Italy will present a new government on Friday based on an unlikely marriage between the left-wing protest 5-Star Movement and the right-wing League. It’s a populist union that found common ground on immigration, taxes and the social safety net. After 3 months of unproductive negotiations, and rejected political appointments, they finally have a deal.
The stream of Euroscepticism inside both parties cannot be denied and the rise of non-performing bank loans is plaguing Italian financial markets. But here’s why the reality won’t live up to the fear.
70% like the euro
The biggest reason why Italy won’t leave the euro is simply that Italians like the single currency project. Even at the height of the Eurozone crisis, various polls today indicate a majority of 67% to 70% support to keep the euro. Even with Italy’s GDP remaining well-below pre-2008 levels, the public is loath to blame it on the euro. And, remember that the median Italian is still wealthier than his German counterpart, and the euro is essential for protecting that wealth.
Primary surplus and Current Account Surplus
Italy has a primary fiscal surplus (domestic finances) of 2.0% of GDP. It also has a current account surplus (external finances) of 2.8% of GDP. In the case of primary surplus, the government is running a surplus between spending and receipts when the cost of paying interest on its debt is ignored. There is still a generational hole in its finances but it’s not getting worse. Even if the new government reverses some austerity measures, the situation isn’t dire. With the ECB still planning to buy bonds into year-end, borrowing rates remain low over any time horizon.
Over 60% Italian government debt is held by Italian residents. That is unlike in the case of Greece, where foreign investors held the bulk of Greek bonds, which were at the mercy violent swings and complicated settlements and negotiations over default. This also means, that Italians (individuals, institutionals and the Bank of Italy) have more at stake in preserving the value of their bond holdings — most of all will avoid euro exit at all costs. Can you imagine the financial consequences on Italians if their debt is redenominated into liras?
The ECB is here
The fact that the coalition government’s proposal for Finance Minister was rejected by president Mattarella because of his anti-euro views speaks volumes. Whether Mattarella was instructed by ECB president Draghi to block Paolo Savona or not, the end product is clear. Just as the ECB will make sure policy will not be hijacked by economic nationalist, it will ensure the stabilisation of Italian BTPs (government bonds). The ECB can resort to its Outright Monetary Transactions by stepping up its purchases of Italian bonds to stem any bleeding.
64 out of 72
Ever since it became a Republic in 1946, Italy has had 64 governments. 64 different governments over the past 72 years. Political wrangling and inability to reach consensus was part of the landscape more than half a century before the euro came to being. Blaming the single currency, Brussels or the European Central Bank for lack of consensus is senseless and madness.
Separation is a means, not an end
The problem is that in much of Europe, openly disparaging Germany and eurocrats is a clear path to political success. That’s something that isn’t going to go away but like everything in politics, the reality rarely lives up to the rhetoric. In almost every region where unity is an issue, the threat of separation is used as a political tool. Yet separation is exceedingly rare. The tough talk from Di Maio and Salvini is more of a tactic to reform and loosen eurozone rules than a mission to leave the euro.
Unravelling the Spaghetti
It looks like a big, twisted mess but ultimately it works. Italy’s electoral system and the nature of its politics leads to the impression of instability. The numerous parties, shifting alliances and constant threat of collapse is a source of uncertainty but in the post-war period, the results rarely match the fears. The public ultimately restrains any tilts to the extremes and common sense generally prevails.
So the result for Italy is probably be what it always is: bigger deficits, sluggish growth and no meaningful change in the trajectory. Before long, the government will implode and the cycle will restart.