Political uncertainty across Western Europe – such a major concern at the beginning of the year – has diminished considerably. Looking forward, political uncertainty will further decline in H2, facilitating improved market conditions and resulting in a stronger than expected euro-to-dollar rate. Despite the positive news, MNCs should not take their eye off a lingering threat to the eurozone economy: Italy and its banking sector.
Italy continues to be a weak market in MNCs’ Western Europe portfolio. Ongoing political volatility, which delays the implementation of necessary liberal reforms, could still potentially create shockwaves for the weak Italian banks in 2017 or 2018, threatening Italy’s sluggish growth and the fragile health of the banking sector.
The economy suffered a deep recession in 2008/2009 and 2012/2013, and since then has struggled to fully recover. Structural problems have perpetuated, and growth has failed to improve substantially in H1 2017, and FSG expects 1% this year, same level as in 2016. External factors have helped drive this minimal growth – low oil prices and the weaker euro compared to 2016. In H1 2017, manufacturing production has strengthened, supported by higher corporate investment and rising production of machinery, food, and pharmaceuticals. As a result, B2B clients will see some improvement in their business.
Fundamentally, immediate banking sector reforms and labor reforms are required for the economy to substantially improve. Ongoing recapitalizations of banks and the ECB’s accommodating monetary policy have minimally helped the banking sector in H1 compared to 2016. Despite the establishment of the public-supported Atlante fund, which helped recapitalize failing banks, the health of the banking sector has only minimally improved. Non-performing loans (NPLs) continue to amount for 15.3% of all loans as of Q4-2016 – the highest in the eurozone in absolute terms – which weighs on the profitability of the weak banks. Additionally, consumer bank lending has slightly improved, but consumer demand continues to struggle as unemployment remains above region’s average – above 11% in April – and a slowdown in wages remain a hindrance to growth. Liberal labor reforms are necessary but unlikely in 2017. Hence, MNCs will remain under strain to upsell this year, as consumers remain hesitant to spend with confidence declining due to the long-term economic and political uncertainty.
Ongoing political volatility combined with resistance to reforms is the primary reason behind the deadlock in the Italian economy. The Democratic Party (PD) leader and former Prime Minister Matteo Renzi resigned in December 2016 after losing the mandate for constitution reform to abolish the bicameral system, increase his powers and streamline banking and labor reforms. A PD government led by Paolo Gentiloni took over since then, and necessary reforms have stalled. In May, Renzi was re-elected to PD’s premiership and is intent on becoming prime minister once again and achieve his reform agenda.
Ultimately, the lack of confidence in the political elite has reinforced public discontent in traditional parties; the PD has failed to satisfy voters, and in turn populism has been on the rise. According to polls, since June 2014 the ruling pro-business PD has been losing ground due to economic issues, and the populist Eurosceptic Five Star Movement – with a euro referendum in its agenda – has been making gains; currently the parties are neck-and-neck in a new potential election fighting for popularity.
Since May, Renzi has periodically mentioned his interest in early elections in September, prior to the planned elections by May 2018. However, early elections would be unwise for Renzi without a new electoral law in place, as the current electoral system in the two chambers of parliament would produce an inconclusive result, and majority is beyond reach for any party. Hence, Renzi has favored a cross-party deal to decide on a new version of the electoral law to facilitate early elections, which would give him the majority needed to push through his reformist agenda. However, talks on this deal between the PD and other main parties have recently collapsed, and Renzi is now unlikely to push further for early elections. New elections in the current system would bring an unstable coalition to power, and trigger a new series of elections, causing political and economic uncertainty to surge.
On the one hand, early elections in H2 could set the fundamentals for the renewed reform momentum. On the other hand, they would destabilize the fragile economy. Although we are unlikely to see a full-blown banking crisis spread across the region, a downside for the Italian banking sector is still possible and could lead to contained euro depreciation pressures. Above all, early elections would hurt the improved economic confidence and halt Western Europe’s recovery momentum after the positive election outcomes in the Netherlands and France, and an improved performance of Western Europe markets in 2017.
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