With a week to go before Italy’s parliamentary election, a late surge of support for former prime minister Silvio Berlusconi has raised fears about a new government’s commitment to economic reform and has caused yield spreads on Italian government bonds to widen.
Most political analysts still expect that a center-left coalition will emerge victorious from the February 24 election, but the pace of reform may well slow as elected politicians take back power from the technocratic government of Prime Minister Mario Monti, which has governed since November 2011.
The most recent Italian opinion polls showed the center-left Democratic Party headed by Pier Luigi Bersani had the support of 35 percent of the electorate, Berlusconi’s center-right coalition had 28.5 percent and Monti’s centrist group, Civic Choice, had 13.1 percent. A possible spoiler in the election was the antiestablishment Five Star Movement, headed by comedian Beppe Grillo, which polls show could take as much as 16 percent of the vote. There have been no polls since February 8 under Italian law, which bars polling in the closing stages of elections.
While Bersani’s lead seems strong enough to give him control of the lower house of parliament, he could be vulnerable in the upper house, the Senate. A loss in the Senate would produce a standoff remarkably similar to what is happening in the U.S. Congress.
The party with a plurality nationally is awarded a majority in the lower house. But the Senate works differently, awarding a majority to the party with a plurality in each region. Franco Pavoncello, a political analyst at, and president of, John Cabot University in Rome, says it is possible that Berlusconi’s coalition could win majorities in the northern regions of Lombardy and Veneto as well as Sicily, which would give him the ability to block legislation from being adopted.
<> Michael Hewson, senior market analyst at CMC Markets in London, says the possibility of Berlusconi having an effective veto over legislation in the Senate was the reason international investors sold Italian bonds, driving up yields on the benchmark 10-year bond to 4.5 percent last week from 4.07 percent on January 25. “There is a possibility you could get paralysis in Italian politics, and the reform process could stall,” Hewson says. Another concern for investors is how much a new Democratic government will be committed to the reforms implemented by Monti since he took office in November 2011, when Berlusconi resigned amid a debt crisis.
An economist and former European competition commissioner, Monti managed to get parliament to enact $40 billion in new taxes and budget cuts. He also raised the retirement age in a pension reform measure but failed to get trade unions to agree to change restrictive labor laws that make it almost impossible to fire older workers and deter firms from hiring younger workers full time.
Monti’s reforms, along with a statement from Mario Draghi, head of the European Central Bank, to do “whatever it takes” to defend the euro, were enough to calm market fears and bring down interest rates on Italy’s sovereign debt to more sustainable levels last year.
One unknown is how well Bersani and Monti will work together after the election. Bersani has said he wants to continue with some of Monti’s reforms, but he has formed an election alliance with far-left parties that reject many of Monti’s key ideas. Monti has said he will form a coalition with any party that supports his reforms, but when he asked Bersani to split with the far left and join him, Bersani refused.
“One of the main market concerns is that Bersani is leftist, and although he has suggested he will not backtrack on previous commitments made by Monti, it is very likely the pace of reform will slow down,” says Elwin De Groot, senior market analyst at Rabobank International in Amsterdam. “This is the last thing Italy needs.”
Another concern is that while the reforms were popular among market analysts and European politicians, Italians were mainly unhappy with what happened to the economy under Monti.
Adopting government austerity in the face of a private-sector slowdown has pushed the economy into a deep and prolonged recession. Statistics released last week showed that Italy’s economy shrank 0.9 percent in the fourth quarter, the sixth consecutive quarterly decline. Economic output has declined by 3.4 percent since the second quarter of 2011.
In addition, Monti’s goal of reducing Italy’s public debt, the second-largest in Europe after Greece, didn’t pan out either. Public debt increased to $2.66 trillion, or 126 percent of GDP, at the end of 2012 from $2.56 trillion, or 121 percent of GDP, a year earlier.
Moody’s Analytics predicts the Italian economy will contract another 0.9 percent this year, making it almost impossible for a new government to achieve Monti’s fiscal target of reducing the budget deficit to 1.8 percent of GDP for 2013.
Berlusconi, who resigned in disgrace in 2011, has capitalized on discontent with Monti’s handling of the economy. He promised to refund a tax on homes and small businesses that Monti’s government enacted last year to reduce the deficit. He also promised to “stop singing the tune” of German Chancellor Angela Merkel and end Italy’s emphasis on austerity. Both pledges proved popular on the campaign trail, helping his numbers surge in recent weeks.
For all of his embarrassing shenanigans — Berlusconi last month praised Mussolini and defended paying bribes to third-world officials — Berlusconi remains a master politician whose rapport with many Italians easily exceeds that of Monti, who comes across as a boring economics professor.
But it is undeniably true that the austerity program, while necessary to stop the bond market from spinning out of control, has caused a collapse in consumer confidence. “What you have seen in Italy over the past year is consumer spending is down sharply because of the austerity,” De Groot says.
While the economic crisis has forced Spain and Greece to cut domestic wages, Italy has not been able to do so because of its rigid labor laws, so it cannot compete with its neighbors in the European market. At the same time, the high value of the euro has made the country relatively uncompetitive in global markets.
“Growth is going in entirely the wrong direction,” says CMC’s Hewson.
The best guess is that Bersani and Monti will form a successful coalition, but that reforms will slow down as the Democratic Party seeks to maintain its coalition with far-left parties.
Analysts are also struggling to figure out what role Grillo will play after the elections. Although he is not personally a candidate, his Five Star Movement, which contends that a corrupt established political order is Italy’s real problem, has gathered strength with revelations of bribery at the nation’s largest defense contractor and a scandal over derivatives that masked the poor health of Italy’s oldest bank, Banca Monte dei Paschi di Siena. The bank is controlled by a foundation run by politicians from Bersani’s Democratic Party.
Grillo has not indicated what positions he might support other than cutting the salaries of parliamentarians and nationalizing the banks.
