Italy is now in a complicated situation with none of the coalitions envisaged prior to the elections being able to form a government with a majority in the Senate.
A minority government led by Pier Luigi Bersani is a plausible scenario. However, it seems very likely that such a minority government would not last for long.
A broad Bersani-Berlusconi government seems to be the most realistic option. This would probably be short-lived too and its main contribution could be a reform pause.
New elections, which may not be called before the new president has taken over office, are unlikely to take place before September.
It is our assessment that if a new government is unable to undertake new reforms for a while it will not be a disaster.
What is important is that a new government behaves in such a way that investors can remain confident that the ECB’s OMT programme will remain in place.
However, in the current situation, the process of asking for help and agreeing on the content of a Memorandum of Understanding could prove lengthy and complicated.
If Italy were to need help there is a real risk that while Italy and the EU engage in lengthy discussions on the terms, the debt crisis could return with a vengeance.
Scenarios
Italy is now in a complicated situation with none of the coalitions envisaged prior to the elections being able to form a majority government. The Italian president will begin informal consultations with party leaders to find out which options there might be to form a government anyway. The new parliament convenes on 15 March and a new government may not be formed prior to that.
Pier Luigi Bersani has said that he should be given a first chance to form a government as his coalition won the most votes. It should be said though that the party that won the most votes was actually Beppe Grillo’s Five Star Movement. A minority government led by Bersani is a possibility and probably Bersani’s preferred option. He would have a majority in the lower house, but his coalition has as little as 113 seats in the 315 seat Senate. Mario Monti’s Civic Choice, which only got 18 seats, is therefore of little help. Bersani would thus be dependent on votes from either Grillo’s Five Star Movement or Berlusconi’s centre-right to pass through new legislation. Barsani has said that he will make some policy proposals that can help him to win over senators from the Five Star Movement. These may include laws to slash politicians’ pay, abolish provincial governments, a reform of the electoral law, a law on conflicts of interest and measures to help the economy to get out of the recession. It seems unlikely that Bersani will be able to win over enough senators to form a majority and he would then remain dependent on part of the “opposition” to support him on a case-by-case basis. It seems very likely that such a minority government would not last for long. That would be in line with Italian tradition. Italy has had as many as 63 governments since 1945. Hence, a government that may only remain in office for six months should not in itself result in a loss of investor confidence in Italy.
A broad Bersani-Berlusconi coalition seems to be the most realistic option at the moment. Bersani wants to take responsibility for trying to form a government and Silvio Berlusconi has signaled that he is willing to negotiate. They may agree on revising the election law, cutting down the size of parliament as well as local governments and maybe even some tax cuts. The problem is that on a range of other topics there is very little common ground. It would probably be a very short-lived government that would not contribute with much beyond a reform pause. It seems unlikely that the Five Star Movement will join any government coalition given its election campaign as a protest anti-establishment “non-party”.
The next election might take place in September
If new general elections were called immediately they would probably result in pretty much the same outcome. Maybe Beppe Grillo’s “non-party” Five Star Movement could even gain additional votes, which would just complicate things further.
In addition, the current president is about to end his term in office in May and therefore he cannot dissolve parliament. New elections will thus not be called before the new president has taken over office. The constitution requires a minimum of 60 days from the dissolution of parliament to the election. If elections were called in mid-May they could then take place in mid-July. However, in Italy, elections never take place in July or August (when Italy is on summer vacation). New elections are thus unlikely to take place until September.
Reforms can wait but ECB OMT must remain in place
It is our assessment that it will not be a disaster if Italy ends up with a government which does not undertake reforms for a while. What is important is that a new government does not start to roll back reforms and that it behaves in such a way that investors can remain confident that the ECB’s OMT programme will remain in place. Just three days before the Italian elections, the ECB announced it had bought EUR99bn of Italian government bonds under the Securities Market Programme, in what could be seen as a reminder to the Italian people that they need friends with big pockets. The Italian people seem not to be bothered but investors are.
The ECB’s OMT programme is still in place as a backstop, but we think that the ECB is ready to show that its willingness to do “whatever it takes” depends on the government’s willingness to deliver sound policies. Asking for help could also be tricky.
In the instance of Italy requiring help from the ESM and ECB, the new parliament would have to sign up to a Memorandum of Understanding, which would inevitably include some reform measures. In the current situation the process of asking for help and agreeing on the content of the MoU could prove complicated. This may cause panic in the financial markets.
We do not believe that Italy will consider asking for help before 10-year government bond yields have increased to 7% or more. If Italian government bond yields approach unsustainable levels it is likely that there will be a pronounced negative market reaction with a sharp increase in volatility. There is a real risk that while Italy and EU engage in lengthy discussions on the terms for help the debt crisis could return with a vengeance.
