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Italy Politics February 2018

Italy: March elections outcome unlikely to lead to bold reforms

Italians head to the polls on 4 March, amid a fragmented political landscape and with little hope the resulting government will be strong enough to fix the country’s many economic and fiscal weaknesses. Polls suggest the likeliest outcome is a hung parliament, with no coalition winning an absolute majority. Laborious negotiations would ensue, and a weak centrist grand coalition, which would have difficulty implementing a broad reform agenda, appears to be the most likely result. The elections come at a time when the economy is expanding at a reasonable pace, helped by improving conditions in the banking sector and gradual progress in the labor market. However, Italy’s weak fiscal position and structural issues expose the economy to possible political inaction and lax fiscal policies.

Under a new voting system, it is unlikely any coalition will obtain the level of support estimated to be necessary to obtain an absolute majority. This would leave a fragile centrist grand coalition as the most probable outcome, made up of the center-left Democratic Party (PD) and Silvio Berlusconi’s center-right Forza Italia (FI), plus some other minor parties. Such a government would likely adopt a gradual approach to reforms and maintain the fiscal deficit below 3% of GDP, broadly ensuring policy continuity and a good relationship with the EU. However, it would not likely deliver much-needed reforms such as privatizations, and substantial spending and tax cuts. Therefore, growth will remain slow compared to Italy’s European peers, and the improvement in labor market conditions will remain slow. Moreover, Italy’s fiscal parameters would barely improve, leaving the economy structurally weak.

Another possible outcome is an absolute majority of the center-right electoral coalition formed by Forza Italia, the federalist right-wing Northern League (LN) and the national-conservative Brothers of Italy. In this case, more tax cuts and less fiscal discipline are to be expected. Both the FI and LN are in favor of introducing a flat tax cut on household and corporate incomes; however, the Northern League (LN) proposes a 15% rate, while the FI opts for a more prudent 23% rate. Such tax cuts would foster business investment and household spending, and thus boost growth. However, they could translate into a rising fiscal deficit, which would not bode well for public finances’ sustainability. Also, given the two center-right parties’ divergent policy proposals, their coalition could be unstable and short-lived.

In an extreme scenario, there is also a small probability of an anti-establishment government formed by the 5 Star Movement (M5S) and the LN, or of re-run elections if coalition negotiations fail. That said, the possibility of new elections in 2018 is very unlikely as parties will want to avoid returning to the polls, which could risk increasing political support for the M5S. While the M5S is expected to win the most votes out of any party, a lack of support among other parties makes it very unlikely they would be able to form a government.

Commenting on the most likely post-elections scenarios, Nicola Nobile, Lead Economist at Oxford Economics, says that:

“While a euro exit is now only a remote risk, we think that none of the political scenarios is optimal for either fiscal sustainability or structural reforms aimed at tackling the perennially poor productivity performance in Italy. Given the political landscape and the electoral system, a reformist government is very unlikely.”

Recent data for Q4 2017 GDP showed that the recovery is underway, although long-standing problems continue weighing on Italy’s economic performance. These include the second-highest public debt-to-GDP ratio in the EU, cumbersome bureaucracy, sluggish productivity growth, high taxes and public spending and inefficient institutions. Compounding these is a weak, albeit improving, banking system. The formation of a grand coalition government would likely guarantee some small improvements in the fiscal deficit, but not a raft of much-needed reforms.

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