Is Italy a risk worth taking?

Italian voters go to the polls on September 25 for a snap election following a political crisis that led to Mario Draghi resigning as prime minister, which invariably prompted a spike in Italian risk and its country risk score sliding in Euromoney’s survey.

A perennially high-risk, industrialized country, Italy’s falling risk score has sent it tumbling down tier 3 – the middle of five tiers in Euromoney’s global risk rankings – to 69^th out of 174 countries.

That retains its status as the riskiest eurozone member state, and the riskiest in the EU, bar Hungary. It also makes the country a similar bet to Bulgaria, Guyana, the Seychelles and Kazakhstan, all of which bear non-trivial investor risks.

Elections uncertainty

These will be the first elections to be held since the pandemic started and a constitutional amendment was passed in 2020 slimming down parliament to 400 members of the Chamber of Deputies (from 630 previously) and 200 in the Senate (from 315).

The various opinion polls undertaken in August indicate the frontrunners are the Democratic Party (PD), led by former prime minister Enrico Letta, and Brothers of Italy, a neo-fascist rising force led by Giorgia Meloni.

These two each have the support of roughly a quarter of the electorate, with everything to play for.

Yet, as Jose Miguel Infantozzi, business development manager at Novastone Capital Advisors, points out, for nearly a decade, Italian governments have been formed by ideologically diverse parties.

“No party or coalition of parties has been able to win the majority of seats in both the Chamber of Deputies and the Senate,” he says.

The question then is what the make-up of the next government will mean in terms of political stability, domestic policymaking and foreign policy, notably with respect to Italy’s relations with the EU and Russia.

As in previous polls, the left wing looks extremely fragmented, leaving free space to the right-wing parties

 - Monica Bertodatto

ECR contributor and Italian voter, Monica Bertodatto, speaking in a personal capacity, says the political situation in Italy is “extremely fluid”.

She goes on to state that, while in mid-August the official candidate lists were deposited at the Ministry of Interior Affairs and are no longer amendable, the programmes and alliances are still under discussion and far from finalized.

“As in previous polls, the left wing looks extremely fragmented, leaving free space to the right-wing parties. The Five Star Movement (M5S) achieved very poor results at the last local elections and its presence in parliament will certainly be reduced.”

Norbert Gaillard of NG Consulting believes the coalition comprising Brothers of Italy, Forza Italia and Lega is most likely to form the next government because the Democratic Party’s potential partners are too weak.

“It seems clear that the right-wing coalition will get a majority, with probably 60% of the seats in the Chamber of Deputies and the Senate, and it will manage to form a new government which could be stable in the short term.”

Infantozzi concurs. Italy's centre-right coalition gives a stronger signal of alignment and appears to be more consolidated than the centre-left, he says.

Another contributor, Constantin Gurdgiev, notes that based on the national opinion polls, PD will split Italy's left with the highly populist M5S.

“The traditional coalition of the relatively centrist Forza Italia and Lega will fall under control of Fratelli d'Italia (Brothers of Italy). Worse, the rift between M5S and PD means that at least on many votes the centre-right will hold an absolute majority,” he says.

New policies

Gaillard believes that such a government will embark on several economic measures that should be positive, such as those designed to rationalize the tax system and support small and medium-sized enterprises, but he also notes three areas of concern.

First, he says, the right-wing coalition may question the EU's conditions for receiving funds from the NextGenerationEU recovery plan.

“This initiative could trigger political tensions between EU members and delay the transfer of funds.”

Second, the fiscal deficit may widen much more than expected in 2022 and 2023.

“In the present energy crisis, public spending will rise dramatically. If the next government implements its tax cuts, public finance will be under pressure, which will affect Italy's 10-year government bond yield.”

If the next government implements its tax cuts, public finance will be under pressure

 - Norbert Gaillard

Third, the full adhesion of the right-wing coalition to European values is uncertain and major strains in the EU could appear if Rome tries to negotiate bilaterally with Moscow over gas and oil supplies, or stops applying economic sanctions.

“The next government might opt for a ‘moral hazard’ strategy: as it knows, Italy is too big to fail, it could be tempted by ‘heterodox’ fiscal, economic and/or diplomatic policies. This move would undermine the unity of the EU and its credibility.”

These risk are all encapsulated in Euromoney’s survey, showing a big fall in the score for the regulatory and policy environment.

Gurdgiev says that, so far, most of the campaigning in August has been dominated by political personalities and populist sloganeering, as opposed to serious debates.

In so far as policy proposals go, the centre-right has been offering voters tax cuts and higher pensions. The centre-left has been locked into promising higher pensions too, along with youth subsidies and increased state salaries.

“Both sides of the political divide have plans (of varying scale) to increase housing supports and subsidies. The centre-right at last has a unified manifesto on key policies, including a promise of a 15% flat income tax (Salvini's Lega) to 23% (Berlusconi's Forza Italia). The latter proposals are as new as Rome itself.”

Gurdgiev goes on to say that, crucially, both the centre-left and centre-right proposals cut across the longer-term fiscal stabilization agenda and reforms expected from Italy by the EU.

“The country's debt-to-GDP ratio is north of 150% and the largest buyer of its public bonds is the ECB. With changes in monetary policies from the pandemic period stimuli to inflation-fighting monetary tightening, Frankfurt will have much less room to support the Italian Exchequer without the latter restoring the Draghi-period structural and fiscal reforms path.”

Government finances

Gurdgiev says that after the election fever dies down, Italy will be on a path to deeper fiscal insolvency, without any serious reforms and no room for economic stimuli.

Its deteriorating government finances score in the survey reflects this and Gurdgiev goes on to state that this is unlikely to sit well with an Italian electorate that is “about to be economically shocked by massive energy bills and the general cost-of-living hikes coming in the rest of 2022 and into the winter/spring of 2023”.

Gaillard, meanwhile, points out that Italy's economic prospects are not so gloomy and are comparable to the eurozone forecasts.

Real GDP grew on a calendar and seasonally adjusted basis in Italy by 1% in the second quarter, up from 0.1% in the first quarter, which was affected by Covid restrictions. This led to 4.6% year-on-year growth, following 6.2% previously.

However, Gaillard adds that it will slow significantly next year. Moreover, inflation will likely reach 7.5% in 2022, he says, and it could remain relatively high in 2023, possibly above 3%.

Infantozzi agrees, stating that in line with the weak global outlook and Italy's slowing economic momentum, it seems that it might be carried into next year.

“Driven by increasing energy and food prices, households’ purchasing power, saving and spending has reduced, while rising interest rates impacts on funding costs, which reduce business investment,” he says.

In July, annual inflation eased slightly, but it remained high at 8.4%, according to the harmonised index of consumer prices.

Ominously, in the same month, economic sentiment took a hit in all sectors bar construction, according to the European Commission’s monthly indicators. Consumer confidence took another dive as households felt the full force of rising prices.

Not only that, but Italy also faces other risks, according to Infantozzi, including a new leadership pursuing a new agenda, and also partial or total energy supply interruptions affecting gas prices and, of course, global warming problems threatening crops.

The remaining question, then, is whether Italy is still a risk worth taking.