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Disagreements over fiscal policy are likely to reveal
considerable fault lines between the ruling Lega and M5S parties,
increasing the risk of government collapse well before the end of
the current parliamentary term.
Italy is poised to remain trapped in a damaging cycle where low
growth produces populist governments and populist governments
preclude long-term reforms conducive to growth.
Italy is likely to fall short of establishing truly flexible
labor markets, a key ingredient to bring about improved labor
productivity.
With regards to the banking sector, IHS Markit does not
envisage any rapid correction of the NPL issue, suggesting that
credit flows to non-financial firms will remain disrupted,
remaining an obstacle to any sustained renaissance of private
investment.
Italy is expected to make further progress in further opening
its product and service markets, and deliver an improved business
climate, and implying lower prices for all.
The continued obstacles to fully reversing the productivity and
growth malaise point to Italy remaining one of the weaker growth
performers in the eurozone over the medium and long term.
Our current baseline anticipates that the reform process in
Italy is likely to be slow, and will be further delayed by recent
political events. Specifically, the resignation of the
reform-minded prime minister Matteo Renzi in late December 2016 was
a major blow to the fragile reform consensus, which had helped to
deliver the landmark Jobs Act. Furthermore, the new M5S and Lega
coalition has already begun to question the effectiveness of the
Jobs Act, suggesting a lack of desire to kickstart the process.
Ultimately, we continue to assume that a deeper structural
overhaul in Italy will require acute financial market stress,
helping to relaunch a political consensus that further action is
needed to deflect intense market pressure. Still, the challenge for
Italy's political elite will be to convince a wary electorate to
embrace deeper supply-side reforms, accepting that they will have
shorter-term negative economic consequences but will eventually
deliver more positive longer-term prospects.
Banking reform likely to be slow
Our baseline scenario assumes that Italy is likely to push ahead
with reforms to further open product and service markets to deliver
an improved business climate. However, progress is expected to be
more labored in other areas. For the banking sector, we do not
envisage any rapid correction of the non-performing loan (NPL)
issue; that suggests credit flows to non-financial firms will
remain disrupted, remaining a major obstacle to any significant
renaissance of private investment.
An inflexible labor market
Also, Italy is unlikely to establish truly flexible labor
markets, a key ingredient to bring about stronger labor
productivity. A concern is that a more decentralized wage
bargaining process will trigger a prolonged period of falling real
wages, implying further downward pressure on already squeezed
household incomes.
Clearly, the lack of new reform momentum in Italy is an
increasing risk to medium- and long-term growth projections, and
suggests that Italy could fall back further when compared to its
eurozone peers.
Fiscal matters will continue to create political fault
lines
The prospect of being trapped in a low growth environment does
present a risk to Italy's membership of the euro. In addition, the
electorate sent a strong message in the recent general election
that Italy needs a new direction, namely a more expansive fiscal
policy to generate stronger growth, and deliver more open-ended
employment without watering down existing employment protection
legislation. This was accompanied by demands for stricter
immigration controls. In addition, the e M5S and Lega coalition's
agenda of a lower tax burden and measures to alleviate poverty is
proving popular with the electorate. However, without a substantial
boost to growth or spending cuts elsewhere to provide adequate
funding, the new measures will unsettle bond markets and rating
agencies.
The uneasy alliance between M5S and Lega is likely to be a major
obstacle to any immediate start of the reform process. Even more
worryingly, the risk remains that some of the recent measures such
as the 2015 Jobs Act could be pushed back. The best hope for a
renewed reform drive is that policy conflicts pull the coalition
apart, including on fiscal matters in particular, which have the
potential to generate financial market turmoil. Notably, the Lega
remains sensitive to any downturn in support from its wealthier
constituency in the north. Indeed, if market pressure and EU
resistance to expansionary fiscal policy grows markedly during
2019, this will increase the probability that the coalition
government will be replaced by a unity government formed by
technocrats, which could reignite the reform process.
But, given the increasing reluctance to adopt measures which are
perceived as informal conditionality from the European Commission,
it is likely that a serious reform drive would face severe backlash
in the next general election, benefiting either the duo of
Lega-M5S, or some other nascent populist movement. Italy is thus
poised to remain trapped in a cycle where low growth produces
populist governments, and populist governments preclude long-term
reforms conducive to a stronger growth performance.
Posted 03 August 2018 by Dijedon Imeri, Senior Analyst, Country Risk, S&P Global Market Intelligence and
Raj Badiani, Economics Director, Europe, S&P Global Market Intelligence