With all the news about America and the UK, it was different to have Italy headlining for a change, although to no less a calamitous tone.
In case you missed it, the referendum was called by the outgoing PM Matteo Renzi. If he had won, the country’s constitution would have changed and made law-making an easier process. The current process, which requires both chambers of the Italian parliament to approve legislation (including after each amendment to a bill) has rendered government in the country quite slow, and Renzi has devoted considerable time in his premiership to these reforms. However, he staked his political future on the vote, promising to resign if the ‘no’ vote won. His idea was to increase the turnout of the vote, but it was instead seen as a chance to get rid of the PM, and one that the voters eagerly took.
There was far more at stake here than just the reform of government – the consequences could be far-reaching, for Italy’s banks, its economy, and the Eurozone as a whole.
Italy’s economy is notoriously poor (it has a BBB+ credit rating at best), and its output gap has been negative since the financial crisis in 2008. Its debt-to-GDP ratio (133%) is second only to Greece, and this means that many of the country’s banks are in need of refinancing.
The banks are important players in this, especially seeing as they are particularly vulnerable to a loss of confidence (especially the troubled Monte dei Paschi bank, which is already teetering on the brink of collapse). Like in America, they’ve made a lot of bad loans (around $400 billion worth), and Renzi wanted to organise a government bailout. He came up against a significant obstacle – after the financial crisis, the EU made some rules prohibiting this kind of bailout. Under the new law, creditors must take losses before the government can pump in any money, and this is a problem because some 45% of bank debt is held by ordinary Italians. Complying with these rules could cost many Italians their life savings.
Italian banks have been trying to shore up their balance sheets, but investors are likely to get spooked by this ‘no’ vote, making it difficult to obtain the funds they need. The turmoil could hamper the growth of the economy, making it even less likely the loans will be repaid, and less likely the government could help in the event of a crisis. And a crisis is more probable than not – banks would start to sell their assets, devaluing the values of assets in previously sound banks and starting a downward spiral.
There is a big worry here – the ‘no’ vote could indicate a general souring with the EU project, also making investing in Italy less likely. Depositors won’t want to put money into Italian banks if there is a chance that they will eventually be converted into depreciated lira. And in the hypothetical event of an Italian exit, people would draw their euros out of Italian banks before they devalued as lira, and we have the Greece situation all over again, only worse. For Italy is a country that is too big to fail and too big to bail out, and the pressure it would put on the EU would effectively destroy it.
Currently, these are worst-case predictions, but they are likely enough to discuss. We’ve already seen some negative fallout – the euro was hit, dropping to its lowest level against the dollar since March 2015 ($1.0505), and shares in the Monte dei Paschi bank fell considerably, prompting fears it will fail. If elections are called, as may be the case, it seems likely that there will be a strong showing for the Eurosceptic Five Star Movement – in the last Italian elections (in 2013), they got 25% of the vote, a strong showing considering the fractured political system. The most recent polls have put them at 30%, tying with the governing Democrats.
It’s too early to say conclusively what will happen in Italy but, from an economic point of view, it would be worth keeping a close eye on it. However, it also serves as another example of voters taking out their frustration on the establishment and figures in the German and French governments will be watching intently, just as they did after Brexit and Trump, and it remains to be seen whether similar shockwaves will be felt throughout the continent in the near future.