September 10, 2019 / 2:31 PM / 7 days ago

Breakingviews - Cox: Italy’s summer “coup” occupies fragile throne

PARIS (Reuters Breakingviews) - Last weekend at the elegant Villa d’Este hotel with its commanding view of Lake Como, an elite squad of Italian business leaders, investors and policymakers, including three former prime ministers, were asked for their view on the state of the country’s affairs. Though not ebullient, they were more optimistic than at the same time a year ago. Given what’s transpired in the world’s eighth-largest economy in the past 12 months, that’s perhaps not surprising.

Italian Prime Minister Giuseppe Conte rings the bell for the new cabinet's first meeting at Chigi Palace in Rome, Italy September 5, 2019.

In a poll conducted at think tank The European House-Ambrosetti’s forum in Cernobbio, the percentage of respondents expressing “sufficient” to “medium” to “high” confidence in Italy’s current situation and its prospects was 61%, up from 44% a year ago. True, more than third were still pessimistic, but that’s the baseline in a country that has failed to keep up with global growth for 20 years.

Investors have been even more enthusiastic in their appraisal since early August, when the anti-immigrant and EU-sceptic League party pulled its support for the coalition it put together a little more than a year before. Though the League boss Matteo Salvini’s decision to call for elections appeared designed to provoke a crisis, the move backfired. His former coalition partner, the quixotic 5-Star Movement, assembled a new government with the centre-left, led again by Prime Minister Giuseppe Conte. It should receive formal confirmation by the Senate on Tuesday.

As the process dubbed a coup by supporters of the League and a restoration by their opponents has unfolded, financial markets have reassessed their view of Italy. The FTSE MIB Index of the country’s largest companies has gained nearly 10% in the past month, outpacing gains in German and U.S. stocks. The extra yield investors demand to hold Italian 10-year government bonds relative to the German equivalent has plummeted to around 150 basis points, from 238 basis points in August and a high of nearly 300 basis points over a year ago.

Yet Enrico Letta, a former prime minister who also led a coalition government five years ago, points out that “with a spread alone, you can’t govern the country”. Pulling together various forces that wanted to oust Salvini was the easy part, Letta told me in an interview for The Exchange podcast at the Ambrosetti shindig. Now comes the hard work of figuring out what this government actually hopes to accomplish.

Moreover, while Salvini may appear a damaged figure, support for his party is still strong. Though it only has around 17% of the seats in parliament today, various polls suggest it would snag between 30% and 35% of the vote in a general election. That’s in line with the group’s showing in May’s ballot for the European Parliament.

Though Salvini’s credibility has been tarnished – including by questions around his ties with Russia – the League’s popularity means he will be lurking in the shadows and waiting for a comeback opportunity. The new government will need to act quickly to show it is grappling with some of the issues, including immigration, that Salvini used to gain support for his party beyond its northern Italian base.

Letta ticks off a few of the economic priorities. The first, he says, is to re-establish better relations between Rome and Brussels. Salvini adopted a page from British campaigners for Brexit in castigating the home of the European Commission as Italy’s primary nemesis. Negotiating some fiscal breathing room, principally to avoid a mandatory sales-tax hike while reducing the burden on working people, should be job one, he says.

But there are other measures that could make a difference. In recent years, Italy has lagged in making critical investments that could help growth and increase productivity, argues Carlo Cottarelli, a former director at the International Monetary Fund who was nearly named prime minister before last year’s coalition government was formed. In a paper presented to the conference, Cottarelli calculated that Italy’s gross domestic product would have grown by 0.6% more per year if commitments of public spending had remained constant with 2009 levels.

He estimates that by making up that shortfall in investment levels between 2020 to 2023, Italy can generate an incremental 108 billion euros of economic output, thereby reducing the country’s debt-to-GDP ratio by 3 percentage points, to around 130%. That’s still large by developed-economy standards. But the added growth would also help reduce unemployment in a country where one in three young people are out of work.

Equally, Italy needs to do a better job of getting women into the workforce, improve its educational outcomes, reduce tax rates to incentivise labour and increase its digital penetration, argues Enrico Giovannini, an economics professor whose name surfaced in recent weeks as a possible technocratic candidate to lead the new coalition government.

“A country that does not know how to decide what its future should be and what role it can play in the world, risks being an unattractive country,” he writes in the preface of the latest edition of the Global Attractiveness Index, which Giovannini unveiled over the weekend in Cernobbio. While Italy rose a notch in the rankings, it languishes at 16 out of 25 countries included in the survey.

Like the increased confidence expressed by his fellow attendees, that’s a slight improvement from the year before. But the work that lies ahead for Italy’s new government, particularly given its fiscal constraints, makes it hard to share the market’s cheery assessment. Salvini may have retreated from the public consciousness for now, but any sign that his successors are stumbling will bring him back with a vengeance. 

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