Italian Referendum Outcome - Italy votes “no”
On December 4, 2016 Italians voted against a change to Italy’s current constitution. While markets were largely
expecting a “no” vote, what surprised markets was the strength of the “no” vote at 59.8% (40.9% for the “yes”
camp), above the upper range of polls. The vote came after Prime Minister Matteo Renzi called a referendum
vote on a key constitutional reform after the matter failed to garner the required two-thirds majority in parliament.
As a whole, the referendum aimed to improve the efficiency of Italy’s legislative process, speed of lawmaking and
reduce bureaucracy (by reducing the overlap between the central government and regional authorities).
Currently, Italy has two chambers of parliament– the lower house and the Senate. Both chambers have equal
power and must therefore agree on legislation before it gets passed, which makes it difficult to pass new laws. A
key element of the proposed reforms was senate reform, whereby the lower house would be the only one to be
elected and would be able to pass most laws. Conversely, senators would no longer be elected, but would instead
be nominated at the regional level (by the regional councils) and the number of senators would be reduced from
315 to about 100.
Those in support of the referendum viewed constitutional reform as a milestone initiative that would allow the
government to continue implementing much needed reforms. Italy has had lackluster economic growth and
deflation, high levels of unemployment and has barely exhibited growth since joining the euro in 1999. Average
annual productivity growth in Italy has also been one of the worst in Europe since 2000, due to lackluster private
investment trends and relatively low levels of education spending. Reforms were therefore seen as critical for the
government in order strengthen the economy.
Those against the referendum feared that the proposed changes would relegate excessive power to the executive
and remove the current constitution’s vital checks and balances. There are still others, however that voted against
the reform to reject Renzi, as he had previously indicated he would resign if the referendum was not approved.
Following the defeat, Renzi tendered his resignation and has ruled out any possibility of accepting a new
mandate.
The key question now is, how will Italy be governed going forward and what will this mean for markets? Our
expectation is that a technocratic government will be formed in the near-term that will then work closely on
electoral reform. Electoral reform will in turn make it easier to pass additional reforms. Therefore, in our view, the
most feared scenario of snap elections and the rise of the Five Star Movement (M5S) is unlikely. Reforms are
also likely to continue, as technocratic governments have a track record of implementing reforms in Italy. That
said, higher political risks may hamper bank recapitalisation efforts. It is also important to note that a “no” vote
does not trigger an exit from the European Union (EU). In the near -term however, markets may be volatile on the
uncertainty that the resignation of Renzi creates.
1. SNAP ELECTIONS AND RISE OF FIVE STAR MOVEMENT UNLIKELY
In the lead up to the referendum, the overriding concerns was that a “no” vote would lead to early elections in Italy
and strengthen the power of the anti-establishment Five Star Movement (M5S). However, we continue to believe
that elections will not take place in Italy until 2018, given the nature of Italy’s constitution. It is the President that
must call a snap election (after checking whether there’s any majority in parliament willing to support the current
or a different cabinet led by a politician or a technocrat). Based on the last 25 years, Presidents have tended to
favour creating a new government, as opposed to calling an election. We therefore expect that President
Mattarella will move quickly to appoint a new technocratic (impartial) Prime Minister. Two likely candidates are
current Finance Minister Pier Carlo Padoan, who is a respected figure with knowledge of EU and international
authorities, or the current President of the Senate, Peitro Grasso, a former magistrate with a solid reputation and
no political career.
The new Prime Minister would then form a new government that would be tasked with approving electoral
reforms. Under a newly approved electoral law, the party with the majority of the votes (over 40% of the votes)
would have an automatic majority in Parliament, essentially guaranteeing the existence of a solid majority for any
future government. The proposed amendment to the electoral law is to give a majority bonus to the coalition of
parties rather than to a single party. If approved, this would diffuse power and make it less likely that the Five Star
Movement wins the next election, as it is less likely to join forces with another party. Further, the electoral
changes would help the lower house and Senate work more efficiently and potentially increase the ease of
passing future reforms. Our base case is therefore a technocrat-led government, as seen in 2011-2013, that will
then work to redraft electoral law.
That said, snap elections cannot be completely ruled out and there is concern that the landside “no” vote
empowers the anti-establishment to request snap elections. However, the only two parties likely to support snap
elections are the Five Star Movement and the Northern League. Given they both have only a small representation
in the lower house – at 14% and 3% respectively –this limits their influence. The remaining two parties are likely
to agree on a temporary government in order to amend the electoral law.
It is also worth noting that the “no” vote leaves the current constitution in place and in effect reduces the risk of
anti-establishment parties coming to power. Based on the current constitution, the Five Star party would only get
a proportionate number of seats in parliament, therefore limiting its power in parliament.
2. REFORMS CAN STILL CONTINUE BUT BANK RECAPITALISATION EFFORTS COULD SLOW
Renzi was elected on a platform of reforms and since coming into power in 2014, has implemented a number of
initiatives such as bankruptcy reform to speed up bankruptcy and foreclosure proceedings (in turn improving the
health of the Italian banking system), school reforms aimed at improving the educational system, and labour
reforms that make it easier to hire and fire employees. With Renzi’s resignation, there is a concern as to whether
Italy can implement what it needs in order to jumpstart economic growth.
We reiterate, however, that technocratic governments in Italy have had a long track record of implementing
reforms (as recent as 2011-2013). More importantly, success by the technocratic government in passing through
changes in the electoral law would make it easier to pass future reforms. However, higher political uncertainty in
Italy does create execution risks for bank recapitalisation efforts, particularly for the weaker banks.
3. A “NO” VOTE DOES NOT TRIGGER ITALY’S EXIT FROM THE EU
The other overriding concern has been that to the extent that a “no” vote strengthens the Five Star Movement, it
would trigger Italy’s exit from the EU, as the Five Star Movement has been vocal in its call for Italy to leave.
However, it is important to note that this was not a referendum on EU membership. Also, while skepticism against
the euro has been rising, there is no overwhelming consensus in Italy against the common currency. In fact,
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Italians for the most part believe they would be worse off if they exited the euro or the EU 1. What the Italian public
is calling for is leniency from the EU on budget matters.
4. IMPLICATIONS FOR MARKETS
The “no” vote was largely priced in and Italian cyclicals and financials had been under pressure prior to the
referendum. We expect volatility to persist until there is greater political clarity. The Financials sector could also
see further downward pressure, as investors fear that banks’ recapitalisation efforts could be delayed. Although
economic momentum in Europe is gathering pace, the euro could weaken on fears that a “no” vote fuels populist
movements in other European countries, such as Germany and France both which have upcoming elections in
2017. To the extent that the euro weakens, this should help enable the export sector to become more competitive,
underpinning economic growth. We also highlight some positive news out of Austria as the right-wing populist
candidate, Norbert Hofer, lost in the presidential race, which may help contain fears of rising anti-EU sentiment in
Europe. Although the Presidential role in Austria is largely ceremonial, investors were closely watching the
Austrian election as a gauge of populist sentiment in Europe and Hofer’s loss will likely be seen as a mild positive
for markets.
Bond yields are unlikely to rise meaningfully on a sustained basis from current levels. Importantly, the European
Central Bank is set to meet on December 8, 2016, where we expect it will extend the duration of its bond buying
program. This should provide some support to economic activity by keeping long-term interest rates lower. There
is a risk, however, that business and consumer confidence would suffer and Italian economic growth forecasts
may be revised down slightly.
CONCLUSION
Although markets, and in particular Italian equities are likely to be volatile in the near-term, we believe the longerterm impact of the Italian referendum will depend on how the political landscape unfolds. The AGF Global Core
Equity Strategy2 is underweight Italy, as the country allocation framework indicates Italy has poor price and
earnings momentum characteristics. Further, given our focus on high quality companies through the lens of EVA
(Economic Value Added), we believe we are well positioned to withstand any potential volatility following the
referendum vote.
For more information, visit AGF.com/Institutional.
1
Cornerstone Macro, November 2016.
2
AGF Global Core Equity Strategy representative account as of October 31, 2016.
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Published Date: December 5, 2016
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