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Italy: All bets are off

Economic Update

  • The Italians have rejected a constitutional reform that would have improved the governability of their country
  • Renzi has resigned and a caretaker government will likely be put in place to reform the electoral law. Early elections will follow, probably between mid-2017 and early 2018
  • The initial market impact has been fairly muted, while it is just another blow for the economy. We expect economic growth to decelerate from 0.8% in 2016 to 0.6% in 2017
  • We continue to see the ailing banking sector as Italy’s Achilles’ heel 
  • The odds of a referendum on Eurozone membership haven’t increased after yesterday’s vote. If anything, the chance of a referendum has only reduced

Weak economic recovery kills constitutional reform

On Sunday 4 December, the Italians voted against a constitutional reform that would have improved the governability of the country (see here for more details about the reform). The most important reason for the “No”-vote wasn’t necessarily the reform itself, however, but opposition against the ‘Demolition Man’, i.e. Prime Minister Renzi. Being frustrated with the weak economic situation the Italians have been in for years, voting No was the ultimate chance for them to punish Renzi for not delivering on his promises to get the economy going again (see figure 1). Given the landslide loss of almost 60% to 40%, and in 17 out of Italy’s 20 regions, Renzi saw no other option than to resign. The opposition therefore got what it hoped for.

Figure 1: No speedy recovery for Italy
Figure 1: No speedy recovery for Italy Source: Macrobond, Nigem, Rabobank
Figure 2: Labour market in the South is the weakest link
Figure 2: Labour market in the South is the weakest linkSource: Macrobond

The frustration of the Italians is understandable, considering that the purchasing power of households is currently equal to that of 15 years ago, and still about 8% weaker than at the pre-crisis peak. The unemployment rate of 11.7% (September) is more than twice as high as the pre-crisis low. Especially people in the South and the youth – two groups with the highest share of “No”-voters – are still feeling the pain of years of recession, respectively 19% and 37% is currently without a job (see figure 2). (For more details on Italy’s weak crisis recovery see here and here). The paradox is, however, that by voting No, the Italians may have ruined a chance to put an end to a long history of political instability (see figure 3), to reduce bureaucracy and to smooth the implementation of reforms. These are all often cited as reasons for Italy’s decades of weak economic growth.

Figure 3: 63 governments in 69 years
Figure 3: 63 governments in 69 yearsSource: Rabobank

So what’s next?

For politics

The “No”-vote should also be seen within the context of the Italicum electoral law, which has already passed in Parliament but is currently being challenged in the Constitutional Court. The Italicum was designed to ensure that elections don’t produce hung parliaments, as it would ultimately give the winning party a majority of the seats in the Chamber of Deputies. Nothing has been arranged to elect the Senate, as the Italicum law was approved under the assumption that the constitutional reforms would pass as well. Two issues will arise if the Italicum remains unchanged: (i) it would favour a single party as the Five Star Movement (M5S) and might give them a majority in the Chamber of Deputies and (ii) it would almost certainly produce a hung parliament, given that the Senate is being elected on the basis of (regional) proportionality.

Now Renzi has resigned, President Mattarella has three options to consider: (i) calling snap elections ‘immediately’, (ii) rejecting Renzi’s resignation, (iii) appointing a new PM to head a caretaker government. The first option is feared by financial markets, yet preferred by the anti-establishment Five Star Movement (M5S) and the radical right Lega Nord. In our view, immediate elections are unlikely given the current problems with the electoral law, both legal (it’s challenged in the Constitutional Court) and logical (it will certainly produce a hung parliament). Simply put, the electoral law is a mess right now and President Mattarella has claimed to contain political instability and uncertainty as much as possible. It’s therefore the most likely scenario that the President will ask a caretaker government to come up with a new electoral law for both houses of Parliament. This could happen relatively quickly.

Snap elections will then be called after these electoral reforms are completed. The currently ruling centre-left PD and the M5S are neck-and-neck in the opinion polls for the next general elections (figure 4). The markets and most parties fear a victory by the ‘Grillini’ which is why we think that the electoral law is likely to be redrawn in such a way that it reduces the risk of a populist and anti-establishment win. Please note the irony here: the “No”-vote has basically mandated a change in the electoral law and this reduces the odds of the M5S clinching to power. At this stage, the most likely date for elections will be probably somewhere between mid-2017 and early 2018.

Figure 4: PD and M5S go neck-and-neck, average of opinion polls October - November
Figure 4: PD and M5S go neck-and-neck, average of opinion polls October - NovemberSource: Opinion polls, Rabobank
Figure 5: Market impact has been fairly muted
Figure 5: Market impact has been fairly mutedSource: Macrobond

For financial markets

The initial market impact has been fairly muted – even more so than we had expected. Sovereign spreads have widened “just” a few basis points and the euro has already recovered from its overnight losses, whereas stock markets across the Eurozone – and even in Italy – are currently trading above last Friday’s close. “Sell the rumour, buy the fact?”, as investors finally come to reason that the “No”-vote doesn’t immediately lead to snap elections (which would risk a M5S-win) and is not a direct vote against the Eurozone or the European Union.

Going forward, however, we might still see some volatility and weakness in the Italian banking sector, particularly when the caretaker government fails to come up with a plan to recapitalise the Italian banks. It is therefore up to the safeguards within the Italian political system to contain the fallout on this sector as much as possible. We continue to see this as Italy’s Achilles’ heel (see figure 5).

For the economy

The economy was not doing well before and for sure is not going to prosper after this No-vote.

In the short term, uncertainty about what’s next in politics and policy and with the banks, will depress domestic demand. Accordingly, we expect growth to decelerate from a meagre 0.8% in 2016 to 0.6% in 2017 (see table 1). Consumption growth will furthermore be hampered by inflation outpacing wage growth (see figure 6). Investment growth is also suppressed by weak credit growth, less additional stimulus from the ECB’s monetary policy, and uncertainty about the economic outlook. The weak economic climate will in turn hamper employment and wage growth, while fiscal space to cut households some slack is limited, due to large public debt. Accordingly, households are unlikely to experience a large increase in purchasing power over the coming few years.

Table 1: Forecast table Italy
Table 1: Forecast table ItalySource: Rabobank, Nigem
Figure 6: Inflation outpaces loan growth in 2017
Figure 6: Inflation outpaces loan growth in 2017Source: Macrobond, Rabobank
Table 2: Italy’s long-term economic outlook compares very weak
Table 2: Italy’s long-term economic outlook compares very weakSource: Rabobank, Nigem

In the more longer term, the No-vote affects economic growth as with Renzi’s resignation, the reform drive that Italy desperately needs and had not seen for many, many years, goes down the drain. The OECD estimated in 2014, that Italy’s economy would grow by 6%-points more over ten years if Italy were to fully implement all reforms introduced or put on the agenda by Renzi. Given that we expect Italy to grow by about 0.6% per year between now and 2023 (see table 2), reforms thus mean a great deal.

For Eurozone membership

We explained already in greater detail here that a referendum on the Euro or the European Union is unlikely at this stage. The odds of this haven’t increased after yesterday’s vote. If anything, the chance of a referendum has only reduced. This is thanks to Article 75 of the Italian Constitution, which states that Italy cannot hold a referendum on anything related to international treaties. It would require a change in this Article to give the Italian people a direct say in whether they would like to be in, or out, of the European Union and the Eurozone. And for this Article change one needs a three-quarter majority in both chambers of Parliament, or a simple majority and a referendum win. We should all know by now that constitutional changes don’t go easy in Italy...

Conclusion: the good, the bad, the ugly


Even though the reform package would have improved Italy’s governability by strengthening the executive, there was always the risk that the Five Star Movement would be the party benefiting from this. If a caretaker government also rewrites the electoral law in such a way that it eliminates the current “run-off system” or reduces bonus seats given to the party winning the elections, e.g. the M5S, the “No”-vote might have been a “lucky escape” after all.


We don’t expect anything other with regard to structural reforms or other growth-enhancing measures. The Italian economy wasn’t doing well before the referendum and it isn’t expected to do much better after. Structural reforms are needed badly, but the politicians will have their hands full with the electoral law and stabilizing Italian politics. In that sense, 2017 will be a lost year. Also in the longer term, the reform drive and implementation will remain weak, as policy procedures and the public administration will remain inefficient.


The banking sector remains Italy’s Achilles’ Heel and is exposed to financial market volatility. It’s up to the caretaker government to contain the fallout on this sector as much as possible.

Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2257 0569
Stefan Koopman
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 71 21328

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