Italy's referendum: Short-term outlook and long-term implications

Currently, the lower and upper houses (Chamber of Deputies and Senate) have equal powers, which has made policymaking in post-war Italy extremely cumbersome while governments have been weak and short-lived. Presently, the polls show a small lead for those intending to vote No to a reform of this system.  With almost two months to go and around 40% of Italians still undecided, the outcome is still open. But we cannot rely on wishful thinking but have to be prepared for a No vote as well. 


Whenever Europeans are asked to vote on complex issues (Brexit, EU constitution) they tend use the opportunity to register their disapproval with the government of the day or wider economic issues A No-vote in Italy would also reflect the unpopularity of the Renzi government.  All opposition parties are campaigning for a No.


A Yes vote – Italy reloaded?


If the constitutional reform passes in the referendum, Italy has a chance of moving to more stable governments and more effective law making. A newly strengthened Renzi would be in pole position to win the 2018 election, which – if they take place under the new Italicum electoral law – would give him a strong one-party majority in parliament. He could then revive his reform program.


While markets would rally, most of the impact would take years to materialize. We forecast Italian GDP growth at only 0.7% and 0.9% for 2016 and 2017, respectively, even in our upside scenario. Over the medium to long-term, however, a more effective political system – if used for growth-boosting measures – could lift Italy’s growth potential from around zero today to 1%.


There are caveats to our upside scenario, however. The Italicum electoral law gives an automatic parliamentary majority to any party that wins in a second-round run-off election. It would thus end Italy’s tradition of weak coalitions. However, the June local elections have shown that this kind of seat premium mainly benefits the populist Five Start Movement. Therefore, current attempts by Italy’s smaller parties to rewrite the law might yet be successful (the law is also pending for review at the Constitutional Court).


A No vote – Stuck in stagnation


In case of a No vote, we consider continued political paralysis more likely than a full-blown economic crisis. Renzi would be weakened but even if his own coalition partners force him to resign, the president is more likely to ask one of Renzi’s party colleagues to form a new government or put in place an interim government to sort out the electoral law before new elections can be called.


The confidence shock following a No vote would depress markets and lead to spread widening. But the risk of a debt crisis in the short term is low while the ECB stands ready to deploy OMT in case of market stress.


Again we consider the main implications of a referendum No to be long-term. Growth would be only marginally lower in 2016 and around 0.5% in 2017. But with continued political gridlock and without a big push to tackle Italy’s most important  structural flaws (bad demographics, no productivity growth, stifling debt burden) potential growth could slip into negative territory over the medium term. If the eurozone’s third largest economy does not grow and shows itself unable to reform, the viability of the euro could be in question in the medium to long term.

Link to Research Paper below:

Dr. Michael Heise

Allianz SE
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