BMI View: Italians go to the polls on February 24-25 to elect a new parliament (Chamber of Deputies and Senate), and thus a new government. The last surveys before the election suggested that the centre-left alliance is likely to win a majority in the Chamber of Deputies, but the outlook for the Senate is complicated by the resurgence of support for ex-premier Silvio Berlusconi. We see a significant risk that Italy could be left with an unstable government, and this would raise investors' concerns about its fiscal policy.
Italy will hold general elections on February 24-25, which will be the first since the onset of the eurozone crisis in 2010. The vote will also herald the transfer of power from the technocratic caretaker government headed by Mario Monti that took over after the resignation of Prime Minister Silvio Berlusconi in November 2011. At stake is whether the sense of stability that Monti brought to Italy can continue, and whether the next government can maintain the austerity measures and business environment reforms that Monti has sought to implement.
The Election System: How It Works
Elections are to be held for the Chamber of Deputies (lower house) and the Senate (upper house).
The Chamber of Deputies has 630 seats, which are filled by a party list system of proportional representation. Under the rules of Italy's electoral system, the party or alliance that wins the most number of votes is automatically awarded at least 340 (54%) of the seats in the Chamber of Deputies, giving it a comfortable majority. Typically, parties form pre-electoral alliances to maximise their strength in the legislature. Small parties find themselves attracted to joining forces with larger parties, because within an alliance they need only 2% of the popular vote to enter parliament. If small parties run on their own, they need to surpass a 4% threshold to be represented in the Chamber. These dynamics arguably give small parties a great deal of power, since the large parties need their support for a majority.
The Senate has 315 elected members, and currently four appointed Senators for life. The Italian Senate is much more powerful than upper houses in most other countries, with virtually equal power as the lower chamber. The government therefore needs the support of both houses to remain in office. The Senate is elected on a regional basis, and only voters aged 25 and above can partake in the election. This means that parties with a strong following among younger voters are likely to be disadvantaged in the chamber. As regards the mathematics, parties in alliances need 3% of the vote to qualify for representation in the Senate, or 8% if parties are running on their own. The winning party or alliance in a region is awarded at least 55% of the Senate seats from that particular region.
Italy's Political Parties: The Main Contenders
Italy has a large number of political parties, although only two are powerful enough to actually lead coalitions - the centre-left Democratic Party and the rightist People of Freedom party. Opinion polls are not permitted two weeks before the election, so all cited support ratings refer to the last known surveys.
Democratic Party (Partito Democratico, PD): The PD is currently leading in opinion polls with just over 30% support. It is a social-democratic party that was founded in 2007 through a merger of left-wing parties that had existed since the 1990s. Its leader since 2009 is Pier Luigi Bersani, who has held several cabinet posts since the 1990s, most recently Minister of Economic Development in 2006-2008, in the last centre-left government. The PD is spearheading an alliance that includes six other small parties. Of these, the one attracting the most support is the Left Ecology Freedom (Sinistra Ecologia Liberta, SEL), led by Nichi Vendola.
People of Freedom (Popolo della Liberta, PdL): The PdL is a liberal-conservative party led by former prime minister Silvio Berlusconi, and formed the core of the government that ruled Italy from 2008-2011. It was created in 2007 through a merger of Berlusconi's Forza Italia and the National Alliance (Aleanza Nazionale, AN), led by Gianfranco Fini. Fini became prominent in the early 1990s as a defender of fascism, but later moved away from his radical viewpoints. In 2010, he split from the PdL to form a new party, Future and Freedom for Italy (FLI). Although Berlusconi appeared to retire from frontline politics after his 2011 resignation, in January 2013 he announced that he would spearhead the PdL, while stating that the party's secretary, Angelino Alfano, would become prime minister if the PdLwins. However, Berlusconi would wield tremendous political influence in that scenario. The PdL-led coalition includes several other right-wing parties, the most prominent of which is the Northern League (Lega Norda, LN), which theoretically favours the independence of wealthy northern Italy from the south. At the time of writing, the PdL's support was in the high 20s, having narrowed the gap with the PD to just a few percentage points in some polls.
Five-Star Movement (Movimento 5 Stelle, M5S): The party was founded in 2009 by comedian and blogger Beppe Grillo and is populist, environmentalist, and eurosceptical. It favours a tough stance towards corruption, and a more direct form of democracy via the internet. M5S was polling around 19% support in early 2013, and its rise reflects a broader discontent with Italy's traditional parties, something which has been exacerbated by Europe's sovereign debt crisis.
Civic Choice (Scelta Civica, SC): The SC is a new centrist party formed by Mario Monti to keep him in the prime minister's office, or at least maintain his reforms. Monti has won considerable praise abroad for his handling of the Italian economy, although his domestic popularity has declined from a peak of 70% to around 30%. The SC leads the Con Monti per L'Italia (With Monti for Italy) coalition with two other parties, the centrist Union of the Centre (Unione di Centro, UdC), led by Pier Ferdinando Casini, and the aforementioned FLI of Gianfranco Fini. The SC's support stands at around 15%.
The Challenges Facing The Next Government
Because the 2013 election will be Italy's first since the start of the eurozone crisis, and because Italy is the third-largest economy in the eurozone, the outcome will be watched particularly closely by investors. Below, we list the key issues that are likely to be faced by the next Italian government.
Fiscal austerity: As with most countries in the eurozone, especially the southern ones, Italy under Monti has been committed to fiscal austerity measures. Although Italy's budget deficit is less severe than many other European countries, concerns persist about its vast debt load, which is EUR1.9trn, or 128% of its GDP (the second-highest proportion in the eurozone after Greece's 188%). Monti's technocratic administration has pursued budget cuts and tax rises out of necessity, dictated by pressure from investors via the bond market, but now these measures will be put to the electorate. Many Italians are fed up of austerity, especially with unemployment at a 13-year high of 11.2% and youth joblessness at a record 37%. Bersani has said that he would continue Monti's fiscal programme, albeit with more pro-growth measures. By contrast, Berlusconi has been critical of spending cuts, arguing that they are constraining Italy's economic growth, and he has promised lower taxes. Grillo is also against austerity measures. Yet if the market comes to perceive that Italy is backtracking from fiscal austerity, then Italian bond yields could surge again, plunging the country into crisis.
Attitude towards Germany/northern eurozone: Closely linked to the issue of fiscal austerity is Italy's attitude towards the northern eurozone states, led by Germany. Outgoing prime minister Monti is in some ways the ultimate EU technocrat, having served as a European Commissioner from 1995 until 2004, when then-prime minister Berlusconi chose not be reappoint him. In 2010, Monti was tasked by the European Commission to create a new plan to advance the development of the single market. Pier Luigi Bersani, too, is a Europhile, having called for deeper European integration along the lines of a federal Europe. By contrast, Berlusconi has had a somewhat difficult relationship with Germany, and has even warned that Italy could be forced to leave the eurozone, unless the European Central Bank (ECB) does not become the lender of last resort. However, it is unclear if Berlusconi is serious in his remarks or just posturing. Grillo for his part is a known eurosceptic.
Economic reform: Although there are a myriad of economic challenges facing the incoming government, ultimately the biggest obstacle to generating robust growth and ensuring debt sustainability is Italy's poor competitiveness. Low productivity has long been a structural impediment to growth, which held the economy back during the pre-2008 global boom. Indeed during the 2000s the Italian economy was one of the worst-performing in the world. This poor economic record presents a far greater risk to debt sustainability than the public finances. Compared to other heavily-indebted Western European states, Italy has actually maintained relatively robust fiscal accounts and has traditionally generated primary budget surpluses. However, extremely high public debt, accumulated over the decades by previous governments and not paid down during the good years, has left the economy in a precarious position. Although fiscal reforms are a necessary part of the solution, unless the government can revive economic growth, it will struggle to stabilise the national debt. Specific reforms will need to target labour market rigidities, the liberalisation of closed professions, breaking down corruption in the public and private sectors which impede market transparency and efficiency, and encouraging consolidation within industries to generate firms of sufficient size to compete effectively in global markets.
Corruption: Italy has long been regarded as more corrupt than other Western European nations, and Berlusconi himself has been tainted by accusations of corruption. By contrast, Monti and Bersani are seen as relatively clean cut, and Grillo has long been campaigning actively for cleaner politics. As the election neared, a new scandal had emerged at Banca Monte dei Paschi di Siena, Italy's oldest and third-largest bank. The bank lost EUR730mn from allegedly non-transparent financial products between 2007 and 2009, which has now triggered a probe into its management. The scandal is potentially damaging to Bersani and Monti, for although they are not implicated in it, the PD's local party officials have traditionally had close ties with the bank, and Monti agreed to increase the size of a bailout for the lender. The scandal is illustrative of the close relationship between politicians and the financial system. Berlusconi and Grillo are likely to be the main beneficiaries of the MPS scandal.
Immigration: Although immigration is not a big issue in the current election campaign, it will likely re-emerge at some stage. As with many European countries, Italy's population is ageing, with the UN forecasting the proportion of people aged 65 and above rising from 20.4% in 2010 to 32.7% in 2050. The UN also foresees Italy's population peaking at 61.29mn in 2020, before declining slightly to 59.16mn by 2050. These demographic factors suggest that Italy will struggle to remain economically dynamic unless the country receives more immigrants or raises productivity substantially. However, as with virtually every other European nation, immigration is proving politically contentious. Owing to its location on the Mediterranean, Italy is often the first port of call for migrants coming from North Africa and the Middle East - and often from even further afield - into the EU. At a time when Italy's economy is weak, voters are likely to be more reluctant to take in more foreigners, but there is no escaping the immigration issue.
Foreign policy: Apart from relations with the eurozone, foreign policy is not likely to feature prominently in the 2013 election. Although Italy maintains 4,000 troops in Afghanistan, making it the fourth-largest contributor of troops there after the US, UK, and Germany, NATO is already committed to withdrawing in 2014. Going forward, Italy's main foreign policy challenges will come from the south. Italy found itself as a frontline state in NATO's war in Libya in 2011, and although the West's involvement there is over, North Africa will remain a source of instability in the Mediterranean region for the foreseeable future.
There are several potential scenarios emerging, based on the latest opinion polls. As noted, the PD-led centre-left alliance appears poised for victory in the Chamber of Deputies, but may fail to win control of the Senate. This would necessitate a coalition between two alliances.
PD-led victory under Bersani: Opinion polls point to a victory by Bersani's PD-led alliance. Bersani is generally viewed as a safe pair of hands, and his victory is more or less expected, so this would not cause any market shocks. The risk is that he could receive a weak mandate, potentially constraining his room for manoeuvre.
PD-SC Bersani-Monti coalition: In the event that the PD falls short of a Senate majority, Bersani could seek to form a coalition with Monti's bloc. Monti has said that he would not join hands with the PD unless he is offered the premiership, but Bersani is unlikely to concede the top position. In any case, Monti would have a dubious claim on the prime ministerial post if his party became the junior partner of a coalition. Despite these differences, a PD-SC coalition remains a realistic possibility in our view. Investors would probably welcome such an alliance, since Monti would retain political influence. The risk is that this coalition of coalitions would prove to be too unwieldy, eventually leading to a political divorce and a new general election well before the end of the next five-year term.
PdL-led coalition: A victory by Berlusconi's PdL remains a wild card to say the least, but cannot be completely ruled out. Berlusconi's bloc has been catching up with Bersani's PD, and Berlusconi is a master campaigner. However, the sudden resignation of Pope Benedict XVI on February 11 completely dominated Italian news that week, keeping the ex-premier off the front pages. Regardless, it is not clear whether a PdL-led coalition would automatically return Berlusconi to the premiership, which could be taken by party secretary Alfano. That said, Berlusconi would probably be seen as 'paramount leader', and this would raise investors' concerns about who is in actual charge of policy. We would deem a PdL victory as a negative market shock, as it would likely strain Italy's relations with Germany and cast doubt on Monti's reform agenda.
Strong M5S performance: Regardless of which coalition wins, there is a chance that M5S and other smaller parties will score better than expected. A strong performance by M5S could embolden it to become more confrontational against the traditional parties or make the latter adopt some of M5S's policies in an attempt to co-opt their supporters. This would inject a higher degree of uncertainty in the legislature, and could worry investors.