RaboResearch - Economic Research

The voice of Italy


  • In this Special we give our final take on the Italian constitutional referendum
  • The proposed reforms would radically change the balance of power within Parliament and are one of the showpieces of Renzi’s administration, but are certainly not without its downsides
  • The conclusion that a “No”-vote would spell doom for the Italian economy is a dramatic oversimplification, but there’s a risk markets will trade as such nonetheless

The constitutional referendum

On December 4, the Italian people will vote on a significant revision of the constitution that was proposed by PM Matteo Renzi and Elena Boschi, the Minister for Constitutional Reforms. 47 out of the 139 articles in the Italian constitution have been revised in order to streamline the Italian political system, which has a bad reputation for its indecisiveness. This revision has been one of the milestones of Renzi’s reform package and was already approved by the Italian parliament earlier this year. However, as it failed to get the necessary two-third majority after the party of former PM Berlusconi suddenly pulled its support, it now needs to be ratified via a plebiscite.

The question that the Italians will face on Sunday is the following[1]:

Do you approve the text of the Constitutional law on “Dispositions to overcome perfect bicameralism, the reduction of the number of MP’s, the containment of the institutions’ operational costs, the abolition of the CNEL and the revision of Title V of the second part of the Constitution?

These revisions are mostly about the balance of power within parliament and the balance of power between local and central authorities. Yet the reforms should also be seen within the context of the new electoral law (the Italicum, which is challenged in the Constitutional Court and on which our Rates team has written extensively here and here), and the fact that Prime Minister Renzi has staked his future on the vote, saying he would quit if he doesn’t succeed in securing a victory.

In the next paragraph, we’ll explain the reform in more detail. We furthermore discuss how it should speed up law-making and the implementation of structural reforms, but that a vote for sí isn’t a positive for Italy per se. Subsequently, we’ll (admittedly) get a bit more speculative and discuss how Italy’s politics are expected to unfold in the upcoming months, to what extent a referendum on the Euro and/or the European Union is a possible scenario and how this all may affect financial market sentiment.

Quid pro quo, or status quo?

When Matteo Renzi came to power in 2014, following a party coup which deposed his predecessor Enrico Letta, he gave himself the nickname Il Rottamatore, or “The Scrapper”. This was based on his ambition to break Italy out of the economic and political rut in which it had been stuck for years and years. Even though everyone knew from day one this was easier said than done, he got off to a relatively good start – earning the trust of investors and becoming one of the few bright spots that emerged from the sovereign debt crisis.

The constitutional reforms are arguably one of the showpieces of his administration, for its potential impact on the Italian political constellation in the decades to come. It would radically change the balance of power within Parliament, by stripping the Senate of most its powers and completely undoing the existing system of perfect bicameralism.

Perfect bicameralism means that both chambers in Parliament have equal legislative powers[2]. This means that all bills can be initiated and amended by either house. They must also be approved by both houses before becoming law, which often requires multiple readings of the same texts, resulting in lengthy legislative procedures. This system has often been criticised, both in- and outside of Italy, as the bills bounce back and forth from the Chamber of Deputies to the Senate until they are exactly the same – at times resulting in endless discussions about commas and full stops. This is often cited as one of the reasons that Italy has been so slow in following up the reform recommendations from institutions such as the European Commission or the OECD. Structural reforms had to be either watered down significantly, or something had to be given in return, in order to get the Parliament’s seal of approval. In that sense, perfect bicameralism became the perfect tool for political power play. Illustratively, the constitutional reform bill itself took two years to crawl its way through both houses of parliament. Though, this is not that shocking, as Senators were in fact deciding over their own future job.

If the reforms are ratified, the Chamber of Deputies becomes the main legislative body, while the Senate sees most of its powers being stripped. Even though it will keep its influence in a number of “bicameral” laws regarding the constitution, EU/international treaties and the electoral system, it will lose it on almost all other legislative matters. Its size will be reduced as well; from 315 senators to just 100. Five of them will be directly appointed by the President – based on their merits for society – whereas the others will represent their respective region in proportion to the region’s share in Italy’s population. The Senate will therefore become a Senate of Regions, instead of a Senate of the Republic. The position as senator will be part-time, as they will continue to serve as either a regional councillor (74) or as city mayor (21). Finally, the senators won’t be elected by the public, as they are now, but by regional councils. How this exactly should happen is not yet clear.

Another feature of the reform, is that more power is transferred from regional governments to the central government in Rome. For instance, Rome would get increased control over employment policies, transport and navigation, environmental issues, management of ports and airports and the production and distribution of energy. As regional governments are typically more susceptible to protecting regional/special interests, this is done with the intention to leverage the power of the executive and to streamline the implementation of government policy. The latter is often cited as perhaps being an even bigger problem than the lengthy approval cycle of proposed reforms within Parliament.

Why markets want a Sí

With the reform, the executive will almost exclusively depend on support in the lower house. Moreover, regional governments will be less able to tweak legislation to tilt the balance in favour of vested interests. Accordingly, the reform should – in theory – make governments more stable, reduce political power plays, increase the ability to implement structural reforms and push Italy on a higher growth trajectory. Note, for instance, that Italy had 63 governments in the past 69 years (see also the figure below), a fact that pretty much underlines the desirability of these reforms on its own.

Figure 1: 63 governments in 69 years
Figure 1: 63 governments in 69 yearsSource: Rabobank

This is also where the new Italicum electoral system, which goes along with these reforms but is not an integral part of it, complements the constitutional reforms. The Italicum hands out a hefty seat bonus to the party that wins the election, either in the first or in a second round, which guarantees an absolute majority in the lower house (again, note that this is being challenged in the Constitutional Court as it might give the winning party undue representation). The Italicum was designed at a time when Renzi’s PD polled at roughly 40% of the vote, unthreatened by the Five-Star Movement or any of the centre-right parties. The Italicum and the constitutional reforms provided an excellent opportunity for Renzi to seize the positive momentum and clinch to power for four more years. Seeing the national poll figures as they are now – even Renzi is willing, and in fact claiming, to amend the electoral law.

Why Italians might vote No

Even though the reforms should help Italy moving away from the status quo, it’s not without its downsides. It may be argued, for instance, that the reform package creates future volatility by giving the executive too much power – that’s not such a big issue when the executive is deploying market-friendly policies, yet it is when he or she is doling out favours for votes. Maybe Italy’s entrenched instability creates some form of stability after all, as checks and balances in disguise. It is thus amazingly difficult to quantify the positive economic impact beforehand – and that’s assuming there even is one! Moreover, the fact that the central authority gets more power over regional authorities doesn’t necessarily imply smoother implementation of reforms. For decades, Italy’s public administration has been notoriously inefficient and sluggish, whereas judicial proceedings are extremely lengthy as most courts are completely clogged. The high stock of non-performing loans in the Italian banking sector is illustrative of this, as it has been notoriously difficult for the banking sector to clean up their books. Work on enhancement and solvency reforms has been done by Renzi’s government, but it will take a long time before the Italian economy can reap the benefits of these measures. The constitutional reform alone won’t certainly be enough to materially change this.

Furthermore, as Renzi has said to resign if the outcome is No, Italians might use the vote to express their dissatisfaction about their Prime Minister. More specifically, about the weak economic situation they have been in for years.

Figure 2: Italy’s recovery lagging other Eurozone countries
Figure 2: Italy’s recovery lagging other Eurozone countriesSource: Macrobond
Figure 3: That’s not the quadrant where you want to be
Figure 3: That’s not the quadrant where you want to beSource: Macrobond

Italy’s economic recovery is significantly lagging that of most other eurozone countries, except that of Greece (figure 2 and 3). Early 2014, the Italian economy started to slowly recover from the country’s longest recession since World War II, although the losses suffered during the crisis years are still far from being recovered. Compared to the pre-crisis peak, gross domestic product is still almost 8% lower, GDP per capita around 10% and industrial production more than 20%. The unemployment rate of 11.7% (September) is more than twice as high as the pre-crisis low (5.7% mid-2007, figure 4), with especially youth unemployment at concerning high rates (37% in September). What’s more, houses are still worth about 20% less, banks have accumulated loads of bad loans on their balance sheet, and public debt has only risen further over the past years, to more than 130% of GDP. Yet what probably bothers households the most, is that they have suffered large declines in their purchasing power. Real household disposable income still has to recover around 8% to match pre-crisis levels (figure 5). In fact, the purchasing power of households currently equals that of 15 years ago.

Given the weak economic outlook, households are unlikely to experience a large increase in purchasing power over the coming few years. We expect growth to decelerate from a meager 0.8% in 2016 to 0.6% in 2017, on the back of lower domestic demand. One of the reasons is that inflation will likely outpace wage growth, suppressing consumption growth. Moreover, investment growth will be hampered by the weak banking sector combined with less additional stimulus from the ECB’s monetary policy, and uncertainty about the economic outlook and future domestic policy. 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.

Figure 4: The labour market isn't doing great either
Figure 4: The labour market isn't doing great eitherSource: Macrobond
Figure 5: And purchasing power has eroded
Figure 5: And purchasing power has erodedSource: Macrobond

All this suggests that both reforms enacted since Renzi entered the stage, such as the major overhaul of the labour market early 2015, the tax incentives to stimulate employment on permanent contracts, and the income and corporate tax reductions have been insufficient to fuel a speedy recovery and restore household disposable income. It goes without saying that Italians are losing faith in Renzi and that they have come to doubt his ability to brighten their future.

How could we still see a sí?

Figure 6: Opinion polling for the constitutional referendum
Figure 6: Opinion polling for the constitutional referendumNote: A two-week blackout period has started on November 18.
Source: Macrobond, aggregate of polls

In the past few months, polls have seriously underestimated the populist uprising in the UK and the US and most investors saw “Brexit and Trump” only as low probability events. We have to wait until Sunday evening to see whether the Italian pollsters have also underestimated the share of the “no”-vote, which is still possible, but it’s already clear that it won’t be a low probability event this time. Indeed, figure 6 illustrates that the gap looks almost unbridgeable. Renzi only has a few outs. For one, the large number of undecided voters may still turn things around. Even though the question asked in referendum is clear – most people don’t know what they will be voting for. Is this a genuine referendum or a Renzi popularity contest? Should you vote sí or no if you do recognise the reforms’ benefits, but don’t like Renzi? This ambiguity potentially makes polling highly unpredictable. Another complication is that pollsters have difficulties in factoring in the votes of Italians residing abroad, which are generally expected to vote for sí but whose turnout may be low.

Will Renzi resign if No prevails?

Suppose the outcome will be No, as currently indicated by the polls, will Renzi resign as he has pledged to do? In all fairness, no one knows for sure. But it seems like it. Yes, he voluntarily staked his future on the outcome of the referendum in an interview on January 12 and, yes, he subsequently realised that this promise doing his campaign no good. He handed his critics a golden opportunity to boot him out (especially as he has never been elected for office in the first place) and that was obviously a massive error of judgement. The referendum is now being framed as a national confidence vote on Renzi, on his government and – if we’re allowed to draw the parallel a bit further – on the global political establishment as a whole. This, of course, didn’t go as planned. Renzi himself realised this as well and has since watered down his promise to step down if the outcome turns out to be a No. If this was in the hope of changing the public sentiment around the referendum – that it is judged on its merits, for instance – it may have been too little, too late. Indeed, in a number of recent interviews, he doubled down on his promise to resign if he loses the referendum, saying that “if the Italian citizens want a decrepit system that doesn’t work”, he won’t be the one leading this system.

To make things even more complicated than they already are, the newspaper Corriere della Sera ran an article yesterday which noted that Renzi might even resign when the vote turns out to be a sí. In that case, Renzi would seek to be re-appointed to form a new government with a broader majority within the current parliament. This might be another last-minute strategy to take the sting out of the referendum and we don’t expect this to lead to much reforms on other fronts.

What happens when he resigns?

It is up to President Mattarella to decide what happens when Renzi resigns. The President is Italy’s head of state and one of the job’s responsibilities is to choose the head of an interim government, should the President accept Renzi’s resignation. There are already a few centrist names popping up in headlines, similar as what happened when Mario Monti and Enrico Letta had to form a government in 2011 and 2013, respectively. President Mattarella may also decide not to accept Renzi’s resignation and this may lead to a situation in which Renzi will lead a caretaker government. No matter if Renzi or someone else will become the Prime Minister, in both cases the caretaker government would most likely be in place until new elections are held. Even as this inevitably means that political instability will rise, crises as these are not uncommon in Italy.

Another problem is that a “no”-vote pretty much invalidates the Italicum, given that this law only provides in an electoral system for the Chamber of Deputies. This means that the Senate will revert to a standard system of proportional representation and that Italy is back to square one again. The caretaker government has to sort this out – one way or another – and come up with a new electoral system before May 2018, when the next Italian elections are ultimately scheduled. Please refer to this article for more on this.

The biggest risk we see here is that a “no”-vote and subsequent political unrest leads to a sell-off in Italian stocks and debt, with the banking sector being the most vulnerable here. Shares of Italian banks have already underperformed their European peers by roughly 40% this year, as the sector sits on high levels of non-performing loans and investors priced in some of the risks related to the referendum. If banks face yet another sharp sell-off, it would make the recapitalisation efforts an even more painful – and politically loaded – struggle, which is expected to reflect badly on Italy’s economic growth as well.

How realistic is a referendum on the euro?

Some consider the constitutional referendum as “just” a prelude to a vote on the European Union, already coining the term Quitaly. First of all, we don’t believe that a country can remain in the Eurozone while leaving the European Union, for the simple reason that the EMU is a subset of the EU. Therefore, a referendum that questions the relationship with the EU will be de facto equal to a referendum that questions the euro. That being said, it’s not as if an Italian political party can call a referendum out of the blue[3] – especially not when an international treaty is the subject. Article 75 of the Italian Constitution lays out the rules for a referendum (emphasis ours):

A general referendum may be held to repeal, in whole or in part, a law or a measure having the force of law, when so requested by five hundred thousand voters or five Regional Councils. No referendum may be held on a law regulating taxes, the budget, amnesty or pardon, or a law ratifying an international treaty.

It would require a change in Article 75 of the constitution 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. We should all know by now that constitutional changes don’t go easy in Italy.

However, let’s briefly review the necessary steps for this to happen. Firstly, there has to be a Eurosceptic majority in Parliament, but in order to get to such a majority, elections have to be held first. There are a few Eurosceptic groups in parliament, coming from different angles. There is the relatively small but vocal Lega Nord (LN) on the right of the political spectrum and then there is the Five Star Movement (M5S) on the left. Given current polling, the market’s fear is that the M5S is able to clinch power in the upcoming elections. Under the current Italicum law, the M5S can get a hold of power relatively easily – they “just” have to win a run-off from Renzi’s PD to grab the majority premium.

The M5S under the leadership of Beppe Grillo can certainly be labelled as Eurosceptic, but they have recently toned down their rhetoric somewhat, especially now they have won big mayor positions in, for instance, Rome and Turin. They don’t always take such strong positions as the Lega Nord, the Dutch PVV, the British UKIP or the French Front National, and may still decide that they can have the most impact by changing the European Union from within, pushing for more “Southern-friendly” policies and redefining the concept of the Ever Closer Union.

But still, let’s suppose they do want to hold a referendum. If they fail to assemble the necessary two-third majority in Parliament, but can still gather an absolute majority, there has to be a referendum on amending Article 75 first – similar to the referendum that will be held this week. If Article 75 is modified, a new referendum may then be announced to vote on Italy’s relations with the European Union. So, what we’ll then have is a referendum to hold another referendum. You’re still with us? If the latter referendum outcome points to an EU-exit – and one recent poll even suggested that this is not unthinkable – the way may be open for Italy to leave the European Union, following the same route as the UK. But, at this stage, the probability that Italy will get to this isn’t particularly high, especially as it is much more path dependent than it was in the UK.

The irony, if we may call that, is that a Yes vote in next week’s referendum and no amendments to the Italicum electoral law may actually increase the likelihood of this. The introduction of the run-off system under the Italicum law increases the chance that M5S wins the next elections and thus sufficient bonus seats to obtain an absolute majority in the Chamber of Deputies. However, even then it would still have to deal with the Senate, which isn’t directly elected and keeps its say on international treaties.[4]

Conclusion: lost opportunity

The fact that the polls switched from to no the moment Renzi made the plebiscite personal, illustrates that this referendum fits neatly with the anti-establishment storyline. It was a huge error of judgment, creating unnecessary uncertainty in both the economy and in financial markets. Then again, the conclusion that a No vote would spell doom for the Italian economy and lead to Europe’s collapse is a huge oversimplification, even though you can expect numerous headlines on Monday morning suggesting anything like this. In this special, we hoped to add some more nuance to this issue. The Italian economy wasn’t doing well before the referendum and it isn’t expected to do much better after, regardless of the direction of the vote. More reforms are needed for this to happen, but that’s not to say that this isn’t a lost opportunity.

This nuance doesn’t mean that we don’t expect that markets from trading in risk-off mode should the “no”-vote prevail, meaning weakness in (bank) equities, another setback to the euro, lower core yields and higher sovereign spreads – we expect to see Italian bonds widen versus both Germany and Spain. However, we think that this widening will be ‘relatively’ constrained, because a “no”-vote will not herald a public vote on Italy’s membership of the Euro any time soon (a “no”-vote is much more an anti-Renzi vote than it is an anti-euro vote). It is up to the safeguards within the Italian political system to contain the fallout on the banking sector as much as possible. This continues to be Italy’s Achilles’ heel.

The bottom line of all this is that Italy’s timeline for the upcoming eighteen months is very murky, with the pivot points to watch being 1) the referendum outcome, 2) whether the Italian banking sector can stomach increased volatility, 3) the verdict of the Constitutional Court on the Italicum’s legality, 4) the changes made to Italicum to limit the M5S’s chances and 5) the general elections that are set to take place at least before May 2018.


[1] Unofficial Rabobank translation

[2] Perfect bicameralism was introduced a few years after WW2 ended, when Italy effectively had a two-party system consisting of the Christian Democrats and the Communists, and designed as such to limit any revolutionary tendencies from either side. Whether this has worked out well remains contentious. The other side of the bicameral coin is that it’s hard to get anything done, especially after the tinkering with the electoral system for both houses since the mid-90s. As a consequence of this, the lower house (the Chamber of Deputies) and the upper house (Senate) may have very different compositions and majorities.

[3] In 1989, a non-binding referendum to re-affirm support for the European Economic Community was held. This referendum was called by all main parties, but they had to introduce an ad-hoc constitutional law to make this happen. 88.1% of the votes were in favour of supporting the process of European integration.

[4] It’s likely that the Italicum electoral law will be tweaked, regardless of the verdict of the Constitutional Court, in such a way that it’s less generous to single parties. This should contain the M5S’ possibilities to seize power and, hence, soothe concerns within the PD. Please refer to the latest Rabo Rate Directions for more on this subject.

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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