Italy: Government coalition collapses, raising uncertainty ahead of 2020 budget
Political uncertainty has spiked after Prime Minister Giuseppe Conte resigned on 20 August, amid a clash between coalition government members the League and the Five Star Movement (M5S) as the League seeks to capitalize on its popularity and force snap elections. However, it is uncertain when elections will be called, or if at all; political parties have until 28 August to attempt to form a coalition and talks are ongoing between M5S and their traditional foe the center-left Democratic party (PD) to form a new coalition government. Regardless of the result, uncertainty will likely continue to loom large until a stable government is in place, shaking already low confidence in the economy and keeping financial markets on edge at a time when the government should be working on the critical 2020 budget.
An outline of the budget is due to be submitted to the European Commission by mid-October and passed in full by the Italian Parliament by the end of the year. The budget should strike a balance of encouraging growth, restoring confidence and conforming to EU rules. If no alternative budget is agreed on, a EUR 23.1 billion VAT hike is set to come into effect in January, which would take a painful bite out of already subdued activity. Given the chaotic political situation, it is uncertain what shape the budget will take. The League has promised a EUR 50 billion stimulus package in the budget, which could worsen the country’s already precarious debt pile. Meanwhile, it is unknown whether a coalition between PD and M5S could agree on a difficult budget, or whether the bill could be carried out by a caretaker government or delayed in the event of elections.
Assessing the consequences of a new election, ING’s research team noted:
“If we get elections in October then the period of uncertainty is likely to be short but intense. League election rhetoric will gain in importance given its implication for the 2020 budget. There is a possibility that the League’s economic agenda might ultimately be perceived positively by investors, but the near-term risks surrounding the election should dominate price action, especially as the build-up to the Italian election would coincide with the build-up to Brexit. If we get that, we see the 10Y Italy-Germany spread testing 300bp to the upside during the campaign.”
The political drama adds to an already weak growth outlook for the Italian economy. Growth is seen at a near standstill this year as the domestic economy remains hindered by fragile confidence, muted productivity growth, an unfavorable tax regime and political and policy unpredictability. If a market friendly budget is not agreed upon, the government clashes with EU officials again or if there is a prolonged period of political instability, further financial turbulence is a strong possibility.