Italy’s referendum: a clear win for “no”
ITALY VOTES AGAINST CONSTITUTIONAL REFORM
On 4 December 2016, a large majority prevailed in favour of ‘no’ in the country’s referendum with 59.1% of voters rejecting the constitutional reform put forth by prime minister Matteo Renzi’s government. Renzi was quick to acknowledge and take responsibility for the defeat, announcing his intention to step down soon after the vote was confirmed. He is now expected to hand his resignation to the President of the Republic in their meeting scheduled for 5 December 2016.
CARETAKER GOVERNMENT LIKELY
In the run-up to the election, three main scenarios were discussed in the case of a ‘no’ outcome: the Renzi government staying in place; a “caretaker government” replacing it; Parliament being dissolved and snap elections called. We think the appointment of a caretaker government is by far the most likely next step. While parties at the extreme ends of Italy’s political spectrum – expecting to benefit from Renzi’s loss – have asked for snap elections, the centrist parties hold a parliamentary majority and are likely to oppose the idea.
The most important argument made in favour of a caretaker government taking over is the need to modify the electoral law under which the next elections will be held. As a result of the ‘no’ vote, there is currently an inconsistency between how the Upper House and Lower House seats are decided (the two are defined by different electoral laws), which needs to be addressed. This would be the main task of the government that would be put in place after Renzi’s resignation. Elections would then take place either in February 2018 as scheduled, or at an earlier date (most likely in H2 2017).
ECONOMIC AND FINANCIAL IMPLICATIONS
While the collapse of an Italian government and even the risk of new elections would not normally be of significant concern to investors – who have, after all, experienced such events numerous times in the past – the timing of these developments is more critical this time around.
An important cause for concern at the present time is the state of the Italian banking sector. Suffering from high levels of non-performing loans and under pressure from the European Central Bank to clean up their balance sheets, Italian banks are facing a tough market environment, evidenced by their poor performance in equity and credit markets.
We have pointed out in the past how non-performing loans formation is a function of the country’s economic performance. We have also highlighted the fact that, as growth has returned in Italy, the balances have stabilised and even started to come down. If this process were allowed to play out, along with successful rounds of recapitalisation, the outlook for the banking system would improve over time.
The risk we identify at this juncture is that political instability, especially if it is protracted, can result in a loss of confidence and potentially even lead to another recession, thereby breaking the virtuous cycle described above and hurting recapitalisation efforts that are currently under way. The chance of state intervention and bail-ins would then arise, complicating matters further – especially in an unstable political environment. While this scenario is a risk that we have identified and continue to closely monitor, it is not our base case.
We will now be watching for the ability of Italian political forces to reach consensus about the best way forward in the wake of the referendum result. In order to ensure stability, reassure financial markets, and avoid an episode of prolonged uncertainty that could generate negative consequences for the country’s economy and its banking system.
While the extent of the public’s rejection of the proposals was at the high end of market expectations, the ‘no’ outcome was largely priced in. As a result, the market reaction is unlikely to be particularly negative for risky assets, especially if our base case for the implementation of a caretaker government is confirmed over the next few days. We therefore see no reason to change our portfolio positioning at this stage, but will carefully monitor developments, remaining ready to reassess our stance.
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