Italy has a crisis of democracy and a crisis of economics, but will it tear the EU apart and what is the impact on investors?
Can the EU survive Italian crisis?
Italy is in crisis: the two most successful parties in the recent election, which between them hold more than half the seats across Italy’s parliament, have been rejected by the country’s President and will not form the government. It’s a crisis of democracy, a crisis of economics, but will it tear the EU apart, what does this mean for investors?
In December 2015, an Italian pensioner in Civitavecchia, near Rome, killed himself. The tragic event occurred after the decision by the Italian government to write-off investments and bonds held by 130,000 Italians as part of the so-called ‘bail-in’ of four Italian banks. The pensioner in question lost 100,000 euros as part of the ‘bail-in’ of Banca Etruria.
It was a hugely unpopular decision by the authorities and the pensioner criticised the government in his suicide note.
But back then, the Italian economy was left devastated by the euro crisis earlier this decade, not that the issue of Italian government debt was even new at that time.
The biggest problem facing Italy is demographics, its working age population is expected to fall from 35 million to 32.2 million between now and 2030, while the overall population is expected to remain unchanged. This will put massive pressure on Italy’s declining working age population to produce the goods and services the country needs, yet productivity growth in Italy is poor. For Italy’s GDP per capita to remain at the current level, its working age population needs to become seven per cent more productive by 2030, yet over the last two decades productivity has declined.
In March 2018, the Italian Election saw the populist Five Star Movement win 333 seats across the 945 seats that make up Italy’s two parliamentary houses. The Lega Party - which is situated pretty far out on the right wing, won 183 seats.
So, between them, the two parties control just over half of the seats. Their ideology is quite different. Lega is especially popular in the wealthier north of the country – it wants to see more regional autonomy, is anti-immigration and pro-lower taxes.
Five Star is bigger across most of the rest of the country, except around Rome, where the moderate Democrat Party, which now controls 163 seats, is dominant. One of its flagship proposals was for a kind of universal basic income.
As was the case in the US with Trump, and the UK with Brexit, there has been a rural/urban divide, but in Italy, it was more nuanced than that.
Both Lega and Five Star are united by scepticism concerning the euro.
The two parties agreed a joint coalition - with plans consisting of tax cuts, a kind of universal payment to poorer families, reversing pension reforms, such as reducing the retirement age and a reversal of some banking reforms. Among their proposed banking reforms was to reduce the capital buffer needed by banks when lending to smaller companies.
They had dropped plans to hold a referendum on the euro.
Overall the plans would have led to a massive rise in Italian public debt and the banking reforms would have been in contravention of Basel III banking reforms, meaning an inevitable clash with the EU.
The new Prime Minister
But the Italian President, Sergio Mattarella, who is meant to be neutral, and holds very little power, except in the appointment of Prime Ministers, rejected the coalition plan, and has instead appointed Carlo Cottarelli, a former IMF economist, as Prime Minister, with a new election planned for the autumn.
Mr Cottarelli is hardly likely to support Five Star or Lega fiscal policies, and the Italian people may well end up with economic policies that are quite different from what they voted for.
But the can has been kicked a little further down the road. Italy is on hold until the Autumn. And the result of the next election is key.
The possibility that the election will throw up a result which creates an Italian economic descent, akin to that experienced in Argentina many decades ago, is real. Argentina was the eighth richest country in the world, until the populist gained control.
The possibility that the election will throw up a result that makes some kind of an EU/euro referendum inevitable is real. Although, opinion polls suggest a substantial majority of Italians support the euro.
End of euro?
A bigger threat to the euro lies with the possibility that an Italian government elected later in the year will select policies that makes continued membership of the euro area untenable.
Should the euro fall apart, and should this lead to a collapse in the EU, the economic shock waves will make the 2008 crisis seem mild.
Yet, somehow, the EU has managed to cobble together a package that has kept Greece in the euro. It is good at cobbling together, kicking cans down the road, and if you do that long enough, one of two things will happen eventually, either something will turn up that makes the issue go away, or we see some kind of crash.
And for investors
For quite a while now, many analysts have been saying that EU equities seem to be good value for money.
This has not necessarily changed. But tread with care.
Talk of an existential threat to the euro has been going on for years, and no doubt will continue for years. But it’s the economy that matters. The euro economy has been strong over the last 18-months. But growth slowed to 0.4 per cent in Q1. Recent purchasing managers indexes suggest Q2 is seeing similar expansion. If the euro area is going to grow its way out of difficulty, it needs to do better. Unless the recent slowdown proves a blip, I see problems building for the future.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees