- Italy’s political crisis has deepened over the weekend, with a fresh election in the country now a near certainty.
- Many commentators now believe that the turmoil in the eurozone’s third-largest economy has started to pose a threat to the wider euro area.
- Markets are spooked, with major European assets selling off aggressively.
- Business Insider looks at how Italy got to this point of deepening crisis.
Whisper it quietly, but the eurozone may be about to plunge headlong into another crisis as the political situation in its third-largest economy, Italy, deteriorates rapidly.
Almost three months after an inconclusive election left the country without a government, Italians could be headed back to the polls imminently.
Italy’s political situation is notoriously complicated, so Business Insider has tried to break down exactly what’s going on and why it’s all happening now.
A nation in crisis
The growing crisis can trace its roots all the way back to 2009, with the foundation of the 5-Star Movement, which in less than a decade has grown to be the largest party in Italian politics, winning 222 out of 630 seats in Italy’s lower house of government, the Chamber of Deputies, at March’s election.
The party’s policies don’t fit neatly into the traditional left-right political spectrum, something it is keen to emphasise. It is variously antiestablishment, eurosceptic, anti-immigration, and pro-green. Its name refers to its five flagship issues: publicly owned water, sustainable (eco-friendly) transport, sustainable development, right to internet access, and environmentalism.
5-Star’s popularity has led it to moderate its stance on certain issues and install a new leader, the 31-year-old Luigi Di Maio, who replaced 5-Star’s founder, the comedian Beppe Grillo, in October.
Such political shape-shifting has allowed 5-Star to quickly grow into its position as Italy’s largest and most powerful party.
But while it emerged from March’s election as the biggest party, 5-Star fell well short of being able to form a government on its own.
This posed problems. For several years the party said it would not be willing to enter into a coalition government or power-sharing agreement with any other party. That is because much of 5-Star’s appeal has been based on its rejection of the country’s establishment parties, which it believed to be corrupt.
After the party gained a plurality in March, however, the party leader Di Maio relented, sensing the opportunity to govern the country. Over six weeks of talks with various parties followed, until eventually late last week it looked as though a government would be formed by 5-Star in coalition with the Lega Nord, a right-wing party led by Matteo Salvini.
The League, as the party is often known, previously had ties to Silvio Berlusconi’s Forza Italia party, but it moved toward 5-Star when an opportunity to govern presented itself.
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The League and 5-Star’s alliance is an uneasy one, but the parties managed to put together a program of government that removed some of the more extreme policies from both sides – like plans to leave the euro – and just about pleased President Sergio Mattarella (who must approve any program of government) enough to govern.
Late last week it seemed as though the alliance would be governing Italy with the law professor Giuseppe Conte, a political novice, as prime minister. Mattarella had reluctantly agreed to allow Conte to form a government, and it looked as if months of deadlock were finally coming to a close.
That was until Mattarella began the process for approving the coalition’s appointments to key offices within government. Under Italian law, the president can reject the appointment of an elected official.
Trouble with the finance minister
All was going well until Mattarella got to the two parties’ nomination for finance minister. The coalition had put forward Paolo Savona, a highly eurosceptic economist and former banker who was minister of trade and industry in the 1990s.
Savona has frequently advocated that Italy leave the euro, describing the single currency in a recent book as a “German cage.” He has been highly critical of Germany in particular, saying in the book that “Germany didn’t change its idea on its role in Europe after the end of Nazism, even if it abandoned the idea of imposing itself militarily.”
He also claims that Italy’s decision to join the euro back in the 1990s has “halved Italians’ purchasing power.”
Such assertions were enough for Mattarella, a europhile, to reject Savona’s appointment as head of Italy’s economic and fiscal policies.
Mattarella told reporters it was important for confidence in broader financial markets that Italy signal an intention to remain part of the euro.
“Membership of the euro is a fundamental choice for the future of our country and our young people,” he said.
Mattarella’s rejection of Savona as finance minister was viewed as a rejection of the mandate of 5-Star and the League to govern. This caused outrage from the two parties, with Di Maio calling for Mattarella’s impeachment. Salvini, the League’s head, stopped short of such calls but did criticise Mattarella’s decision.
The rejection of the coalition left Mattarella with two choices: call another election or attempt to appoint his own technocratic government.
Mattarella sprung for the second option, on Monday appointing a former International Monetary Fund official, Carlo Cottarelli, as interim prime minister with a task to try to form a new government and bring order to political and constitutional turmoil.
Cottarelli is likely to struggle to form a government, as he will need to have the support of at least half of the country’s 630 deputies to rule with any sort of efficacy. Given that the League and 5-Star account for 347 of those deputies and surely will not approve a Cottarelli government, it seems impossible that Italy will have a government anytime soon.
With no foreseeable path to a working government, it looks as if the only option for Italy will be to hold another election, with the most likely outcome of that election being a strengthening of support for 5-Star and the League. Indeed, a poll released on Monday evening showed the League increasing its vote share by almost 5 percentage points from the election.
The Dutch bank ING summed up the situation, with the economist Paolo Pizzoli writing to clients (emphasis ours):
“Should he [Cottarelli] manage to obtain the parliament confidence, he would try to have the 2019 budget approved, and resign before the end of 2018, taking the country to new elections in 1Q19. Instead, should he fail to get the parliamentary confidence, he would resign and remain in office as a caretaker for ordinary business, taking the country to new elections after August. We believe the chances of the government passing the confidence vote are extremely slim, and hold an autumn vote (in September or October) as our new base case.
“It is still too early to understand where the party leaders will position themselves in view of the upcoming election. Chances are that the perceived institutional wound might induce both the Northern League and the 5SM to radicalize their electoral message, but different political possibilities remain possible.”
“His chances of succeeding are slim and elections are likely in September,” Kit Juckes, a strategist at Societe Generale, wrote on Tuesday morning. “Which leaves us 3-4 months of uncertainty ahead of a vote that may be seen as a referendum on Euro-membership.”
Markets are spooked
Any such vote could be disastrous given that Italy is one of the three most crucial members of the eurozone project, alongside France and Germany.
Such an outcome seems to be something that senior figures in the eurozone are taking seriously. According to Yanis Varoufakis, who was Greece’s finance minister during the height of the country’s latest debt crisis, plans are being made for Italy’s exit from the euro, which is being variously known as “Italexit” and “Quitaly.”
“I have it on good authority that the German finance ministry, the European Central Bank and every major bank and corporation have plans in place for the possible exit from the eurozone of Italy, even of Germany,” Varoufakis wrote in an editorial for the Guardian newspaper.
Perhaps the simplest way to imagine the eurozone is as a three-legged stool. Germany, France, and Italy are the legs holding up the rest of the project. Remove any one of those three pillars and the stool falls over.
Simply put, if Italy goes, it is likely to be curtains for the euro area.
This prospect has markets freaking out on Tuesday, with assets selling off sharply across a broad spectrum. Here’s the full wrap from Business Insider’s Australian markets team:
- Yields on Italy’s two-year debt rose by almost 50 basis points overnight – the biggest one-day move since 2012, at the height of the eurozone crisis.
- When European markets opened a short time ago, Italian two-year bond yields continued to rocket higher, climbing by another 70 basis points. They are now sitting at their highest level since 2013.
- Demand for safe-haven German bonds is increasing, with the yield on both two-year and 10-year German debt falling to its lowest level this year.
- Reflecting capital flows between Europe’s periphery and core, the spread between German and Italian 10-year bond yields has soared to 261 basis points, the highest level in four years.
- The euro has also come under pressure, dropping below 1.16 against the US dollar for the first time in 2018.
- Italy’s banking index is also getting hosed, down 3.4% at a 13-month low.
Markets do tend to be highly sensitive to euro-exit-related developments, so some of Tuesday’s moves may be a knee-jerk reaction, but it certainly feels as if a crisis is brewing both politically and economically.
Analysts at the Australian investment bank Macquarie, however, urged calm for the time being.
“While we see near term market pressure, we do not think that events today are sufficient to derail the economic recovery (activity has been desensitised to political shocks in the past decade), suggesting that markets will soon present a buying opportunity,” a team led by Ric Deverell wrote.
Deverell and co. were clear, however, that things could escalate. “A victory for the populist parties in a new election, while far from assured, could trigger a substantial risk-off event,” they wrote.