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Analysis
Italy downturn signals troubled summer

Italy downturn signals troubled summer

League's European poll strength will be crucial

by Sofia Melis in Rome

Wed 27 Feb 2019

Luigi Di Maio, leader of the Five Star Movement (M5S), and Matteo Salvini, head of the League, proclaim the strong partnership between Italy's two governing parties. Not only will they retain power, they say; they will also implement all the expensive social spending policies agreed in their 'government contract'. But recent developments – especially the sharp economic slowdown – raise doubts whether the coalition can agree the 2020 budget. This portends a troubled political summer.

M5S seems to be losing ground, while the League's approval rating is strengthening. On 18 February, M5S upheld Salvini's parliamentary immunity in a legal case over his action on blocking immigration, a move that broke electoral commitments and enhanced internal divisions. The trend was seemingly confirmed on Sunday 24 February, when a centre-right coalition headed by League Senator Christian Solinas won local elections in Sardinia. Solinas received 47.8% of the vote, against 11.8% for the M5S candidate.

May's European elections will be critical. Pundits predict the League will perform well, winning around 30% of the vote at the expense of M5S, whose share is expected to continue to decline to around 20%. Discontent is likely to precipitate a party split. After the European elections, a group of dissident M5S members of parliament and senators is expected to defect from the party in protest at Di Maio's leadership.

If Salvini secures enough votes in the European elections, he may opt to break the coalition in June or July, in time for new elections potentially in early autumn. This would leave enough time for a new 2020 budget to be tabled by the 31 December deadline. Salvini could lead a new coalition comprising the League, Silvio Berluscioni's Forza Italia, the national-conservative Brothers of Italy and sections of M5S. He could continue to strengthen his leadership, allowing FI and the Brothers of Italy to provide receptacles for supporters of business interests and fascist sympathies respectively. All this would leave M5S the weaker partner.

If his successes in May are more modest, Salvini is likely to press to renegotiate the government contract and demand control of important ministries such as health and infrastructure. When Paolo Savona was made head of the Italian Companies and Exchange Commission in February after serving as minister of EU affairs since June 2018, the League did not press for one of its own party members to replace him at the ministry. The League seems to be saving its political capital for more important posts. Health and infrastructure are key for the implementation of fiscal federalism, a vital goal for traditional League voters.

In this latter scenario, Salvini and Di Maio will in the autumn try to pass a highly unpopular belt-tightening budget. The two parties will seek to make each other scapegoats for their economic failures. Elections would then be likely in spring 2020 in a political landscape marked by further change in the opposition. In March, Nicola Zingaretti is expected to become leader of a left-leaning Democratic Party. Former Prime Minister Matteo Renzi will split off from the DP, forming a centrist, anti-populist movement dubbed 'a third way' in his latest book.

In view of the fourth-quarter economic slowdown, rumours are circulating of budget corrections in the next couple of months – the latest in a long tradition. The government will need to address concerns about rising sovereign debt, casting further doubts over whether it can implement M5S's proposed universal citizens income (RDC). The League's pension reform has had an impact on INPS, the welfare agency tasked with delivering RDC, with around 700 staff expected to take early retirement. With the public administration unable to make new hires until November 2019 to limit public spending, coping with these enhanced responsibilities poses great problems.

Heightened political risk has depressed business confidence and weakened investment. Interlocutors in Rome have different opinions on the reasons behind the economic dip. Many talk about stagnation more than a recession. Some blame external conditions, while others believe weakening internal demand (contrasting with relative export buoyancy) reflects lower consumer confidence caused by political uncertainty.

The slowdown could reverse the improvements in Italy's non-performing loans, especially if higher spreads on Italian government bonds start to work through to higher borrowing costs. Banks have started to reprice credit – but not yet to restrict it.

Debate over Italy's membership of the euro has died down. Anti-euro comments from League MPs – including Salvini's attack on Banca d'Italia independence – look like attempts to distract voters from the weaker economy. Much will depend on whether the European Central Bank enacts, as generally expected, a new set of liquidity measures to relieve pressure on Italian banks. If he wishes to allow his (not yet decided) successor a relatively unencumbered start to the job, ECB President Mario Draghi needs to implement such easing well before he steps down at end-October.

Sofia Melis is Relationship Manager at OMFIF.

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