Italy: Political crisis is likely to have muted economic consequences, but raises outlook concerns
Prime Minister Giuseppe Conte resigned on 26 January, opening the door to a period of political uncertainty. Conte’s resignation will likely lead to the formation of a new government, although snap elections also remain a possibility. The political turmoil has seen financial tensions rise: Yields on government bonds rose as markets grew more concerned over the country’s weak fiscal position and the use of the incoming EU recovery fund. On 29 January, President Sergio Mattarella granted Lower House Speaker, Roberto Fico, an “exploratory mandate” to see if an agreement can be found among parties to form a new government.
Conte’s move came after former Prime Minister Matteo Renzi and his small, center-left Italia Viva party left the cabinet and withdrew its parliamentary support earlier in January. This caused the ruling coalition to lose its absolute majority in the Senate. The main bone of contention was the allocation and management of over EUR 200 billion in EU grants and loans, which Renzi favored using for long-term measures rather than temporary relief.
Different possible outcomes are on the table to solve the current impasse: A “Conte III” government, reshuffled to win back a parliamentary majority; a coalition headed by a different prime minister, but composed of the same parties; a cabinet supported by the more centrist groups of the center-right opposition; a national unity government headed by a technocratic prime minister; or snap elections. The latter option seems the most unlikely, however, as pointed out by Loredana Maria Federico, chief Italy economist at UniCredit:
“The Italian government crisis has generated political uncertainty and, potentially, a period of political instability. However, we see early elections as the least likely outcome. We believe the current crisis will be resolved via the formation of a new government, without going to new elections. […] Indeed, at present, few political parties would be better off in the resulting new parliament, which will be a reformed one, where the number of seats would be substantially less than it is now (from 630 to 400 seats in the lower house and from 315 to 200 seats in the Senate). This is likely to discourage several parties from moving towards dissolution of parliament and early elections, and to encourage their efforts to form a new government in the current legislature.”
Looking at the possible consequences of the current political turbulence, analysts at Goldman Sachs stated:
“The latest political tensions within the Italian government have added to the pandemic in bringing to the forefront concerns regarding economic growth and the debt outlook. The combination of the Recovery and Resilience Facility (RRF) and the accommodative European monetary framework still provide a large buffer against sovereign stress in Italy. Political frictions can nonetheless affect the implementation and effectiveness of the RRF by triggering a combination of three different risks (implementation, allocation and fiscal conduct) that might weigh heavily on the pace of the recovery and the outlook of debt reduction. If the political fragmentation will be resolved by mid-February as expected, the highlighted risks will be tamed without reversing the opportunity provided by the RRF to support growth and facilitate debt reduction. Our results therefore highlight that swift and efficient implementation of the RRF is key for the Italian fiscal outlook.”
GDP should recover some of last year’s losses in 2021, as the gradual easing of restrictions and rising inflows of EU funds unleash pent-up capital and consumer spending, and the reopening of economies abroad fuels external demand. That said, the pandemic has dealt a severe blow to Italy’s already-ailing economy and has led to a widening of the fiscal deficit and further accumulation of the mountainous stock of public debt, while also deteriorating banks’ balance sheets. EU recovery funds should reduce the likelihood of financial turmoil, although political instability and long-standing problems such as a cumbersome public sector, much-needed market-friendly reforms, high taxes and a sluggish judiciary all cloud the outlook for Italy’s economy.