By Aashay Tripathi
The year 2016 witnessed quite a few historical reforms, having a consequential impact on major parts of the world. With Brexit – 52 % of the voters chose to leave the EU; in the USA, Mr Donald Trump was elected as the President; and now the Italian referendum shows that 2016 does indeed have a grudge. Many analysts are calling this referendum the biggest political event of the year, even overshadowing the significance of Brexit.
When reforms meet repudiation
Italians took to the polls on Sunday to vote on the proposed constitutional changes, to eventually make the parliamentary system of the country pass laws easily. Prime Minister Matteo Renzi, rooting for a “yes” win, wished to make it easier to govern the nation. The reform suggested transferring the power of approving the proposed laws from the Senate to the lower house, i.e. the proposed laws would only require the approval of the lower house of Parliament.
Many Italians seemed to have based their votes not on the content of the referendum question, but on how they feel about Mr Renzi and a course of labour-market reforms adopted last year. Those changes were meant to make it easier to hire and fire workers. Applicable only to new hires, they thus disproportionately target young people who now look set to vote “no” amid a rate of youth unemployment of 37%.
With a massive turnout of 68% Italian voters, 59.95% voted against the reforms, which they believed would give more power to Mr Renzi. It proved to be regarded as an opportunity to reject establishment politics. Following through with his promise, Mr Renzi resigned as the Prime Minister of Italy, handing over his resignation to President Sergio Mattarella.
Italy’s dealing with its instability cards
Renzi’s resignation will leave Italy without a government for the next few months, making it harder for authorities to respond, in case Italian banks run into more trouble. The next election isn’t scheduled until 2018. But with Renzi stepping down, it is possible that fresh elections will be called in 2017 instead. If they are called for early 2017, it is conceivable that the Five Star movement could come to power. The party is currently on around 28 per cent in the polls, not far behind Mr Renzi’s Democratic Party, which has a 32 percent share.
An emphatic referendum victory might give Five Star the momentum it needs to triumph.
Reuters reports suggest that Italian banks need at least 20 billion euros in capital in the coming months to cover losses from fresh loan write-downs and planned bad debt disposals. Analysts fear that this decision by the Italians could cause financial instability and possibly even panic among investors. It would be more difficult for banks to raise the required funds making it significantly detrimental for the banking sector. Various media reports anticipate that up to eight of Italy’s troubled lenders are at risk of failure. Megan Greene, chief economist at Manulife Asset Management, believed that the referendum in Italy could provoke another banking crisis in Europe.
The decision by the Italian voters impacted the Euro as well. Stocks and the Euro fell in early trading in Asia. However, the contained losses show that the investors had correctly anticipated and were prepared for the result as it rolled out in reality. As the vote count was under way, the common currency fell to $1.0564, about 0.9% lower against the U.S. dollar from Friday’s close. It lost 0.7% against the Yen. Additionally, futures on the S&P 500 and the FTSE 100 opened to losses for the U.S. and U.K. stock markets respectively. Japan’s benchmark Nikkei 225 was down 0.5% in early trading, while the Australian S&P ASX 200 was down 0.7%.
Will Italy head the taken road?
There have been growing concerns over the financial stability of the Italian economy. Italy’s economy is 12% smaller than when the financial crisis began in 2008. The banks remain weak and the country’s debt-to-GDP ratio is at a high of 133%. If elected, Five Star has said it would hold a referendum to decide whether Italy should leave the Eurozone. And even a slight probability of Italy exiting the EU can spook investors.
Currently, a Euro in an Italian bank is worth exactly the same as a Euro in a German bank. If Italy were to leave the Eurozone, Italian Euros would likely be converted to Italian Liras, and the value of this new, separate currency would quickly fall in value against the Euro. Fearing this outcome, people would start pulling euros out of Italian banks in the weeks before any referendum on European membership.
But, if investor confidence is shaken on the long-term viability of the Euro, it would be the harbinger of chaos for the European system. People will be reluctant to lend euros to people in peripheral countries for fear that they’ll eventually be paid back in depreciated Italian lira, Portuguese escudo, or Irish pounds. That, in turn, will hamper the growth of peripheral economies, hindering economic growth in these countries even further and increasing public dissatisfaction with the euro regime. That could increase pressure on peripheral countries to exit. This would then be another example of ‘expectations being self-fulfilling’.
With populist party rising and Italy deciding for the ‘Renxit’, the question remains whether they are resilient enough to deal with the problems ahead.
Aashay is an analyst at Grail Research, Noida.
Featured Image Credits: Eurasia Group