The Italian political time bomb is ticking for investors

Ahead of elections scheduled for February, investors are increasingly considering political risk as a key factor to watch for in Italy.

Italy has become a ticking time bomb, with political risk looming over the country. Its financial stability is taking its toll on investors’ confidence to take exposure to the country.

Following the decision by Mario Monti to first resign from his role as technocrat prime minister, and then to take part in the electoral campaign heading a coalition of centrist parties, the so-called ‘Monti Agenda’, the likely outcome of elections coming up in February has become even more uncertain.

Historical evidence collected by Morgan Stanley indicates that close to a government collapse the cumulative rise in short-term interest rates is about 24bp. Similarly, equity markets fall by around 5% over the same period, and this has turned investors’ attitude towards Italy more bitter.

Electoral polls released at the end of last year suggested that a federation of centrist parties led by Mario Monti will be Italy’s second most important political body.

Structural reforms

Fabio Fois (pictured), economist at Barclays, says: “Mario Monti’s decision to lead a federation of centrist parties may reduce the risk of political impasse, which could emerge in the ­aftermath of February’s general election. Electoral polls published at the end of December indicate that Monti’s decision to lead political parties that accept and support his reformist agenda has boosted the popularity of these centrist [parties].”

“We continue to think that financial markets will remain focused on structural reforms. A stable political outlook is a necessary condition for reforms to be ­implemented ­decisively. As we previously argued, even if structural reforms approved by the outgoing government were a step in the right direction, Italy still requires decisive action to eradicate long-standing impediments to higher potential GDP growth.”

In this scenario, Raiffeisen Capital Management warned that despite the easing of tensions on the market, the crisis is far from over and in 2013 developments will be mainly political, with elections scheduled in Italy but also in Germany.

Investors’ reactions to changes in the political landscape are harder to assess. Surveys have suggested that investors looking for continuity after the election would welcome a role for Monti in the new government, but what is become known as the ‘Monti effect’ could have unintended consequences.

A Monti-led centrist alliance would in fact lead to a much more fragmented parliament; a non-homogeneous coalition government with less ability to reform.

The outcome of February’s elections will be a key development for Italy’s future economic policies but also for broader European policy, Morgan Stanley has warned.

Economists at the bank say the ­distinction at stake is between what happens until the ballot vote and shortly after (politics) and what happens once a new parliament and government are up and running (policy).

A recent report by the bank said: “Markets should care, too. With austerity taking a toll on an already weak economic fabric, the risk is that discontent might continue to rise, thus affecting the next government’s ability or willingness to pursue bold reforms, or result in an anti-reform election campaign at the very least. Historical evidence suggests that political developments affect Italian financial markets.”

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