Once again the European Union and the future of the Eurozone seemed to be in a bit of suspense following the latest Italian elections and the problem of putting together a coalition government.
In the end, Italy stepped back from square one in rejecting the Northern League/Five Star Movement selection of the fiercely Euro-skeptic Paolo Savona to the key position of Finance Minister, which Italy’s President Sergio Mattarella may have intended to avert a fundamental crisis between Rome, Frankfurt, and Brussels.
But in the process Mattarella threw the country into a new crisis until the last minute agreement on a new government, and in a bizarre unintended twist , may have played right into the hands of the fiery Northern League leader, Matteo Salvini. Prime Minister-designate Giuseppe Conte presented his list of ministers to President Sergio Mattarella for the second time in a week.
Ministers were drawn from both the anti-establishment Five Star (M5S) and right-wing League. Attempts to form a technocratic government had failed earlier. While Mr Mattarella had rejected Mr Conte’s original choice for finance minister a different candidate was agreed after meeting President Mattarella, Mr Conte confirmed that the new candidate for the key finance post would be economics professor Giovanni Tria. Analysts say he is critical of the European Union but not an advocate of leaving the euro, making him more acceptable to President Mattarella.
The deal will bring at least temporary calm to a political crisis that has embroiled Italy for weeks. The tumult raised questions – in Brussels and among investors around the world – about whether the rise in Italian populism and the collapse of traditional parties posed a threat to Italy’s long-term future in the Eurozone.
With the appointment of a new coalition government in Italy, markets need not fear a new round of elections as a dreaded proxy “referendum on the Euro” as neither party will include that in their platforms by any stretch of the imagination – despite market chatter about mini-BOTs, alternative currency regimes, and other nonsense.
A prolonged budget fight with Brussels on top of tighter funding rates already will most certainly further strain the Italian economy and banking sector that had just started to recoverDr. Mohamed Ramady
The many un-knowns
But there are still many unknowns about how the new administration – an uneasy alliance between two former political opponents, both jockeying for power – will govern Italy.
Salvini, who rose in recent years on the back of incendiary and racist statements about migrants and Roma, will take on the role of interior minister as Salvini has campaigned on the promise of mass deportations of migrants and said a new government would build detention centres around Italy.
He is also a fierce critic of Brussels and has called for closer ties to Russia which is going to cause alarm with those European countries at loggerheads with Russia on various issues. Meanwhile, Di Maio, will take on a powerful new post that will combine labour and industry portfolios in a move that could mark big changes to labour and environmental policies, given the M5S’s stated opposition to big industry.
This continuing Italian political uncertainty is going to cost Italy in the financial markets. A prolonged budget fight with Brussels on top of tighter funding rates already will most certainly further strain the Italian economy and banking sector that had just started to recover.
EU officials are concerned that the Italian banking sector, already under severe strain, has if anything deepened what is a potentially dangerous sovereign and bank balance sheet loop, against EU policy objectives since the debt crisis, and indeed against the positive trend in other countries away from that reliance across the Eurozone.
That downwards pressure is almost certain now to be accelerated through the ratings agencies, where Italian banks do not have much room for manoeuvre. Italy’s current sovereign ratings are a couple of notches above junk and Moody’s and Fitch have indicated these will be under review.
European Central Bank (ECB) rules require an exception for ECB liquidity to Eurozone banks if the highest of four ratings agencies (the other two being S+P and DBRS) was to fall below investment grade.
The Greek example
The Italians have only to look at what happened to Greece as a future scenario. That is what happened to Greek banks that subsequently had to be funded by the Greek National Bank’s ELA lines, until they were recapitalized and had recovered their credit ratings.
And that is what could lie in store for Italian banks were this crisis to continue and take a toll on the real economy, as well as on the banks’ immediate funding costs, and ability to further dispose of non-performing loans.
Very rough estimates are that such a program could require a loan or credit line of as high as 80 or 100 billion Euros – Spain borrowed 30 billion and ended up with some room to spare – and the European Stability Mechanism has some 400 or so billion Euros in its coffers.
A sovereign run on the funding markets would be a different ball game altogether. Some analysts believe that the political turn of events in Italy will prove the death knell to any hopes at this point for a Macron/Merkel push for any deeper Eurozone integration, even on the most modest, almost micro levels.
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First, the EU has been pushing for sovereign bond concentration limits for European banks, intended to make banks more resilient by reducing the sovereign-bank debt loop risk. While Spain, for example, in practice has taken steps to address those risks, all signs are that Italy, the biggest offender by far, will now go even deeper in the other direction.
The new government is expected to take a far more antagonistic stance against Brussels than the previous government, headed by the centre-left Democratic party.
But the alliance between the M5S and the League will have only a relatively narrow majority in the Italian senate, easing concerns among investors and officials in Brussels over the new government’s decision-making.
While both parties are populist in nature, and have railed against Brussels and Italian “elites”, they have long been natural opponents in politics. It will be no surprise to hear of yet another Italian election taking place in the not too distant future.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co-author of ‘OPEC in a Post Shale world – where to next?’ His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.