Former Prime Minister Matteo Renzi, who stepped down after constitutional reforms proposed by his government were rejected by voters at a referendum held in early December, cleared the first hurdle of his political comeback in April, winning re-election as leader of the governing PD, which he vacated in February, following the defection of a faction of left-wing Democrats, who have formed the separate Democratic and Progressive Movement. Renzi received 70% of the vote, and his convincing victory over two left-leaning challengers amounts to a strong mandate for the PD to campaign on a pro-EU, market-friendly platform ahead of the next general election.

No election is required until 2018, but Renzi suggested in late May that a vote should be timed to coincide with a German general election scheduled for late September 2017, on the assumption that an early vote would reduce Italy’s vulnerability to the market volatility that could be triggered by a protracted period of political uncertainty. However, the power to call an early election resides with President Sergio Mattarella, who has stated that he prefers to let the current government headed by Prime Minister Paolo Gentiloni serve out its full term.

However, pressure for an election will grow once the Parliament secures passage of a new electoral law that restores a uniform voting system for seats in both legislative chambers. That objective appears to be close to fulfilment, as Renzi has expressed openness to the revival of the mixed system that was used until 2003, a solution advocated by Silvio Berlusconi’s Forza Italia.

Assuming the voting method approved does not include the assignment of bonus seats to the winning party, as was proposed under the rejected constitutional reforms, it is all but certain that the winner of the next election will need coalition partners in order to claim a parliamentary majority. While that requirement would reduce the likelihood that the populist and anti-euro Five Star Movement, which holds a slight lead over the PD in recent polls, might be able to form a government, it would also increase the risk of a hung Parliament. Given the fragility of the country’s banking system, such an outcome would create a high risk of triggering market shocks that produce an economic crisis.

In any case, the cost of public support for the banking sector is forecast to push the debt-to-GDP ratio above 133% this year, a prospect that prompted Fitch to downgrade Italy’s credit rating from BBB+ (negative) to BBB (stable) in April. It is estimated that lenders are holding about $385 billion of non-performing loans, or more than one-quarter of the euro zone’s entire stock of bad debt, a situation that has raised understandable fears of a destabilizing outflow of capital in the event of any negative political shocks.

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