Italy: Reform standstill sine die

After the defeat in the constitutional referendum Italy’s Prime Minister has tendered his resignation. In the short term heightened political uncertainty is likely to weigh on financial markets and economic sentiment. But we consider an immediate re-ignition of the euro crisis unlikely. More worrying are the longer-term implications of the No-vote – Renzi’s defeat closes the window of opportunity for reforms that he opened almost three years ago. Italy’s weak growth, towering public debt and ailing banking sector will now move back into focus. In the medium to long term Italy’s ongoing economic decline will pose a fundamental problem for the EU and the eurozone.

Following the resounding defeat in the constitutional referendum – some 60% voted against the planned reform – Matteo Renzi has announced his resignation. The overwhelming rejection of the reform proposals is attributable more to widespread disgruntlement with the economic situation in Italy and should therefore be seen first and foremost as a slap in the face for the Renzi government and not as an anti-EU vote.

In the immediate wake of the referendum, sentiment on the markets is likely to be depressed and spreads could widen somewhat, at least until Renzi’s successor is appointed. This could take place relatively swiftly. Italy’s president Sergeo Mattarella will probably ask one of Renzi’s party colleagues to take up the reins. It is also conceivable that Mattarella will appoint a caretaker government. Apart from the reform of the electoral law, the new government would above all need to focus on stabilizing the banking system in the months ahead.

Early elections are unlikely for now as the question of the electoral law needs to be sorted out first. The Italicum applies only to the Chamber of Deputies as it was passed on the assumption that the Senate would in future comprise regional and local representatives. Hence, early elections would result in a solid one-party majority in the Chamber, whereas the Senate would still be fragmented. In the absence of constitutional reform, however, both would have the same powers – this would almost inevitably lead to political gridlock and possibly to renewed elections.

We do not see an immediate re-ignition of the debt crisis as Italy’s refinancing risk is contained by several factors. The ECB’s bond purchasing program provides adequate protection against a massive sell-off of Italian government bonds. Since QE was launched, the Italian bond market has been less sensitive to political and economic upheaval. In addition, the ECB would if needed activate its OMT program to keep yields on Italian government low and ensure continued market access.

However, the No-vote will cast a major pall on the country’s economic outlook. Political and economic reforms are now off the table for the foreseeable future. Without reform of the bicameral system, and assuming that the No-vote will be followed by a return to a proportional voting system for both chambers, Italy will have to live with fragmented and fragile governments until further notice. In the short term we expect business sentiment to cloud over and threaten the still fragile economic recovery. More worrying still are the medium-term implications of the vote, as the focus will now return to Italy’s disappointing growth rates, towering public debt and beleaguered banking sector. A weak caretaker government implies at least another 18 months without progress on much-needed reform. Impending bank recapitalizations will be more difficult in an environment of economic stagnation, weak confidence and divided government. The referendum on its own will not decide Italy’s or the eurozone’s fate. However, in the medium to long term Italy’s ongoing economic decline could become a problem for the EU and the eurozone. 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.


Michael Heise

Allianz SE
Phone +49.89.3800-16143

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