Economic Insight: Italy: Stress is here to stay

  • Baseline scenario (50%) foresees the  government back down from its initial confrontational EU-stance and ultra-expansive fiscal proposals. Following a policy U-turn it implements only a portion of announced fiscal stimulus and finds a conciliatory approach with Europe.  Italian 10-year spreads to the Bund will remain between 180bps and 250bps. GDP growth would more than halve by 2020 to 0.6% with debt-to-GDP embarking on an upward trend to 134% by 2020.

  • Upside scenario (30%) assumes the implementation of limited fiscal measures while the government maintains a constructive approach to-wards Europe. Spreads would still be elevated with less volatility, GDP growth would moderate to 1% in 2019/2020 while public debt stabilizes at 132% of GDP.

  • Downside scenario (15%) assumes a sharp rise in fiscal spending with the coalition embarking on a collision course with the EU. Spreads would rise by an additional +200bps compared to the baseline; Italy could slip in a shallow multi-year recession with debt rising above 140% by 2020.

  • Italexit (<5%) assumes that a political event or a market default, combined with a confrontational stance causes substantial financial stress (spreads up by +500bps to the baseline). Italy would undergo a very deep recession with debt-to-GDP rising towards 160% by 2020. Contagion would follow.

  • In its relation with Italy the European Union will have to strike a delicate balance between upholding its own rules while at the same working constructively with the new government with a view on making more tangible progress on EU reform.