It’s Italy’s turn to spook markets

Vote on Sunday could lead to ‘Italexit’ battle

IAnimal Spirits taly offers so much that’s fascinating to the rest of the world. Beautiful landscapes. A deep and meaningful history. One of the world’s great cuisines. Friendly, passionate people. Delightful wine. Vibrant, historic cities. And, oh yes, political dysfunction.

This last, sadly not uniquely Italian offering has received quite a bit of international attention lately, thanks to a referendum this weekend that’s being billed as Europe’s most important political event since Brexit.

The fate of Italy and the European Union may hang in the balance. Or, you know, maybe not.

Being put to the vote is a slate of constitutional reforms, championed by Prime Minister Matteo Renzi, that seek to rationalize the legislative structure of a country that has produced more than 60 changes of government since the Second World War. In essence, they would make one of the two bodies in the bicameral legislature subordinate to the other (right now they are equal in power); they would also make it easier for one party to form a government, rather than resorting to the habitual hodgepodge of coalitions. With — and only with — these reforms, Renzi argues, the government will finally be able to get done what needs to be done.

But here’s the problem: it looks like Renzi is going to lose, judging from the polls. If the No side prevails, Renzi has threatened to resign. That would open the door to political turmoil even as an upstart nationalist/ populist party, the Five Star Movement, has been gaining popularity. If it forms a government, Five Star would like to hold a referendum of its own — this one, à la Brexit, on whether to leave the EU.

The financial impact of this outcome might be grave, since Italy’s fortunes are intimately tied in with the rest of Europe. Economically, it is hardly thriving. At 133 per cent, its debt-to-GDP ratio is behind only Japan, Greece and Lebanon. The economy is growing at 0.9 per cent annually — a desultory figure that isn’t worse only because of a surprise surge in growth in the third quarter. Its banks are a mess, by and large, saddled by hundreds of billions in bad loans, which amounts to the biggest share of total nonperforming debt in all the euro area. The nightmare scenario for Sunday is that a No vote leads to such political uncertainty that it tips off a financial crisis that bleeds into the rest of the EU.

This potential has encouraged the beating that Italian markets have taken this year; the benchmark FTSE MIB index is down more than 20 per cent. And investors are clearly linking Italy’s fortunes to the rise of economic and political nationalism elsewhere. The MIB fell 16 per cent in the immediate wake of the June 23 Brexit vote — three times more than London’s FTSE 100 declined, and five percentage points more than the Euro Stoxx 50. The doldrums continued in the wake of Donald Trump’s surprise presidential victory in the States in early November.

This all sounds dire, and maybe it’s not such a big leap to link what happened in Britain and America with what might begin to happen this weekend: an Italy taking its anger out on the political establishment — and willing to take the European Union down with it. But I would be a lot more worried about the ramifications of a No on Sunday if the referendum was taking place in any country but Italy.

After all, it has inscribed deadlock on its very political being — perhaps not surprising, given its tragic history with authoritarianism in the form of Mussolini. Its bicameralism might engender chaos in the legislature, yet somehow Italy (and Europe) manages along. This is a system that survived a decade under the rule of Silvio Berlusconi, who was indicted more than 20 times. The departure of the energetic Renzi would not be welcome, but any resulting turmoil will hardly be novel.

In fact, the best defence against “Italexit” and the Five Star Movement may be the same legislative sclerosis Renzi wants to eradicate. If No prevails Sunday, and Five Star somehow wins the next election — which is hardly a done deal, and likely wouldn’t happen anytime soon — it would have a very hard time getting anything done.

Italy also has a legal wrinkle that could put the kibosh on Five Star’s plans: its constitution forbids holding a referendum on international treaties. So, before it could hold an EU-exit vote, Five Star would have to reform the constitution, which might require its own referendum. And so on.

And then there are Italians themselves, most of whom are quite happy with the single currency and don’t want to stop using it. (Of course, that’s according to polls, which we have learned to take with a grain of salt.)

Still, should there be a No on Sunday, European markets can reasonably be expected to take a hit, at least in the short term. But that might present investors with buying opportunities. Even if the vote marks the beginning of “Italexit,” that will take a very long time to unfold. And if it really doesn’t herald the end of the EU — well, then it will be business as usual in Italy.

Which will be bad, as usual. But worse things could happen.