The aftermath of the failed Italian referendum: What MNCs should expect

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Although Western Europe’s economy is steadily recovering, the results of the December 4 Italian referendum could potentially disrupt MNCs’ Western Europe business targets, affect global financial markets, and further empower the anti-establishment sentiment taking hold in the Western world. The Italian referendum and its aftermath is the first of a series of important political events in Western Europe that requires monitoring in 2017, as it could negatively impact the operating environment in the region with possible spillover effects into emerging markets.

On Sunday December 4th, Italians overwhelmingly rejected Prime Minister Matteo Renzi’s constitutional reform package. Renzi’s reform aimed to reduce the number of Senators to 100 from 315, limiting their ability to block legislation in order to streamline policymaking and restrain bureaucracy. However, what pushed Italians to vote NO was concern over the reform allowing excessive concentration of power in the office of the prime minister. The reform was particularly unpopular in the Italian South, where the NO vote signified distrust towards the government and a protest over the status quo.

Immediately after the results, Renzi announced his intention to resign, taking responsibility for the failure of the reform – and MNCs should be prepared to see some political and economic impact. Berlusconi’s Forza Italia and populist Beppe Grillo’s Five Star Movement (M5S) will further gain popular support from the failure of the referendum, and with Italy’s governance at risk, political uncertainty will start weighing on the fragile banking sector and the weak economy. Although financial markets seemed to have already factored in a referendum failure, immediately after results, Italian 10-year bond yields hit a year high, and the share price of Italy’s weakest bank Monte dei Paschi di Siena hit a historic low. Euro shares and the EUR: USD rate, however, stabilized during the day after losing some ground.

As a base case scenario, President Sergio Mattarella will likely initiate discussions for a technocratic government to take over. The new technocratic government is expected to approve the 2017 final budget in the coming weeks, and before the 2018 elections consider passing an electoral reform to limit M5S power (with the winning party to be given the most parliamentary seats). Minister of Economy and Finance, and former IMF executive Pier Carlo Padoan will likely be selected as prime minister, inspiring trust in international markets amid fears over small failing banks. Monte dei Paschi di Siena’s recent private rescue could be at risk, and Unicredit is expected to struggle to raise capital in the coming weeks. The European Central Bank (ECB) will likely provide fresh liquidity in that case, extending its monthly €80 billion bond purchase program beyond March 2017.

Downside scenario would affect currency and credit

Though unlikely, the failure of the referendum could trigger new elections soon. In this low likelihood event, there exists the potential for the M5S to win the elections – currently polling a close second to the ruling Democratic party. M5S would try to initiate a euro referendum as part of its populist agenda; however, the referendum would likely fail as Italians wouldn’t vote against the single currency due to low Euroscepticism in the country.

As this downside scenario materializes, further euro depreciation and a weaker lending environment within Italy and the Eurozone would result. More broadly, countries that trade extensively with the Eurozone, or whose currencies are pegged to the euro – as in Central Europe or in Africa – could see some pressure on their currencies and potentially reduced trade. Eventually, even in the case of this unlikely downside scenario, the country would avert a full-blown banking crisis by accelerating bank mergers and by the potential injection of massive ECB funds to support the weak banking sector – with Italian investors themselves also possibly bearing some losses.

As long as the base case holds, the impact on MNC businesses from the failure of the Italian referendum should be minimal. However, the Italian economy already slowed in the first three quarters – growing by 0.8% YOY – and the potential for increased political uncertainty could further hit business confidence in particular. Market turmoil could constrain lending to businesses, and B2B firms especially should be prepared to face increased pressures on their local supply chains. As the political situation continues to be fluid, MNCs should monitor developments closely and consider hedging on safe haven assets – government bonds and gold – to minimize the impact from any potential financial distress that could result in further euro depreciation and a slowdown in bank lending.

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