Are we done with Italian populism yet?

The Italian elections result was a protest vote directed towards the political elite after years of political and economic frustration. The populist Five Star Movement (MS5) won with 32.0% of the vote, with populist parties gathering 68.2% of total votes. Turnout was surprisingly high, reaching 73.0%. The anti-establishment sentiment was clear: the former ruling Democratic Party (PD) and Forza Italia (Berlusconi’s party) gathered only 19.0% and 14.0%, respectively. The March general election confirmed that populism in Italy – and in Europe more broadly – is indeed here to stay.

What does it mean going forward?

MNCs should expect extended coalition talks between the elected parties with an unpredictable outcome, increasing economic uncertainty for Italy. FSG’s base case is that the anti-systemic MS5 is likely to seek support from the left-leaning PD, and they could potentially form a government by April. Should that fail – if MS5 would see a PD coalition as weighing on its popularity- in a downside scenario, MS5 could alternatively try to form a government with the populist center-right alliance. Although even more unlikely, if this downside scenario plays out, MNCs should plan on increased euro to US Dollar volatility, increased uncertainty over the banking sector and retreating business confidence in Italy. New elections are also a possibility going forward if all coalition talks fail.

If MS5 or the center-right alliance manage to govern, MNCs should expect potentially adverse and volatile economic policies and regulations in the near-term. Populists have abandoned their mandate for a euro-referendum, but their economic policies remain highly questionable. For instance, after its new leader Luigi Di Maio became head of the party, MS5 reconsidered some unconventional policies, but the party is unclear on its earlier commitments to increased taxation of wealth, increased migrants’ deportations, protection over imports, etc.

Moreover, if any of the populists manage to govern without support from a mainstream party influencing policy-making, fiscal risks will exacerbate, threatening Italy’s credit ratings and cost of borrowing for MNCs’ partners and clients. Italy’s government debt to GDP reached 131.5% in 2017, weighing on economic growth potential. If populists decide to further spend, markets are likely to interpret this as disrespect in market rules, risking investors returns from Italian bonds and equity

Most importantly, the record populism election results indicate that the necessary reforms will be substantially more difficult to implement for any party, slowing the country’s economic momentum. The banking sector and liberal labor market reform is essential for Italy’s economic growth to accelerate. Banks’ recapitalizations and mergers are ongoing but would require political will to further accelerate. Non-performing loans (NPLs) continue to amount for 12.3% of total loans as of Q2-2017 – the highest in the eurozone in absolute terms – weighing on the profitability of the weak banks and slowing lending growth. Additionally, consumer spending remains sluggish in most segments, as unemployment remains at 11.1%, well above the EU’s average. B2C MNCs should continue to carefully segment the market, target the right consumers, and optimize their routes to market to maximize performance in Italy, as the B2C environment is likely to continue to be weak.

Eurozone and Italy

MNCs have seen improving market conditions across Western European markets since 2017. The Western European economy accelerated in 2017, after years of sluggish growth accompanied by high political uncertainty. It was primarily the cyclical economic improvements across the world which supported 2017 eurozone growth. Global demand drove inward investments, underpinning eurozone exports growth coupled with a weak euro in H1. Along with exports, manufacturing and construction followed suit.

2017 was the year when political uncertainty substantially retreated in Western Europe, with the defeat of French, Dutch, Austrian, and German populists. The economic improvements have been palpable: a drop in political risk restored confidence in the banking sector, propelling stronger demand for business credit, translating into investments and greater business activity. Non-performing loans are now on the decline across the majority of markets, facilitating further credit expansion. The stronger industrial and banking sectors have encouraged more business hiring, bringing down unemployment levels, especially in the troubled South. Hence, FSG expects that Western European economic growth will remain impressive for developed market standards, reaching 1.9% YOY in 2018, but not considerably further accelerating.

However, cyclical improvements have only masked and not cured the economic malaise of the eurozone, and Italy is the proof. Italy is likely to grow by 1.6% YOY in 2018, below the region’s average. The adverse economic conditions since the financial crisis further deteriorated with the migrant crisis, spurring Euroscepticism and reinforcing wide discontent towards mainstream political parties.

Eurozone and Italian economic potential has indeed improved; however, these elections in Italy served as further proof of the underlying, fundamental structural restraints on growth. A nightmare scenario is indeed unlikely, but as are notable improvements in growth.

For more details on any of the above, clients can check our Western Europe Regional Outlook 2018 to know what to expect for 2018.

Not a client? Read our related blog post Has Western Europe become free of political risk for MNCs? or purchase the Western Europe Outlook for 2018 on our online store.

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