Italy and the Consequences of the “No” Vote

Italy voted “No” to the national referendum on Sunday, December 4 resulting in important economic and political consequences for the nation and the European Union (EU). Italy has been in dire straits for a number of years, despite Prime Minister Mateo Renzi’s bold attempt to change its political system and revive the economy.

Renzi, who started with changes in Italy’s employment laws in hiring and firing workers, also cut payroll taxes by €35 billion ($37.1 billion) creating 580,000 new jobs. But the Prime Minister tried to make further changes in Italy’s government by putting forth a national referendum to change the Senate’s structure.  The referendum has economic and political consequences.

Political consequences

Italy not only has a huge governmental bureaucracy but a constitution that makes passing a law a long, tedious process. Compounding this problem is that the national government can change when there is a lack of confidence exhibited by the Senate and the House of Deputies. The referendum is designed to reduce the Senate’s size, streamline the process of passing a law, and bring more stability in the governmental process.

The Renzi-Boschi referendum, named after Renzi and the Reform Minister Maria Elena Boschi, was meant by the government as a radical approach in ensuring stable majorities for present and future governments in a tightly run parliamentary format. The Senate would have been broken apart and the House of Deputies becomes the actual law-making body in the Parliament.

This referendum also envisioned the simplification in the law-making process and planned to allow the House to pass laws and votes of “No Confidence” in the government. The legislative process was meant to be sped up since the House would be permitted to debate a bill sent from the cabinet of ministers within five days and vote on it in a maximum of 70 days. The reform also planned to reduce the number of senators from 315 to 100.

Those against the referendum saw it as taking away the constitutional right of government and abrogating democracy. Renzi and his supporters marketed it as streamlining government to make it faster and more responsive to new situations as they present themselves.

The “No” vote is a victory for the 5 Star Movement headed by the comedian turned political party leader Beppe Grillo. Grillo regards a “No” vote as a victory for the populist movement and an opportunity to have elections called next year. The 5 Start Movement’s anti-establishment agenda regards Renzi’s referendum as not radical enough. Renzi placed a huge bet on the referendum’s passage. Given his failure, he was forced to resign and the Italian President will be forced to call for elections for a new government in 2017.

This could allow Grillo and his party to assume enough popular votes to take control of the Italian government. Victory for the 5 Star Movement will rank with Brexit and the Trump presidency as another step forward for anti-establishment politicians. It also means that the 5 Star Movement may try to push to exit the euro and, in the long run, leave the EU.

Economic consequences

A larger concern for Italy regarding a “No” vote is the financial market’s reaction.  A “No” vote will result in a loss of confidence by the financial markets who will see Italy changing governments in 2017. Deutsche Bank estimates that if the 5 Star Movement came into power and Grillo becomes prime minister a referendum will be called on Italy’s involvement with the euro and the Stoxx Europe 600 index could drop by as much as 20%. This could also cause Euro Stoxx 50 Volatility Index (VSTOXX) to go higher than its average.

Markets and investors despise bad news and a “No” vote could cause a higher degree of anxiety than many are prepared for. A lethal combination of the unpredictability of Italian politics and serious economic problems for the EU’s third largest economy will cause the market deep consternation. Some analysts feel there will be a domino effect among the European financial markets that the European Central Bank cannot handle and therefore a serious downturn will cause investors to reach for antacid medications.

Compounding the ill reaction by the financial markets will be the effect on Italy’s government bond market, the fifth largest globally. It is bad enough that international bond markets are reeling since the recent American presidential elections, but Italy’s bond market will take a steeper decline in response to the referendum vote. Most recently, the yield on Italy’s 10-year government reached 10% for the first time in more than one year and analysts feel it could go higher. This increase in yields will cause bond and note prices to fall.

“No” could also make it very difficult for Banca Monte dei Paschi di Siena SpA (MPS), Italy’s third largest bank by assets and one of the most troubled in Europe. MPS is looking to raise financial capital by shedding €28 billion ($29.7 billion) in bad loans while raising €5 billion to make up the void in its capital cushion that the write-downs from the sale of bad loans will cause. MPS is planning to sell common stock and swap certain bonds at full face value even if they are presently trading at 50% of nominal value.

With a “No” vote, potential investors will become jittery and avoid the offering. If this transaction cannot occur, then MPS will seek a bailout from Renzi’s government.  Renzi and MPS must move quickly to make this happen in order to avoid a bank run and calm financial markets.

Too many uncertainties

While a “No” vote does not mean that Italy will fall apart, it will cause deep anxiety for investors, financial markets, and those in the EU trying to keep it intact.  In the short term, analysts may compare the result to the quake caused by the Brexit vote. In the long term, “No” may cause more uncertainty and hurt Italy’s opportunity for political and economic stability.

This article was originally published by Global Risk Insights and written by Arthur Guarino, an assistant professor in the Finance and Economics Department at Rutgers University Business School