Italy: Draghi to have little chances for implementing substantial reforms – CE

The markets have reacted well to the news that Mario Draghi has been tasked with forming a new government. It is hard to think of a better candidate to lead Italy through a crisis, but economists at Capital Economics doubt that he would have as transformative an impact on the Italian economy as he had on the European Central Bank (ECB).

Key quotes

“Given that there is not a lot more the ECB can do to loosen financial conditions, and that Italy has implemented a lot less fiscal stimulus than advanced economies outside the eurozone, Mr Draghi may want to increase the government’s fiscal support.”

“Draghi would be unlikely to push for the money to be spent on short-term giveaways that would be rejected by the EU. Italy could receive funds equivalent to nearly 12% of 2019 GDP spread over 6 years, of which just under 5% of GDP are grants. That said, he would not make the spending decisions alone, and some of the extra money from the EU might simply fund spending that would have taken place anyway. What’s more, given that Italy scores poorly in international rankings of government effectiveness, even the best laid plans could go awry.”

“His chances of implementing meaningful reform would depend on how strong the government was and how long it was likely to last. Even a longer lasting government would struggle to make wide ranging and substantial reforms.”

“Mr Draghi’s success would remove the risk of an election in the first half of this year that polls suggest would be won by traditionally Eurosceptic parties. So some downside risk to bonds would be removed. But this doesn’t necessarily mean that bond yields would be much lower under Mr Draghi than any other prime minister, because the main driver of yields and spreads is now the ECB. Whether or not he succeeds in forming a government, we expect the Bank to drive yields and spreads down this year in order to loosen financial conditions and give the economy a boost.”