The Pandemic Depression
The Global Economy Will Never Be the Same
Sometimes the polls are right. In Italy, the last polls published before Sunday’s referendum showed a widening opposition to Prime Minister Matteo Renzi’s proposed constitutional reform package. Although there were rumors that the contest had tightened up in the last two weeks, when polls could not legally be published, the government ultimately lost by a wide margin. Just under 60 percent of the Italian electorate voted against Renzi’s package, whereas just over 40 percent supported it (turnout was a historically high 65.5 percent.) Renzi, speaking just after midnight on Monday morning, acknowledged defeat. He thanked the country for its involvement in the debate and for the high level of participation. He also made it clear that he would tender his resignation.
Yet while Renzi’s resignation will attract headlines, it is hardly the end of the story. Italy now needs a new government and likely some electoral reform, but there are also some more pressing and complicated issues. Now that the referendum has failed, the next Italian government—which will have to draw support from Renzi’s Democratic Party to govern—will need to address five challenges in particular: a worsening sovereign debt problem, an unstable banking system, tangled public finances, immigration, and the disillusionment of the country’s youth.
A TANGLED WEB
The most pressing cause for concern is Italy’s sovereign debt. Over the course of the referendum campaign, especially between September and November, political uncertainty contributed to a widening spread between long-term Italian and German bond yields, suggesting that investors were seeing Italian bonds as an increasingly risky bet. But yields have also been rising because of the European Central Bank’s limited capacity to act as Italy’s purchaser of last resort. The ECB’s large-scale asset purchase program, which began in January 2015, has ensured for the last two years that there would be a steady demand for Italian bonds. Yet that program is set to end in March 2017, at which point the demand for Italian bonds could drop. And although the ECB is likely to extend the program for at least another six months after March, it will probably do so on a reduced scale.
The Italian government meanwhile faces a tough redemption calendar in 2017, with more than $211 billion in government payments to bondholders coming due. ECB President Mario Draghi has already promised that the bank will step up purchases of Italian bonds over the coming weeks in case the referendum results increase bond market volatility. But the ECB's ability to buy is constrained by a legal requirement to purchase assets from countries in proportion to their contributions to the ECB’s own capital. In practice, that means that out of the ECB’s $85 billion in monthly bond purchases, only about 12 percent, or $13 billion, can be Italian; it also means that any increase above that number will need to be compensated by decreased purchases of Italian debt at some future point. Italy must roll over $52 billion in February 2017 alone, and there is a danger that the market will look beyond the effects of the ECB’s support to fears about Italy’s long-term debt-sustainability. All this points to to the possibility that Italian borrowing costs will widen sharply, with negative consequences both for economic growth and for government finances.
The second problem, financial instability within Italy’s domestic banking system, is likely to make markets even more nervous. In recent years, Italy’s banks have tried to shore up their capital to meet new EU regulatory requirements and to offload their nonperforming assets, but many are still holding too many toxic assets in the midst of a stagnant economy in which there is little demand for new lending. Two of Italy’s largest banks, the Monte dei Paschi di Siena and UniCredit, both need to attract billions in fresh equity to cover losses incurred by selling their nonperforming loans. This means that shoring up market confidence must be a priority for the new government.
The third major issue—the country’s budgetary problems—is partly a result of Italy’s relationship with the rest of Europe. Right now, the Italian government is trying to finalize its budget for the coming year. This budget includes forecasts of how much the government will need to borrow, which in turn rests on assumptions about growth, revenue, and requirements for spending. In Europe, this conventional forecasting process is made more complicated by EU rules requiring Italy to begin improving its government accounts by balancing revenues and expenditures while also developing a plan to manage its large public debt—now worth more than 130 percent of the country’s GDP.
For the past year, the Renzi government has been arguing with the European Commission about these forecasts. The government needs more flexibility under the existing rules regardless of how the numbers are finally calculated, but things are made more difficult by the fact that the budgetary goalposts change with each new estimate for growth. Although the rhetoric was often heated, European Commission President Jean-Claude Juncker usually finds a way to accommodate Italy’s needs. But the same cannot be said of other European officials. Jeroen Dijsselbloem, the Dutch minister of finance and president of the Eurogroup, has made it clear that he is unlikely to be flexible with Italy. Since the Eurogroup, which is composed of the eurozone’s 19 finance ministers, will ultimately need to sign off on Italy’s budget proposals, the Italian government will have to find some way to placate or work around Dijsselbloem.
Italy’s fiscal troubles are complicated by its fourth major challenge: dealing with migration (something about which Renzi has repeatedly complained). Already in 2016, more than 173,000 people have crossed the Mediterranean to enter Italy, which is 20,000 more than came in 2015 and more than have thus far arrived this year in Greece. The pace of migration shows no signs of slowing, and its costs—financial and otherwise—are likely to be significant. The fact that many of Italy’s neighbors have tightened their border controls makes matters even worse. Whereas Italy used to be many migrants’ point of entry into Europe, these days, more and more are staying, filling up the country’s reception centers.
The difficulty posed by immigration is as much political as it is economic. So far, the Renzi government has been distributing migrants to cities, towns, and villages across the country. Increasingly, however, these communities have begun to protest the new arrivals. Italians remain welcoming, but they cannot absorb new arrivals indefinitely, and their tolerance is quickly evaporating. They also perceive themselves as having been abandoned by the rest of Europe. According to recent private polling commissioned by Macro Advisory Partners from SWG, an Italian market research firm, 50 percent of Italians now believe that the EU “obstructs Italy in managing immigration,” and 79 percent believe that EU migration policy is unfavorable to Italy. Tackling this issue is thus important not only for Italy but for the cohesion of the EU as a whole.
DARKNESS AND DOUBT
Italy’s biggest problem, however, is not debt, economics, or even immigration. It is the widespread disillusionment of Italy’s youth. The most striking revelation to emerge from public opinion polling prior to the referendum was the extent to which young people feel excluded from the political system. Macro Advisory Partners, a London-based consulting firm, found in its final pre-referendum poll that opposition to Renzi’s reforms was strongest among the youngest voters. Fifty-eight percent of Italians between ages 18 and 24 said that they rejected the constitutional reform package, as did 51 percent of Italians between 25 and 34; opposition among students was 59 percent. The young and charismatic Renzi had hoped that the youth would throw its support behind his “hope and change” message of reform. In reality, however, they were more likely to support the ex-comedian Beppe Grillo and his populist Five Star Movement.
Young Italians have good cause for disillusionment. Despite the fact they are, on average, more educated than their parents are, many are under- or unemployed and still live in the homes they grew up in. Tackling this disillusionment, which is leading to an exodus of youth from the country and a decline in participation among the mainstream political parties, needs to be the next government’s top priority, especially now that the divisive referendum campaign is over. If Italy’s political leadership cannot promise the rising generation better material circumstances or real political engagement, it will soon have to face the consequences.
The end of this tense referendum campaign, therefore, is far from the end of Italy’s political turmoil. It was, at best, the end of the beginning. Renzi made that clear as he acknowledged his defeat. Those who campaigned against the constitutional reforms, he argued, now must accept the obligations of victory, one of which includes actually solving the country’s problems. Now is the time for Italy’s new leaders to get to work.