Italian voters’ rejection of the austerity program carried out by the technocrat administration may deliver one of several options: a Grand Coalition catering to all political tastes, a minority center-left administration or a bridging of the Bersani-Berlusconi divide. In either case, a feisty and unstable marriage in Rome is expected, whether or not fresh elections are required.
An unstable polity is not new for Italy. But this particular crisis will deliver a net negative impact for business owners and investors, both in Italy and in the wider euro-zone, especially for the short-term.
Italian Yields OK, So Far…
Unlike last year’s Greek tragedy, no-one appears to be calling loudly for a euro exit; the 5-Star Movement would like a referendum on the country’s membership, coupled with a sovereign debt restructuring, but other parties will try to steer public sentiment in other directions. Besides, there is no great clamor for an Italian exit among the population, and bond yields, though reacting sensitively to developments, have not yet scaled the heights witnessed last year following the ECB’s underwritten guarantee to do all that is necessary to preserve the euro project.
…But Borrowing Costs Will Dampen Appetite for Capital Outlays
Yet policy stasis will prove the inevitable outcome of a weak mandate. With no clear electoral victor, and the possibility of fresh elections looming, the uncertainty now unsettling equity prices and nudging up borrowing costs, will further constrain an already-weak corporate investor climate. Having contracted by almost 9 percent in 2012, gross fixed investment (involving business capital spending and construction) is sure to decline by 5 percent or more in 2013, a steeper decline than most forecasters had been predicting until now.
Business Interests Take a Backseat to Political Ones
Businesses can expect few favors as the structural reforms needed to improve Italian competitiveness — without relying on the devaluation option of the past — slip down the agenda and fiscal slippage extends the austerity program beyond current targets. Improving the infrastructure and inefficient tax system, and sclerotic labor and product markets, with their burdensome regulations, will take longer than expected, much to the chagrin of Italian entrepreneurs.
Downside, Upside Risks Going Forward
Consumer retrenchment will continue, harming retail sales and delaying economic recovery. Skewed effects, weighing on firms serving domestic rather than ‘extra-euro’ markets, will be apparent, with the private sector crowded-out by public sector job initiatives. Many larger corporations will speed up plans to locate abroad, either in other European states with better governance or in faster growing markets worldwide. Heightened risks of bankruptcy (especially among under-capitalized and small-and-medium sized enterprises) can be expected, and the unemployment rate will break through the 12 percent mark, both in Italy and in the euro zone as a whole this year, encouraging emigration of skilled workers.
But there is also an upside. There may be some tax cuts to stimulate demand, while exporters — not only in Italy, but euro-wide — may receive an unexpected fillip from currency depreciation. This will help firms to compete more effectively for market share outside the single currency zone and should, via a stronger contribution from net exports, prevent what would otherwise be a deeper economic contraction. The centre-left may also receive support for its pro-green technology policy, providing business opportunities and jobs in that particular sector.
Still, these advantages must be weighed against a weak intra-euro market and the risk of inflation (with euro zone countries significant food and energy importers, and the euro now suffering), as well as other detrimental effects associated with Italy’s mounting problems. This includes the possibility of a payments crisis, with no government in place committed to the conditions underlying the European Stability Mechanism that would ensure unbridled support from the ECB. Spain and Portugal are already reeling slightly from contagion; their borrowing costs may have further to rise until the crisis is resolved.
By Christopher McKee, CEO and Owner of The PRS Group, Inc. (www.PRSgroup.com) a leading global provider of political and country risk forecasts and analysis.