish productivity growth, a high tax burden, bureaucracy and the second-highest public debt-to-GDP ratio in the European Union (the highest in absolute numbers). Whether or not a short-term caretaker government is formed, uncertainty will dominate the political landscape in the coming months, clouding the outlook.

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