Italians are voting in a referendum on December 4 that is causing concern across Europe after the UK’s vote to leave the EU and Donald Trump’s US presidential election victory. The vote could lead to the resignation of Matteo Renzi, the prime minister. However, the fallout from a no vote on Sunday could be economic and financial as well as political.
* Why are financial markets worried?
Italy’s vote is seen as the biggest threat to Europe since the UK’s referendum on EU membership in June. The fear is that a vote against the government could trigger a chain of events that might see Italy — a member of the EU since its inception — spiral out of the single currency.
* But isn’t the referendum on a narrow political issue?
It is and it isn’t. The referendum is about constitutional changes but is also seen as a vote of confidence in Renzi. The proposed changes to parliament are part of his attempts to modernise Italy, both politically and economically. Markets like Renzi’s technocratic approach; they think he is needed to sort out the deep-seated problems of Italy’s banks — the weakest in the Eurozone — and are worried because he has pledged to quit if the referendum is lost.
Markets fear that defeat for Renzi would trigger a general election that could result in power shifting to the Five Star Movement. An anti-establishment party formed by former standup comedian Beppe Grillo, it has suggested it would call a referendum on membership of the EU.
“With a wave of elections in Europe in 2017, such a shift in sentiment would undermine political integration and increase demand for national sovereignty,” said analysts at Jefferies.
* What’s wrong with the economy?
Pretty much everything. Italy has an unemployment rate of 11 per cent and living standards have barely grown since the country became a founder member of the single currency 15 years ago.
Nine years after the onset of the financial crisis in 2007, output remains 8 per cent down on its pre-crash level. Shweta Singh, of Lombard Street Research, said Italy’s weakness since the turn of the millennium was the result of three factors: a slow takeup of new information technology; the inability of the government to devalue the currency to restore competitiveness; and the challenge posed by China in many of the markets where Italy has traditionally been strong.
“Italy’s share of global exports has plummeted,” Singh said. “Since the turn of the century, Italy has lost more market share than most developed countries, including those in the euro area.”
* What’s wrong with the banks?
They are in “terrible shape”, according to Kathleen Brooks, research director at City Index. The country’s banking system is fragmented, with more branches than restaurants dotted across its high streets. They are weighed down by €360 billion (Dh1.4 trillion) of bad debts.
The industry took too long to tackle the mountain of bad debts and by the time the regulators wanted action a change in EU rules meant it was difficult to set up a “bad bank”. Renzi is credited with helping devise a solution, creating a backstop fund — known as Atlante — for the industry.
Banca Monte dei Paschi di Siena, the world’s oldest bank, is also one of European weakest after stress tests imposed by the European Banking Authority in July showed its financial strength would be sapped if markets came under strain. A bailout plan is in train.
* So what will happen if there is a no vote?
The anxiety is that the banks will crumble. Brooks said: “If [Renzi] loses the referendum and resigns, then the big question for traders will be if the bailout plan still stands. If not, then eight of Italy’s lenders could be at risk of collapse.
“Due to the interconnectedness of the global banking system, and the weakness of some other European lenders notably Deutsche Bank, a collapse in Italy’s banking system could lead to intense pressure on global financial stocks in the aftermath of a no vote.”
* Wouldn’t the European Central Bank do something?
Almost certainly. The ECB buys €80 bilion of Eurozone bonds each month and in the short term would make buying Italian bonds a priority. That might limit the upward movement in bond yields — the interest paid on government debt. The European commission would also be under pressure to soften rules that put restrictions on individual governments bailing out their banks.
If there is a yes vote does that mean it is a case of crisis over?
Almost certainly not. There might be a relief rally and the shares of Unicredit and Banca Monte dei Paschi di Siena could bounce after recent selling, but the problems of the Italian economy and the country’s banking system will remain. The key issue of whether Italy can live with the pressures of Eurozone membership will be unresolved.
