Polling has already stopped, with a third of voters still undecided. Surveys show that a majority of Italians fundamentally support the move towards a more streamlined political system that the constitutional amendments would entail. On the other hand, the deep-seated dissatisfaction that most Italians express with their country’s political and economic situation, and the fact that 60% consider the referendum as a vote on their increasingly unpopular prime minister, Matteo Renzi, imply a high risk of a protest vote.
In case of a No, we do not expect an immediate political crisis or a re-ignition of the euro crisis. Matteo Renzi might resign in case of a landslide against him but would then be replaced by transitional government tasked with unifying the electoral law for both houses of parliament before the next scheduled elections in 2018.
There would be increased market volatility and some spread widening, but given that referendum risk is already priced in to some extent and Italian equities have been underperforming anyway, the impact would be manageable. Also, Italy has a current-account surplus and most debt is held domestically. The European Central Bank would stand ready to step in to limit fallout and contagion risk. Unlike in the Brexit vote, a No in this referendum would cement the status quo.
We worry more about the medium-term implications of a No, as the focus would return to Italy’s disappointing growth rates, high public debt and weak banking sector. A lame-duck government implies at least another 18 months without progress on much-needed reform. Impending bank recapitalizations would be more difficult in an environment of economic stagnation, weak confidence and divided government. Without the reform of the bicameral system, and assuming that a No would be followed by a return to a proportional voting system for both chambers, Italy looks condemned to fragmented and fragile governments for the foreseeable future. If the eurozone’s third largest economy is unable to generate growth and implement reforms in the medium term, questions about the sustainability of its euro membership will eventually arise.