Rome could plunge eurozone into crisis

Dhe financial markets are looking at Italy this Friday with great nervousness. New risks are also feared in the real economy, among companies. Prime Minister Mario Draghi offered his resignation on Thursday evening because, according to his own analysis, he had lost the support of the broad governing coalition. However, President Sergio Mattarella refused to resign.

The new government crisis comes at the worst possible time for Italy. The country was just recovering from the severe restrictions imposed by the flare-up of the pandemic when the Ukraine war and the energy crisis hit. The economic recovery that began last year is now back on shaky ground.

Because of inflation, the European Central Bank is raising interest rates and halting regular purchases of Italian and other government bonds as part of its pandemic and sovereign debt crisis programs. She continues to appear as a buyer on the market, but perhaps in a more reserved manner. In any case, the plan so far has been for Italy to learn how to finance its budget on its own again.

A political vacuum looms

In this environment, Draghi wants to give up, even if he enjoys more respect than almost any of his predecessors on the financial markets and among companies. And even if the President has initially rejected his wish, the country is now blocked and confronted with a political vacuum. On Monday, the government is planning an important trip to Algeria, which has meanwhile become Italy’s most important gas supplier. Draghi will see them. But how capable of action is Italy? On Wednesday, Draghi will make a statement in the Italian parliament, following Mattarella’s request. What will follow from this is currently uncertain.

Such uncertainty is poison for the economy, especially in a country like Italy that needs determined leadership. The Italian stock market index FTSE-MIB had already fallen by more than 3.4 percent on Thursday. The interest rate differential between ten-year government bonds from Italy and Germany – the most important indicator of Italian risk on the financial markets – shot up by more than 5 percent to 222 points.

This level is still well below previous highs, but that could also be due to ECB intervention. In any case, Italy is now again an element of uncertainty: a country that is much larger than Greece – which could therefore plunge the entire euro area into crisis.

Draghi no longer wants to because he recently lacked the support of the left-wing party “Five Stars”. The former grassroots movement, which now has more MPs in parliament than any other party, felt it had to use all its might to position itself as a defender of the socially disadvantaged and the environment under the leadership of Draghi’s predecessor, Giuseppe Conte. The “Five Stars” are doing poorly in the polls and fear that they will be lost in the next election.

Draghi would be only too happy to continue his governing coalition without her, but at this point it is unclear how that can be achieved. “The government is now weakened,” the analysts at Morgan Stanley note, and consider new votes of confidence in Parliament and the Senate to be possible in the short term. Are new elections coming soon? That could jeopardize the important passage of the budget this year. For this reason, all post-war elections took place between February and June, according to Morgan Stanley.

Not everything is bad

The EU Commission recently raised the growth forecast for Italy for this year from 2.4 to 2.9 percent. Because the construction industry is proving to be robust due to the generous investment subsidies for households. The income from tourism is also good.

But for the coming year, the Commission has lowered the growth estimate from 1.9 to 0.9 percent. The difficulties in supplying energy are one reason for this: Italy is as dependent on Russian gas as Germany is. While the country is making progress in the transition thanks to its geographic alignment with Africa and the Middle East, this new energy transition is costly.

In view of the recent inflation rate of 7.4 percent, the loss of household purchasing power is painful. The continued drought in northern Italy is also fueling the rise in food prices. At the same time, there is increasing pressure to compensate by raising wages, which would further fuel inflation, the EU Commission warns.

The new government crisis was primarily sparked by the dispute over new state aid for the socially disadvantaged. They don’t go far enough for the Five Star Party, but Draghi knows that the Italian public finances are under the special scrutiny of the financial markets given the second highest public debt in the EU after Greece.

Not all of his reforms since taking office in February 2021 have been successful, but he was and is considered a guarantor of stability. His term of office would normally have expired next spring. The early end, if it comes, will put the Italy risk back on the European agenda faster than desired.