Italy Agreement: More Hope Than Expectation

We are currently of the view that the market panic generated by the plan published by the new Italian government is a bit excessive. The agreement between the Five Star Movement and the League is primarily an electoral advertisement, rather than a realistic project, containing a raft of measures the new government would like to implement, some of which can be viewed as “extremely leftist” and some closer to the “extreme right”.

The measures most concerning markets include:

•    A request to the European Central Bank to “forgive” part of the national debt, which equates to asking the rest of Europe to pay Italy’s debts off, while also denting market confidence in the country
•    A proposal to exclude bonds held by the ECB from the calculation of the Debt/GDP thresholds set by the European Union, dropped from the final draft but it is still a signal of how the new government looks at debt monetisation
•    A call to create a “development bank” that essentially already exists (the Cassa Depositi e Prestiti) and has been proven in the past to allocate resources more toward political objectives than economic efficiency
•    The institution of a two-tier personal and corporate tax, an increase to unemployment benefits and a review of the current national pension scheme that might end up costing up to €100bn a year funded primarily by deficit

We think none of these can survive in reality. The government is not born yet and, at the moment, the parties’ priority is to show their electorate that they are fighting the good fight.

As we have noted previously, we suggest keeping an eye on the roles Claudio Borghi and Alberto Bagnai will play in the new government, the pair being the two fiercest anti-euro economists on the Italian public scene. The impact of their views was seen when a recent statement from Borghi calling for Monte dei Paschi di Siena to be nationalised caused the bank’s stock price plummet. If either individual ends up taking a key seat in the treasury or development ministries, we would expect volatility to pick up.

We expect Italy to still trade at a premium to Portugal, even if the current 37bp or so differential on the 10 years will probably reduce once the parties realise they will not be able to get any of the proposals through. In any case, in the near term, the credibility of the government remains in question and we will be very cautious until we see greater clarity once the new government is in place.