Italy Politics December 2016


Italy: Gentiloni takes the helm of Italy's government as banking crisis looms

December 20, 2016

Former foreign minister Paolo Gentiloni took control of Italy’s government in December, avoiding a power vacuum after the resignation of Prime Minister Matteo Renzi. As a new government has already been voted in by the parliament and the 2017 budget has been approved, a drastic increase in political uncertainty has been averted for now. The new government will almost certainly be aligned with its predecessor, as Gentiloni is one of Renzi’s closest allies and the composition of the new government remains much the same. The Economy and Finance Ministry remains in the hands of Pier Carlo Padoan, sending a message of continuity. The new government’s economic plan remains unclear, but top of the list of pending tasks is to avoid the financial turmoil which could stem from the fragile situation of the country’s banking sector. To this end, on 19 December the Council of Ministers decided to seek parliamentary approval to increase public debt by up to EUR 20 billion to finance an eventual operation to strengthen the banking system. The new government will likely have to negotiate amendments to its approved 2017 budget with the EU in order to rein in Italy’s public finances, and any increase in public debt to bail out the banking sector will make this challenge even harder.

Financial instability continues to hit the Italian banking sector, which is suffering the effects of high levels of non-performing loans, reduced intermediation margins and the country’s subdued economic performance. A few days after the referendum, the European Central Bank rejected a petition from Italy’s third largest lender, Monte dei Paschi di Siena (MPS), for more time to raise capital, meaning the bank has only until the end of the year to raise EUR 5 billion. The lender’s shares have been rocked by uncertainty, making a government bailout likely if MPS cannot raise the capital in time, though the EU’s Bank Recovery and Resolution Directive in force since the start of this year means private bondholders will likely take a hit too if a bailout becomes necessary. Meanwhile, UniCredit—Italy’s biggest bank—unveiled a major restructuring plan, which includes a recapitalization plan worth EUR 13 billion and the sale of over EUR 17 billion of bad loans. The plan still needs to be approved and should be completed in the first quarter of 2017.

Commenting on Italy’s outlook, Mark Wall, Chief Economist at Deutsche Bank, adds:

“Italy’s short-term policy priorities are a new electoral law and addressing the banking concerns. These are intertwined. A credible backstop should be larger than the size of the problem. But the only politically digestible outcome might at present be a limited package that deals with the weakest banks. Such an approach could work as long as the recent risk-on mood in markets continues. Markets see positively a potential compromise on an electoral law that requires large coalitions. But governments supported by fragile coalitions mean poor prospects for reforms.”

Although an immediate political crisis has been avoided for now, political uncertainty and economic weakness will continue to beset Italy. The new government will be a transitional one and, as such, it certainly will not address the structural problems affecting the country—its high tax burden, slow judicial system, heavy public debt burden and cumbersome bureaucracy. It will also be tempted to loosen the purse strings ahead of the next elections. Early elections are highly likely as major parties have called for an early vote, but this will depend on if and when a new electoral law is written and approved by parliament, as the relevant law currently applies only to the lower house.

FocusEconomics panelists see the economy increasing 0.8% in 2017, which is unchanged from last month’s forecast. In 2018, panelists expect the economy to expand 1.0%.

Author: Massimo Bassetti, Senior Economist

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