Azad Zangana, European Economist at Schroders, looks at whether investors are finally about to get a stable and strong government which can tackle the problems behind Italy's lacklustre performance over the past two decades:
♦ Italy holds its next general election on 24 and 25 February.
♦ Based on the final polls, Bersani still has a comfortable lead and should take the lower house with a relative majority.
♦ There is a slim chance that Berlusconi wins an overall majority in the upper house. In this scenario, Italy may backtrack on some austerity and structural reforms.
♦ However, the pressure from markets, the European community and the European Central Bank would force even ♦ Berlusconi's party to undertake the necessary measures.
♦ We expect Bersani to become the next Prime Minister of Italy, and will probably have to join forces with Monti's coalition to take the upper house.
Italy holds its next general election on 24 and 25 February, a move forced by former Prime Minister Silvio Berlusconi when he abruptly withdrew his support in December 2012 of the much-needed reforms and fiscal austerity proposed by Mario Monti's technocratic government. Are investors finally about to get a stable and strong government which can tackle the problems behind Italy's lacklustre performance over the past two decades?
It's no secret that Italy's economy has struggled to maintain competitiveness post the euro's introduction in 1999, seeing it suffer years of low growth ever since, a deep double-dip recession since 2007 (which saw its economy slump faster than any in Europe, bar Greece) and, most recently, painful austerity measures causing its economy to contract 2.2% last year. Along with Portugal, Italy is the only other eurozone economy to face lower GDP per head in 2013 than in 1999.
The general expectation is that there will be a lower turnout than in previous elections, well below the 80% of 2008, and perhaps even down to 70%. It is unlikely a major surprise is in store given an apathetic electorate driven by its anger over past political corruption, current economic mismanagement and a future characterised by status quo.
How the major players fare in the final poll results
Since the start of the year, Berlusconi's centre-right coalition has seen a small rise in the opinion polls, leading to questions about Pier Luigi Bersani's ability to lead his centre-left coalition to power. Berlusconi's gains have been at the cost of Bersani and Monti, as both have seen their coalitions falling slightly in the polls. Italian election rules state that polling must end in advance of the actual election and, for that reason, the results in the chart on the next page show the final results of the polls (using a 20-poll moving average). Note that based on the last five polls run on 8 February 2013, approximately 30% of voters are either undecided, or do not expect to vote. However, this is historically normal if not slightly lower than normal.
Based on the final polls, Bersani still has a comfortable lead, even after adjusting for the 3% average polling error. Bersani should take the lower house with a relative majority, and because of the system employed, which is similar to the UK's first past the post system, Bersani will have 55% of the seats in the lower house, even if he wins the popular vote by just one vote.
Will it be as clear-cut an outcome in the upper house?
The uncertainty over the elections really only arises over the upper house (senate), where majorities at a regional level matter more than nationwide. However, as the upper house has approximately the same amount of power as the lower house, an effective government needs to control both. As the Northern League (Lega Nord) has recently joined forces with Berlusconi, an overall majority for Bersani now looks less likely.
The key swing states and relevant region are Lombardy, Campania, Sicily and Veneto. The centre-left is very likely to lose Veneto, while polling for Campania and Lombardy is very close (within the margin of error). Sicily is more secure for Bersani. If the centre-left lose two, or worse, three of these four key states (including Veneto), then they are unlikely to secure an overall majority to take the senate. In this instance, Bersani would seek to form a coalition with other parties, with Monti likely to be the first candidate to approach. If the votes secured by Bersani and Monti are enough to secure an overall majority (note that there is no uplift in the same way as the lower house) then they will have secured a working government in both houses. In our view, this is the most likely outcome, although another smaller party may be needed to secure the overall majority.
If, however, Berlusconi wins a larger share of the votes and Bersani and Monti fail to build a coalition with a majority (in other words there is a stalemate), then the President of the Republic (Giorgio Napolitano) would have to decide whether another election should be held, or whether a technical government be installed. The latter would only be in place to allow for laws to be passed that are voted through in the lower house.
There is a chance that Berlusconi wins an overall majority in the upper house, although that chance is very slim. In that case, he may not be Prime Minister given his agreement with the Northern League, but would still be a very influential minister. In this scenario, Italy may backtrack on some austerity and structural reforms, but ultimately, the pressure from markets, the European community and the European Central Bank would force even Berlusconi's party to undertake the necessary measures.
According to a recently published report by the International Monetary Fund, if all previously proposed reforms were to be implemented, along with new labour-market and fiscal reforms, Italy stands to gain over 20% in GDP growth over the next decade (on average 2% per annum). The potential to transform the economy from its current dire situation is there but whether Italy's electorate will deliver a government with the political will to do so remains to be seen.
We expect Bersani to become the next Prime Minister of Italy, and will probably have to join forces with Monti's coalition to take the upper house. This result should help boost the confidence of investors in Italy's ability to continue along its much needed reforms strategy. Even if the election does not go as smoothly as planned, our view is that volatility in both Italian bond and equity markets represent a buying opportunity.
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