Italy’s scenario a surprise for Europe, Natixis argues

Natixis global asset management’s chief Economist Philippe Waechter argues how will the outcome of Italy’s elections reshuffle the cards at European stage.

Why does the outcome of the Italian elections reshuffle the cards?

First because it comes as a surprise. A relative victory of the centre-left (Pier Luigi Bersani’s Democratic Party) would have meant a possible agreement with Mario Monti, resulting in a sufficient majority to govern the country and carry on with Mr Monti’s work. This was the scenario we all wanted to believe in.

This scenario did not materialise, however, given the return of Berlusconi, the emergence of Beppe Grillo’s movement and the disappointing results of Monti’s centrist coalition. There will be no possible continuity.

The options taken by the three main protagonists do not seem compatible, at least from an economic viewpoint. There are pro- and anti-euro groups (Grillo, Berlusconi in part). Under these conditions, it seems difficult to reach political equilibrium. The local agreements that have often been mentioned only concern local issues. In a coalition government, issues are broader and seem poles apart. The only possible coalition would be one that deals just with non-economic issues. In today’s Italy, that is unrealistic.

Both houses are needed to govern, the lower house (Chamber of Deputies) and the upper house (Senate). Each house has the same weight in adopting laws (unlike in France, where the Assemblée Nationale, the lower house, plays a decisive part). This will not be the case. One option could be to set up a transition government to handle current affairs and organise new elections.

New elections will have to be held, even if a coalition government handles current affairs and deals with certain issues. I find it hard to imagine that two of the three parties susceptible of setting up a coalition will be able to agree on crucial, non-economic topics such as the electoral system – an issue often raised after the elections so as to enable a clear majority to emerge.

The scenario is therefore for a transition period as a lasting coalition does not appear tenable pending new elections.

What will be the impact on Europe?

The baseline scenario was for the newly-elected government to quickly request aid via the ECB and its OMT (short-term bond buyback programme). The anticipation of this momentum partly explains the drop in Italian interest rates in recent weeks or even months.

Failing a legitimate government, it will be impossible to set up this kind of programme, as it implies a long-term commitment. In return for using OMT, governments must undertake to set up clear measures concerning the budget, structural reforms and institutions. If new elections are scheduled, a transition government does not have this kind of authority. This means that any ECB bailout for Italy cannot be triggered at least until the results of the new elections.

This creates a new situation of uncertainty which is negative for the economy. The Italian economy contracted by 0.9% in the fourth quarter of 2012 (-3.7% on an annualised basis) and by 2.2% for the full year 2012. If Italian government bond rates remain above 4.5%, a strong and lasting recovery cannot be contemplated. Nobody will want to invest in these conditions. This will penalise the Italian economy and result in a further deterioration of the labour market, which could fuel the weight of “anti-euros” in Italian society, in particular for the next polls.

For other euro zone countries, lastingly sluggish activity in Italy will be a handicap. Italy is the third-largest euro zone country and an Italy in recession will severely hamper Europe’s momentum. For France, trade with Italy accounts for 8% of its exports.

Furthermore, the political uncertainty surrounding new elections will have a number of impacts. If in the interim Italy’s situation deteriorates further, this could attract more votes against Europe and the euro. More than half of votes more or less reflected this opinion in the polls of 24 and 25 February. This situation could worsen, indicating uncertainty about the euro zone’s effective momentum. If such an option were to materialise, investments in the euro zone would become more risky and it would not invite massive investments in the region.

That is why the Italian elections are bad news for the euro zone. They extend the period of uncertainty, which can only undermine the economic cycle.


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