RaboResearch - Economic Research

Italy suffers more from third COVID wave than from government shake-up

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  • Conte survived the confidence votes in parliament, triggered by Italia Viva’s departure from the government
  • In the Chamber of Deputies the vote passed with an absolute majority, in the Senate only with a simple majority
  • Policymaking will be somewhat more difficult, but the development of the pandemic continues to have a much larger economic impact in the foreseeable future
  • Based on available data the economy looks to have contracted by about 2% q/q in 20Q4 and we pencil in another contraction in the current quarter
  • We expect some relief will come over the second quarter
  • We forecast the economy to grow with about 4.5% this year, after the 8.8% plunge last year

Conte wins confidence votes

Monday 18 and Tuesday 19 January, Italy’s Prime Minister Giuseppe Conte survived a confidence vote in respectively the Chamber of Deputies and Senate. Yet whereas he was able to garner an absolute majority in the Chamber, the government had to settle for a simple majority in the Senate (figure 1). The votes followed the coalition’s Italia Viva’s (IV) departure from the government last week, over frustration of Conte’s plan on how to spend the money from the EU crisis recovery fund and his management of the pandemic – and the country in general. Without former PM Renzi’s party Italia Viva the government no longer holds an absolute majority in the Lower Chamber, whereas it already lacked a majority in the Senate (figure 2). Upon the resignation of two IV ministers Conte now needs to fill the two vacant posts. Yet IV will maintain the presidency of the 4 parliamentary committees Finance and Transport in the lower house and Education and Healthcare in the upper house.

Figure 1: Confidence vote passed with an absolute majority in the Chamber and simple majority in the Senate
Figure 1: Confidence vote passed with an absolute majority in the Chamber and simple majority in the SenateSource: ANSA, RaboResearch
Figure 2: Government lost absolute majority in seats in chamber of Deputies
Figure 2: Government lost absolute majority in seats in chamber of DeputiesSource: www.senato.it, www.camera.it, RaboResearch

Policy implications of the weakened mandate

In Italy’s bicameral political system the Senate has equal powers to the Chamber. Hence it seems inevitable that the government’s very weak mandate and lack of an absolute majority in the Senate’s vote complicates policymaking at least to some extent, going forward. Most importantly, because in the Senate the governing parties will very much continue to depend on IV or other opposition law makers for passing bills - IV has 29 seats in the Chamber and 18 in the Senate (although at least one of the senators seems to return to the PD). With IV no longer in the government it could become (even) more vocal against Conte’s policy.

Most laws can be passed by a simple majority, i.e. abstention by IV for example would suffice. Yet some require an absolute majority and thus outright support by IV or other opposition law makers – beyond the need of support from its natural ‘partners’ outside of the coalition. An absolute majority is necessary, for example, for raising budget deficit targets – something that has been required on multiple occasions since the outbreak of the pandemic – and passing annual budget bills. The important upcoming vote in parliament on the country’s EUR 209bn recovery plan funded with EU grants (EUR 80bn) and cheap loans ‘only’ requires a simple majority. So far, Renzi has signaled IV will continue to support the government on an ad hoc basis, in any case paving the way for the recovery plan to be adopted. But clearly they continue to hold leverage over the government and have gained leeway to criticize it. Combined with the fact that the largest parties in the coalition, PD and Five Star, are by no means best fellows, the government will likely face a very difficult task passing contentious legislation. That said, while tensions are likely to continue to resurface time and again, early elections remain unlikely in the foreseeable future in our view.

Limited risk of early elections

The most important reason is that left-of-center parties will want to avert a return to the ballot box as the (center-to-radical) right would win according to the polls (figure 3). This would also mean they would lose ‘control’ over spending the recovery fund money and appointing the next President, with Mattarella’s term ending in February 2022. Furthermore, the number of seats in both the upper and lower house will shrink by one third after next elections, explicitly endangering the seats held by many current MPs. And finally there is the difficult logistics of a vote during the pandemic.

Figure 3: Polls put center-right alliance on top
Figure 3: Polls put center-right alliance on topSource: Macrobond, RaboResearch
Figure 4: Financial markets fairly untouched
Figure 4: Financial markets fairly untouched Source: Bloomberg

Pandemic has far larger economic implications

The political tumult and subsequent weakened government has no noteworthy impact on the economy in our view. Italia Viva was already a recalcitrant force in the government, challenging government policy, and tensions had been increasing for months. Moreover, financial markets have barely reacted, with government bond yields still near all-time lows and the stock market largely unfazed (figure 4). This does not mean, however, that the country would not benefit from a government with a strong mandate, especially when it comes to implementing necessary reforms to enhance growth in the longer term. But merely that the difference with the old situation is not that large.

It is mostly the development of the pandemic that has worsened the economic environment and outlook over the past months. The weakened government faces the difficult task to control the third virus wave with some much more contagious mutations, even before the second one has been put to bed and hospitals and their staff have had time to catch their breath. So far, Italy has been able to stem the increase in new cases relatively quickly, but only at a high 14-day notification rate – the notification rate is the number of new cases per 100.000 inhabitants. Moreover, both testing and positivity rates and hospital occupancy are high (figure 5 and 6). Consequently, all Italian regions are still classified as a high-risk zones according to thresholds of the European Centre for Disease Prevention and Control, ICU doctors have sound the alarm and tough containment measures will continue to be necessary to prevent the situation from spiraling out of control. In turn this will require additional fiscal support measures, on top of the funding included in the current budget for 2021 to cushion the economic impact -  the government is very much aware of this. At the same time, long-term challenges for economic growth resulting from the longer-lasting economic impact of the current crisis on both public and private balance sheets increase. 

Figure 5: Third wave stabilized for now, yet at high incidence rate
Figure 5: Third wave stabilized for now, yet at high incidence rateSource: Macrobond, ECDC, WHO, RaboResearch
Figure 6: Combination of high testing and positivity rate requires stringent measures
Figure 6: Combination of high testing and positivity rate requires stringent measuresSource: Macrobond, ECDC, RaboResearch

Italian economy contracted in Q4 and will contract again in Q1

After showing some remarkable strength in the third quarter (15.9% q/q), economic activity again contracted in the final quarter of last year. The official GDP figure will only be presented early February, but based on timely activity indicators (figure 7, 8 and 9) and containment measures that were in place (figure 10), we expect the economy to have contracted by about 2% q/q in 20Q4 (compared to -5.5% q/q in Q1 and -13% q/q in Q2). Going forward, we pencil in another, albeit smaller, contraction in the first quarter of this year due to several reasons. One reason is that containment measures, on average, will likely be somewhat stricter than in 21Q1 than in 20Q4 (more detail is provided in the appendix at the end). The lower GDP level at the start of this year and a weakened external environment are other factors that explain a further decline in GDP.

Hence vaccinations have not come in time to prevent another recession, but they do provide the long-awaited light at the end of the tunnel. Although it will take time before the entire population will be inoculated, we think the government will be able to gradually loosen the reigns from the end of the current quarter onwards. In our baseline scenario, we expect the strictness of containment measures to return to last summer’s level over the course of the second quarter. This in turn would pave the way for decent growth already in Q2, yet GDP will remain some 5% below its pre-crisis level of 2019Q4. The recovery will continue in the second half of the year, but it will take a few years before the economy will have returned to its pre-crisis level.  We forecast the economy to grow about 4.5% this year, after having contracted by 8.8% last year.

Figure 7: Despite minor uptick in December, PMIs point towards contracts in Q4
Figure 7: Despite minor uptick in December, PMIs point towards contracts in Q4Source: Macrobond, RaboResearch
Figure 8: Many turnover, sales and production figures have weakened in the first month(s) of Q4
Figure 8: Many turnover, sales and production figures have weakened in the first month(s) of Q4Source: Macrobond, RaboResearch

To conclude

In short, while early elections have been averted, policymaking will be somewhat more troublesome going forward. Meanwhile, the pandemic continues to significantly hamper economic activity. From the second quarter onwards the economy will start to recover, but it will take years for the economy to return to its pre-crisis levels. In the meantime, and beyond, the Italian government will likely very much continue to depend on European support to keep its finances affordable. Which makes it all the more important for Italy to continue to be governed by a pro-EU government.

As shown, government bond yields are near all-time lows. This at least partly results from the ECB’s massive bond buying program and the creation of the EUR 750bn EU crisis recovery fund. The crisis fund not only benefits the Italian economy directly via the funds it is expected to receive, but also via the signaling effect of this big step forward in EU fiscal coherence. That said, in order for Italy to actually receive the funds, Italy would need to get approval from the EU on its spending plans and reach reform milestones. Consequently, it is very important for Italy to present the European Commission adequate plans and make decent reform progress, which will likely prove challenging, given its history and the very weak governing mandate. On the upside, there is some large potential and the carrot approach might well prove much more fruitful than that of the stick.

Appendix - Containment measures 21Q1 and 20Q4 compared

Currently, 54% of the regions in terms of GDP is classified as an orange zone and 28% as a red zone. Hence in over 80% of the regions restaurants are only open for delivery and take-away - in the others they can serve customers until 6pm. Non-essential shops are closed in more than a quarter of the regions. When compared to the most severe situation during the second wave in November, currently more restaurants are closed, but for non-essential shops this is less. Yet measures are much stricter when compared to October, when visits to these venues were ‘only’ limited by capacity constraints. Measures are also more restrictive than in the largest part of December – excluding the holiday season – when much less regions were classified as either orange or red. Furthermore, travel bans between regions installed end-2020 remain in place until mid-February, while ski resorts remain closed until then. Meanwhile, a nation-wide curfew from 10pm to 5am in place since end October is extend until 5 March, as is the closure of museums, cinemas and sport facilities in most regions.

Figure 9: In Q4 the number of people visiting retail and recreation areas dropped
Figure 9: In Q4 the number of people visiting retail and recreation areas droppedSource: Macrobond, RaboResearch
Figure 10: Containment measures have been significantly tightened since the end of October
Figure 10: Containment measures have been significantly tightened since the end of OctoberSource: Macrobond, RaboResearch
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