Italy Back in Poll Position

Executive Summary

• Italian political risk is back in the headlines, with a confidence vote in the current government possible next week. If the current government falls, Italy could have another snap election in the coming months, perhaps around late October.
• The range of outcomes is fairly large at this point, but the biggest risk in our view is that a new Italian government pushes for significantly more fiscal stimulus, risking another showdown with the European Union over its budget plans similar to the one that occurred last year.
• Any scenario that averts the high-risk outcome would probably calm market jitters somewhat. However, even in the best case scenario, Italian political risks would likely remain dormant, but not disappear. Expect these risks to resurface again down the road.

Another Election in Italy?

Last week, news emerged that Italian Deputy Prime Minister Matteo Salvini, the leader of the League party, would call for a no confidence vote in the current government in an effort to force an election later this year. The current coalition government has been in place since mid-2018, when the last general election eventually resulted in a partnership government between the League and Five Star Movement (5SM). These two parties share some distinctly different political beliefs, but were united in their desire to shake up the political establishment and introduce bold policy changes in Italy.

Over the past year or so, however, the marriage between the two parties has been rocky as disagreements have occurred both internally and externally. The League and 5SM have at times disagreed over the best way to pursue fiscal expansion, for example, while externally, EU officials have expressed their disapproval of larger deficits given Italy’s sizable debt burden. The European Commission has threatened to put Italy into an excessive deficit procedure (EDP) if Italy’s budget is perceived to be in violation of the bloc’s rules. Italy’s debt-to-GDP ratio is already well above the 60% threshold (Figure 1 on next page), but its deficit in 2019 appears set to be about 2.5%, which would be a bit larger than last year but still below the 3% limit.

Thus far, Italy has avoided being placed in an EDP, but the risks appear to be growing. An increase in Italy’s value-added tax is scheduled to take place next year, but Deputy PM Salvini has pushed ardently for tax cuts, rather than tax increases. In its spring economic outlook, the European Commission projected that the structural budget balance for Italy would widen to 3.5% next year under the assumption that the VAT increase would not go into effect. Should Salvini and the League get their way and introduce significant tax cuts, the deficit would likely be even larger next year, something that would test the European Commission’s resolve on the matter.

In the previous election, 5SM captured nearly 33% of the vote, while the League’s share was just a bit over 17%. Fast forward to today and the fortunes of the two parties have flipped according to polling data. The League is polling on a national average basis at just under 40%, while 5SM’s polling share has steadily declined to less than 20% (Figure 2 on next page). This polling data, along with the League’s solid performance in the European Parliament election in May, have emboldened Salvini to push forward on a path that could result in national elections later this year.

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