Research Briefing Italy

Transcription

1 Research Briefing Italy 'No' vote = weaker growth Economist Nicola Nobile Senior Economist Using our Global Economic Model (GEM), we find that in the event of a no vote in the constitutional referendum and Italy experiencing a period of political gridlock, GDP growth in 2017 will fall from 0.9% in our baseline to 0.4%. Investment will be negatively affected by a drop in confidence, though private consumption will be more resilient. Lower nominal growth and higher bond yields will mean a deterioration in fiscal metrics. In our scenario, financial markets and private investment will react negatively, of a similar magnitude to what happened after the 2013 election when it took two months to create a government. Furthermore, banks shares will be negatively affected and as a consequence, lending conditions will be tighter. Our results suggest that the Italian economy will be hit, but we do not see systemic consequences for the country. However, for a country whose recovery has been patchy and for which we see growth capped at around 1% in the medium term, even a temporary slowdown could be problematic. Given that the referendum is on a very country-specific topic a change in the Italian constitution we expect the fallout to be pretty much limited to Italy with only limited international spillovers. The political situation is of course interlinked with the domestic banking situation. Contrary to the original plan, it is now unclear that Monte dei Paschi di Siena will be able to raise capital this year. But in the case of a no vote in the referendum, it will be even more difficult to find fresh cash from private investors. This scenario is not entirely factored into our simulation and could be a further source of market volatility. A no vote in the referendum accompanied by a period of political gridlock will see the Italian economy growing well below trend In case of a no vote at the referendum, the Italian economy is set to grow by a subdued 0.4% in 2017.

2 We look at a scenario following a no at the referendum using our Global Economic Model In this briefing, we assess the economic consequences of a possible no vote in the Italian referendum on the 4 th of December. This follows our previous analysis on the political implications of the vote, where we argued that if the referendum motion does not pass, Italy is likely to see a period of political gridlock. We now investigate what that would mean for the Italian economy using our Global Economic Model (GEM). Recent polls are still quite balanced and the journey to the referendum is still quite long, so the outcome is uncertain. The number of undecideds has come down recently, but according to the poll published by La7, remains at 30%. What is also interesting is that the no vote seems to have pulled away from the yes vote in more recent surveys, though the gap still looks quite small (4%). Chart 2 The journey to the referendum is still quite long and the outcome is too close to call, but the number of undecideds has decreased recently. Political gridlock: the 2013 example Recent history provides some help in setting our assumptions for the scenario. Over the past 20 years, Italy has had ten governments. Among those ten, only four came from a clear victory in the elections: Berlusconi s in 2001 and 2008 and Prodi s in 1996 and The others were either coalition governments (such as in Letta s case in 2013 or in Renzi s in 2014) or caretaker governments. The period following the 2013 election could be seen as the main example of a political impasse. At the end of February, the elections resulted in no clear majority in the senate, but a majority for the Democratic Party in the lower house. However, electing a prime minister immediately turned out to be tough due to the absence of a clear majority in the senate and to the president s inability to call for new elections due to being in the last six months of his term 1. Originally, Mr Bersani (at the time PD s leader) tried to form a minority government with the support of the Five Star Movement, but without success. At the same time, President Napolitano realised that the main option to overcome this impasse was to accept a second term as president on the 20 th April, but one of his conditions was the creation of a grand coalition type of government. For this reason, on 24 th April two months after the vote he appointed then deputy leader of the Democratic Party Enrico Letta as designated prime minister. Mr Letta then manage to form a grand coalition with the support of the main right and left-wing parties. 1 According to Italian law, a president in his last six months of his term has fewer powers. For example, he cannot call for new elections. Page 2

3 Chart 3 During the two months for which Italy was without a government, Italian bond spreads over Bunds increased by around 50 bps. Given that our main scenario in the event of a no victory is a prolonged period of political gridlock, the reactions of the financial markets in those two months in 2013 is one of the underlying assumptions in our simulation. Chart 4 The reaction of the stock market to the period of no government was negative. As shown in Chart 3, the 10-year government bond spread against German Bunds rose by on average 50 bps over those days of political uncertainty. Similarly, Italian stocks (Chart 4) fell by around 10% with respect to the pre-election days, before regaining this ground upon the creation of the Letta government. More recently of course, the ECB s QE programme has helped lower government yields. But nevertheless, bond yields continue to react to political events, as has been the case in Portugal and more recently in Spain so we believe this assumption is still valid. A victory of a no likely to have some consequences on investment The other main assumption regards investment. It is reasonable to assume that a rise in political uncertainty and subsequent political gridlock will have some negative effects on confidence, which will affect investment. Moreover, some of this uncertainty may already be present, given recent weakness in both investment and investment intentions, as reported by a survey from the Bank of Italy (Chart 5). Admittedly, it is difficult to attribute this directly to the referendum, but the current political debate is not helping. Page 3

4 Chart 5 According to a Bank of Italy survey, investment conditions are not as positive as at the start of the year. Again, we can calibrate the effect on investment of the Q election 2. That part of the drop in investment not explained by the factors driving business investment in the GEM (such as credit conditions, the change in GDP and the relative return on investment) but by a drop in a residual factor could be linked to the negative effect of falling confidence. Credit conditions to tighten The Italian banking sector is one of the weakest spots in the Italian economy, as it suffers from a very high ratio of bad loans. It is reasonable to assume that a no at the referendum would represent a negative shock for Italian bank stocks. And as shown in the chart below, the Italian bank stock index has been a good indicator of bank credit growth to private non-financial corporates, with some lead time. So a further fall in Italian bank share prices with respect to our baseline raises the risk of credit contracting still further in the following year. Chart 6 The Italian bank stock index is a good indicator of bank credit growth to private non-financial corporates, with a lead of about six months. A further fall in the index implies still tighter credit conditions. 2 In practice, this means applying the change in the residuals on private investment in Q to the period of interest. Page 4

5 Summarising our main assumptions Summarising, our main assumptions in the case of a no vote at the referendum and a period of political gridlock are: A financial market reaction similar to what happened following the 2013 election, when it took two months to create a government. There is a temporary negative shock on equities and government bonds that lasts for around a year. An investment reaction also calibrated to simulate what happened in Investment is negatively affected by uncertainty and a drop in confidence. Contagion spreads to the Italian banking sector. As a consequence, credit conditions tighten further. The results of this scenario from our GEM are summarised in the table below for 2017 (consider that we assume the shock to start in Q1 2017): Effects of a no at the referendum (2017) Italy Baseline Scenario GDP (% year) Investment (% year) Private Consumption (% year) Employment (% year) Unemployment rate Government debt (% GDP) Source: Oxford Economics Effects to be negative but we do not see systemic consequences Italian GDP grows by just 0.4% in 2017 in this scenario, compared to a touch less than 1% in the baseline. The component of domestic demand that suffers the most is investment which contracts in 2017, causing the economy to stagnate in the first half of the year. Private consumption is more resilient, although lower than in the baseline, due to consumer confidence being in our view less affected than business confidence. As a consequence of lower nominal growth and higher bond yields, fiscal metrics will worsen as well. The government debt-to-gdp ratio increases to 133.2% in 2017, thereby further postponing any improvement in debt dynamics. The effect on labour market is negative as well, with unemployment 0.1 percentage points higher than in the baseline. Our results suggest that the Italian economy will be hit, but we do not see systemic consequences for the country. It will just mean that, given that it took more than two years for the constitutional change proposal to be put in place, it may take at least the same amount of time to produce a new proposal. However, this would highlight the inability of Italian lawmakers to reform the country and inevitably slow the process of other reforms. The results are also the consequence of the assumptions mentioned above. If, for example, we see a negative, but more temporary weakening in financial markets with little impact on business confidence, the effect on the economy will be much more muted, with the growth pretty much unchanged. Page 5 Furthermore, our scenario does not assume any fiscal response from the government. But the creation of a coalition government could result in a loosening of fiscal policy which could limit the drop in the economy, though again worsen the fiscal metrics.

6 though it could worsen if MPS plan does not work The political situation is of course also interlinked with the banking situation. Troubled bank Monte dei Paschi di Siena (MPS) announced a capital increase in late July, but the appointment of a new CEO has postponed its implementation. It is now not clear if MPS will be able to raise capital this year; but in case of a no vote, it will be even more difficult to find the 5bn required from private investors. This is not entirely factored into our simulation and could therefore be a further source of market volatility. Concerns could indeed intensify over the Italian banking system, ending in a failure of the MPS rescue package and further volatility in some of the weaker lenders in the region. Finally, mainly as a consequence of the fact that the referendum is on a very countryspecific topic a change in the Italian constitution we still expect the effect to be pretty much limited to Italy and not felt vastly anywhere else in the Eurozone. We would see a marked depreciation in the euro only in the event that markets believe a no will mean a Five Star government in the short term something to which we assign only a very small probability. There could, of course, be some negative reactions in other countries' stock markets in the short term, mainly due to bank shares tending to overreact to these kind of events. But we would not expect these to be permanent. Not a disaster, but another setback for a country that has not enjoyed a full recovery so far Concluding, our model results suggest that a no vote would not be a disaster for the Italian economy, nor it would lead to disastrous outcomes for Italy. GDP growth in the scenario will be lower by 0.5 percentage points with respect to the baseline by However, for a country where growth has been very weak and for which we see growth capped at around 1% in the medium term, even a temporary slowdown could be problematic. Indeed, it will further delay a return of GDP to its pre-crisis level, which in our baseline is seen happening only in Page 6