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Q&A: Why investors are wary of Italy's elections

Published on NewsOK Modified: February 24, 2013 at 11:19 am •  Published: February 24, 2013
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A: Italy's Byzantine election laws could mean many different outcomes. The worst result would be no party or coalition being able to form a government, leading to new elections.

Researcher Vincenzo Scarpetta at the Open Europe think tank says the probability of this is "very low" but that re-run elections could mean "potentially, huge market pressure, which Italy can hardly afford." This pressure would come in the form of rising interest rates on government debt.

Another possibility could be a parliament so divided that it can't govern effectively, or a shaky coalition of parties with clashing agendas — meaning that any policies would be the result of endless compromise and back-room deals. A badly split parliament "would surely affect investors' confidence as Italy's political future would remain unclear," said Aul and Ashley.

The return of a government led by Berlusconi's center-right coalition — regarded as unlikely — could also dismay markets given his call to repeal Monti's home tax and the lack of confidence markets showed in him in 2011.

Q: What do markets want to see?

A: Analysts say investors seem to be anticipating that the center-left Democratic Party, led by Pier Luigi Bersani will win. Bersani opposes budget austerity but is regarded as not totally against all efforts to improve conditions for business. Markets would like it best if he wins but still needs the seats won by small parties led by Monti to govern. That would mean the government might continue with some of the reforms.

Q: So should we expect market chaos and the eurozone crisis to erupt again?

A: Not right away, no. Italian law requires extensive consultation, so it could take weeks to tell who is in charge. In 2008, it took 24 days for Berlusconi to be sworn in despite a landslide win.

However, an anti-reform result could mean Italy's borrowing costs could rise in the days and weeks following the election.

That would be a sure sign that bond investors are more skeptical of the country's long-term ability to pay.

But it's considered unlikely that the yields would immediately rise to the record levels of last year that threatened to push Italy to default. That is thanks to the European Central Bank, which has done much to calm fears that a country will be unable to pay its debts. In September, the ECB offered to buy unlimited amounts of bonds issued by indebted countries, if they agree to reforms and to cut their deficits. No one has used the program yet but its mere existence has lowered Italy's borrowing costs.

Nonetheless, a new Italian government that rejects reform "will lead to more uncertainty, higher yields and a gradual process toward the situation we had last year," says Carsten Brzeski, an analyst at ING in Brussels.

The big problem is the long-term absence of growth rather than what the markets do next week.

Economists Aul and Ashley warn: "Whichever party ends up in power... needs to focus upon Italy's economic frailties as a matter of priority."