Protest and populist parties make large gains, raising the risk of a possible debt crisis, but an Italian exit from the euro or EU remains low-risk, argues Azad Zangana, Senior European Economist and Strategist at Schroders.
Italy is not usually known for its political stability, so the results of its general election come as no surprise. The bitter and divisive contest yielded no overall winner, but the swing towards populist extremist parties could be a concern.
Based on exit polls, the anti-establishment Five Star Movement appears to be the single biggest party, but it is narrowly behind the right-wing coalition. The ruling Democratic Party was the second largest party, but with its left-wing coalition partners is in third place behind the other two groups.
As things stand, it appears that no one group can form a government without involving other parties. A broader coalition will have to be agreed if Italy is to avoid a re-run election.
The right-wing coalition is likely to begin talks with other parties, but it is not clear who will lead the coalition.
Former Italian Prime Minister, Silvio Berlusconi, was expected to have led his party, Forza Italia, to head the coalition. However, it now appears that the League Party (formerly known as the Northern League) may have unexpectedly finished ahead of Forza Italia.
Berlusconi himself is serving a ban from front-line politics, and so would have had to wait at least a year to be a contender for prime minister again, but it now looks like the octogenarian will not get another chance. The League has transformed itself from a separatist regional party, to a far-right national populist movement, which ran a campaign against immigration and emphasised Euroscepticism. A government led by the League would concern many, especially as its coalition also includes the Brothers of Italy, a hard-right nationalist party.
The Five Star Movement is also likely to make a bid for government, and if it can persuade any other parties to join it in coalition, it certainly has a strong chance. However, its leaders have rejected the notion of working with established parties in the past.
Can a coalition be formed?
It will take some time before we have the final results for the number of seats won in both the upper and lower houses of parliament. Exit polls may not map across well to the final outcome due to the new hybrid electoral system which has proportional representation, but also just over a third of seats decided by a first past the post system.
The task of herding the rabble falls to President Sergio Mattarella. If he cannot persuade parties to form a coalition, and cannot establish a minority government with supply and confidence in both upper and lower houses of parliament, he then has the option for pushing for a grand coalition. This would be with one of the party leaders becoming prime minister, or having a technocrat in power as with Mario Monti between 2011-2012. Failing these options, a re-run election would ensue, though this is a very rare event.
Implications for investors
The election result is very important for international investors, especially given the size of the Italian economy. While Eurosceptic parties have done well, exit from the euro and EU are low risk. This is because Italy’s constitution does not allow for such a vote, and a change in the constitution would require a two-thirds majority, which left and right wing Eurosceptic parties do not command.
In our view the bigger risk is fiscal slippage, and possibly the rolling back of important reforms from recent years. This could put Italy on a collision course with the European Commission, and may even awaken the dormant bond vigilantes.
A government led by extremist parties could prompt international investors to dump Italian government bonds, causing yields to rise sharply on its huge mountain of government debt worth around as €2.2 trillion euros or 133% of GDP at the end of 2017. For now, bond buying by the European Central Bank is likely to keep markets calm. However, we do expect quantitative easing to end later this year, making Italy more vulnerable.
This article has first been published on schroders.com.