FLASH NOTE
Flash Note
Italy: Politics
Referendum at heart of Italian political uncertainty
Pictet Wealth Management - Asset Allocation & Macro Research | 14 November 2016
A ‘No’ vote to the government-backed
proposals would add to the current
uncertainty surrounding the euro
area, but the immediate likelihood of
early elections in Italy is relatively
low, in our view.
We believe it is even less likely that
Italy holds a referendum on euro
membership, if anything because
such referendum would not be legally
binding.
The Italian referendum is the next big event on the European political
calendar. The vote will be held on 4 December, just ahead of the next ECB
and Fed policy meetings on 8 December and 14 December, respectively.
Opinion polls have been consistently showing the ‘No’ vote ahead, but the
proportion of undecided voter remains very high.
A ‘No’ vote to the government-backed proposals would add to the current
uncertainty surrounding the euro area, but the immediate likelihood of early
elections in Italy is relatively low, in our view (see Chart 1).
We believe it is even less likely that Italy holds a referendum on euro
membership, if anything because such referendum would not be legally
binding. While a rejection of the referendum will be seen as negative by
market investors, we do not think that it will lead to a systemic crisis.
While a rejection of the referendum
will be seen as negative by market
investors, we do not think that it will
lead to a systemic crisis.
We begin this Flash Note with a brief background explanation of the 4
December referendum before examining the political, financial and economic
consequences of a ‘No’ vote.
A ‘Yes’ vote would boost government
confidence and marginally help
Italian securities, but is unlikely to
represent a significant game changer
for Italy and for the euro zone as a
whole.
Chart 1: Referendum on the senate reform – scenarios after vote
Independently of the referendum
outcome, the outlook for Italy will
remain challenging in 2017.
AUTHOR
Nadia GHARBI
[email protected]
+41 58 323 3543
Pictet Group
Route des Acacias 60
CH - 1211 Geneva 73
www.pictet.com
Source: Pictet WM – AA&MR
A ‘perfect bicameral’ system
The current Italian parliament consists of two houses: the lower house, the
Chamber of Deputies (630 seats), and the upper house, the Senate of the
Republic (315 members). Both houses are elected simultaneously, for the
same five-year term and have (almost) the same powers. A government
needs the backing of both houses to enter office and must resign if it loses the
support of one of them. Moreover, any law/bill initiated by one house needs
to be approved by the other in exactly the same terms.
This (almost) perfect bicameral system finds its rationale in Italian history.
After two decades of fascist dictatorship, the 1946 Constitution was designed
to prevent to ensure that Italy did not drift into dictatorship the same way as
it had after Benito Mussolini had been appointed prime minister in 1922.
However, having two houses with equal powers has contributed to
lengthening or, in certain cases, paralysing the decision-making process.
The Italian political landscape is also characterised by a large number of
political parties and poor government stability. Since the birth of the
Republic in June 1946, the country has had more than 60 governments.
The 4 December referendum
The 4 December constitutional referendum is part of a broader package
promoted by the centre-left government of Matteo Renzi aimed at making the
Italian political system more stable and facilitating the legislative process.
The package includes two main elements: first, a new electoral law, named
Italicum (see below), regulating the elections of the Chamber of Deputies
and, second, the Senate reform, which is the object of the December
referendum. The Senate reform bill was first proposed by the government in
April 2014. After several amendments by both houses, the Senate approved
the bill in January 2016 and the Chamber of Deputies in April 2016. However,
the reform bill failed to secure the qualified majority (2/3 of parliament)
required to become law. As a consequence, as per the Italian Constitution
(Art. 138), a referendum needed to be called. This will be the third
constitutional referendum in the history of the Italian Republic, the others
having been in 2001 and 2006.
Acceptance of the referendum would mean substantial modifications to the
Italian constitution (47 out of a total of 139 articles would be changed), with
the current ‘Senate of the Republic’ becoming the ‘Senate of the Regions’.
The reform proposes reducing the numbers of senators from 315 to 100,
who would no longer be directly elected. Instead, 95 members would be
elected by Regional Councils, with the remaining five appointed by the
Italian president.
Furthermore, the reform aims to shake up the so-called “shared
competences” between the Senate and regional governments, separating the
issues treated by each. More importantly still, the reform proposes to remove
some of the Senate’s legislative powers. The government would only need
to obtain the confidence of the lower house (the Chamber of Deputies) to
pass legislation instead of both houses. This would end the perfectly
symmetrical nature of the Italian parliamentary system. The Senate would
retain some oversight functions, but it would have no power of veto and it
14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 2
would essentially become the chamber of regional governments. Perfect
bicameralism (meaning that both houses would need to approve a
government proposal) would continue to apply in certain restricted cases, in
particular in the case of bills amending the constitution, the election of the
Italian president, and the ratification of EU treaties.
The ‘Italicum’ electoral law causes complications
The electoral law, named Italicum by PM Renzi, came into force in July 2016
(and will apply in the next general election, due in 2018). This new electoral
law applies to the election of the Chamber of Deputies, but not to the Senate.
The key feature of Italicum is the premium it gives to the party that gathers
at least 40% of the vote in the first round of legislative elections,
automatically assigning it 54% of seats in the Chamber of Deputies (340 out
of 630 seats). The remaining seats are divided proportionally among the other
parties that received at least 3% of the popular vote. If no party receives 40%
of votes in the first round, then a second ballot is organised, with the winner
getting the majority bonus (340 seats). The remaining seats are split
proportionally between other parties according to the result of the first
round.
The aim of the new electoral law is to produce more stable governments, as
54% of the seats would be controlled by the same party. However, Italicum
faces a lot of criticism from political parties, including from some members
of Matteo Renzi’s own Democratic Party (PD).
The main reason is that in conjunction with the constitutional changes
proposed in the Senate reform, it would end up giving too much power to
just one party, and could lead to the election of an anti-establishment
government. Indeed, some PD members are concerned that it would allow
the Five Star Movement (5SM) to gain an absolute majority in parliament,
despite having only around 30% of the popular vote (see Chart 2). According
to opinion polls, in a straight fight between 5SM and the PD, centre-right,
voters are more likely to vote for the anti-establishment candidate. A similar
message emerged from the local elections held in June 2016.
Chart 2: Italian polls on voting intentions in the next general election
45
% (Average monthly voting intentions)
M5S
PD
Forza Italia
Lega Nord
40
35
30
25
20
15
10
5
0
12
13
14
15
16
Source: Pictet WM – AA&MR, Various polls
14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 3
In response, PM Renzi has declared that he is open to changes to the electoral
law if internal and external opposition to Italicum can find a compromise.
Meanwhile, the new electoral law is awaiting a ruling on its legality from the
Constitutional Court. The Court was supposed to issue an opinion on 4
October, but the judgement has now been postponed to avoid becoming
mixed up with the 4 December referendum. The referendum and the Court
delay increase the uncertainty surrounding Italy’s future institutional
framework.
But independently of the referendum outcome, Italicum is likely to be
changed in 2017.
Why the referendum has gained so much attention
The referendum has been attracting increasing attention, predominantly
because of pledges made by Renzi in the past to resign in the case of rejection
of the reform. Recently, the prime minister has tried to step back from this
pledge, admitting that he had “made a mistake in personalising the vote”. He
is also adamant that whatever the outcome of the referendum, Italians will
vote in a new general election in 2018, as scheduled.
Nevertheless, other political currents are swirling underneath the
referendum, and part of the electorate is likely to use it as an opportunity to
express its discontent with the government and a desire for change.
The PD and some centrist parties are backing a ‘Yes’ vote but left-wing and
right-wing opposition parties as the well anti-establishment 5SM are
campaigning for ‘No’.
Opinion polls (see Chart 3) have been consistently showing the ‘No’ vote
ahead, but the proportion of undecided voter remains very high.
Chart 3: Italian polls on voting intentions in the Senate reform referendum
60
Average monthly voting intentions ( excluding "dont know", %)
NO
YES
50
40
30
20
10
0
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16
Source: Pictet WM – AA&MR, Various polls
What happens if Senate reform is rejected?
A ‘No’ vote would add to the current political uncertainty in Italy and would
be seen as a negative by market investors. However, we do not believe
rejection of the referendum proposals will lead to a systemic crisis.
14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 4
•
Politics: Snap elections unlikely
A ‘No’ vote would preserve the current institutional setting, but short-term
political uncertainty would likely increase. In spite of recent back-tracking,
Renzi might have to resign. However, snap elections right after a ‘No’ vote
seems unlikely. The main reason is that snap elections would most likely
lead to a hung parliament, given that the two houses would be elected under
two different voting systems. The lower house would be elected under
Italicum (a majority system), while the Senate would be elected under a pure
proportional system after a single round of voting.
The most likely scenario would be for President of the Republic Sergio
Mattarella to ask a temporary government to be formed (which could be led
by Matteo Renzi), whose main task would be to harmonise the voting system
use for two chambers in order to minimise the risk that no party is able to
secure an outright majority in the next general election.
The only way snap elections could be called is if the parliamentary
opposition were to win a vote of no confidence. However, given the
composition of both houses, it would be hard for the opposition to achieve
majority support in a no confidence vote.
•
Markets: Mounting stress, but no systemic crisis
Sovereign bonds. Italian sovereign bonds have been under increasing stress,
even underperforming Spanish bonds, in spite of recent political
uncertainties in Spain. The spread between 10-year Italian government bonds
and their Spanish equivalents is now close to the highest level they have been
since 2012 (see Chart 4). The causes are not only linked to the referendum.
However, should the referendum be rejected, spreads are likely to widen
even more although the ECB would provide a sufficient backstop to avoid
any stress spiralling into a systemic crisis. Moreover, Italy benefits from a
relatively stable base of domestic investors.
Chart 4: 10yr Italian versus Spanish government bonds yield
8
Spread
%
Italy
Spain
Bps
7
200
150
6
100
5
50
4
0
3
-50
2
-100
1
0
-150
11
12
13
14
15
16
Source: Pictet WM – AA&MR, Various polls
Ratings. Two rating agencies, DBRS and Fitch, have placed a negative
outlook on their ratings of Italian government debt. Italian government
bonds are not at risk of being excluded from the ECB’s QE. However, should
DBRS downgrade Italian rating, the haircuts applied to Italian government
bonds posted as collateral (many by Italian banks) for Eurosystem funding
14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 5
would increase. This is because the Eurosystem takes the best of the ratings
assigned by the four main ratings agencies when deciding the size of the
haircut it applies to eligible collateral. Given DBRS’s current rating on Italy,
securities issued by Italian government still carry low haircuts, i.e. those
applied to securities with ratings in the AAA to A- range. Should Italy be
downgraded by DBRS, its banks would have to post more collateral to
keep ECB funding, adding to the profitability concerns that beset the Italian
banking system.
Banks. A ‘No’ vote could increase the difficulty of a market-based
recapitalisation of the Italian banking sector. Two Italian banks are
currently under scrutiny, Banca Monte Dei Paschi di Siena (MPS) and
Unicredit. MPS is due to launch a capital increase before year’s end,
supported by a pre-underwriting agreement with a pool of investment banks.
MPS hopes to have a deal before the referendum vote, but recent news
suggests this will be complicated to achieve. Without a market solution, a
bail-in and a state bailout may be required for MPS. The total amount
involved is manageable, but would likely be seen as a defeat for the
government and could prolong banking industry uncertainty.
•
Economy: Further reforms on hold
A ‘No’ vote would have a limited direct impact on the Italian economy, at
least in the short term. But it could have more of an indirect impact. A
prolonged period of political uncertainty following rejection of the
referendum could dent consumption and investment prospects, hurting an
already fragile and modest recovery.
Moreover, higher sovereign bond yields (even if the ECB’s QE provides
support) could put sovereign sustainability at risk. Currently, nominal GDP
growth around 2% (in Q2 2016) is not high enough to offset any large,
sustained increase in average borrowing cost. Lower growth and higher
sovereign risk could in turn worsen the banking sector problems. In addition,
further reforms would likely be put on hold, at least until the next general
elections.
If the referendum is carried
Approval of the 4 December referendum would be the most marketfriendly outcome, at least in the short term. In that event, Renzi’s
government would be more likely to remain in place until the next elections
are due in 2018. The focus would then shift back to Italicum and the
possibility that changes in the voting system increase the probability of an
anti-establishment party winning majority control of parliament at the next
general elections.
Additional meaningful structural reforms are unlikely, as the government
will need to avoid controversial measures that would cost it support before
the next general in 2018.
Conclusion
Overall, independently of the referendum outcome, Italian growth is likely
to remain modest in 2017 and the reform momentum is unlikely to pick up.
Major weaknesses such as high public debt, low productivity and a fragile
14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 6
banking sector are unlikely to be solved in the current political and global
climate.
A ‘Yes’ vote would boost government confidence and marginally help
Italian securities, but is unlikely to represent a significant game changer
for Italy and for the euro zone as a whole. By contrast, a ‘No’ vote would
add to the current political uncertainty and could hurt an already fragile and
modest recovery.
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14 November 2016 | FLASH NOTE - Italy: Politics | PAGE 7