Veritas – Italy is nearing point of no return

So, Silvio Berlusconi has finally confirmed he is leaving. The announcement caught the headlines of the newspapers across the world. And you could almost hear the cheer across Europe.

But Berlusconi has not yet formally resigned, the essential first step before elections are called. The question is when? For he has already hinted at resigning, though at the time few believed this was anything more than a negotiating tactic ahead of a vote in parliament this week to approve the budget.

He squeaked through on that vote, but only because the opposition abstained. They didn’t want to be blamed for plunging Italy into crisis, but nor were they going to be seen supporting Berlusconi. The vote highlighted the level of unrest within his own party, as 11 MPs decided to rebel. For them, this was a brave move, since the party list system that operates in Italy gives the party leader complete power over the party MPs. 

Berlusconi’s announcement is very far from the end of the game. Who will take over? The outlook is not looking good, if the bond markets are anything to go by. 

EURUSD fell from the high of 1.3860 to 1.3750 on news that LCH Clearnet was raising the margin required to hold Italian bonds. An increase in the margin for debt from Portugal, Ireland and Greece signalled the coming of a bail out. With Ireland, it was a matter of months. Another bailout signal is that Italian yields on 5-year bonds are above the critical 7% mark. But, Italy, with a €1.9trn debt, is too big to bail out. Such is the market mood that the upcoming bond auction looks set to be postponed.

This goes to show that the problem is not necessarily Berlusconi, for all the embarrassment he has caused his countrymen. It is just that he failed to provide the answer to their economic problems.

The Italian bond market is under heavy pressure. Even with Berlusconi gone, Italy could just return to the government instability that was the norm before Berlusconi arrived, the so-called ‘revolving-door government’. It is easily forgotten that he is the longest-serving Italian prime minister since World War II. His replacement carries risks for the reform package agreed with the EU and the IMF – not what the bond markets want to hear.

Italy’s only hope now is for the quick installation of a government of technicians, possibly headed by Mario Monti, former EU commissioner and president of the prestigious Bocconi University. Before that can happen, Berlusconi must formally resign. Italy’s President Giorgio Napolitano then can appoint an interim government, and set a date for general elections.

All of which will take weeks, if not months. On Tuesday evening, Berlusconi met President Napolitano, not to hand in his resignation but to ‘discuss the vote’. Berlusconi favours calling an early election, which theoretically could allow him back in. Otherwise, President Napolitano would appoint an interim government of technicians to implement the agreed reforms. But Berlusconi has to formally resign first.

Berlusconi is not finished yet. One fund manager described him as “cunning, stubborn and a survivor,” suggesting the old fox may yet surprise us. But the markets will have the last word. Barclays Capital has already concluded that Italy is “mathematically beyond the point of no return”.

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