Still no government deal in Italy. But a deal in the future could mean several things. In the most likely scenarios, we could see either more political fracturing or a populist coalition government formed by the Northern League and 5-star. If this were to happen, the coalition will most likely push fiscal expansion, and this has economists concerned about Italy’s future in the Eurozone. Thus, the hefty task for Eurozone leaders will be to consciously balance Italian Euroscepticism while also guiding the country to meet Eurozone debt-to-GDP and deficit targets, in hopes that another crisis could be staved off. This political balancing act could impact how Eurogroup leaders handle high-debt countries in a new era of populist movements, and be the story to watch as Italy forms its fiscal, tax reform, and pension reform policies.
Italy’s populist parties have won on platforms generally aimed at changing the tax system, reforming pensions, and offering some form of fiscal expansion. While these issues are of major concern to most Italians, tactful and thoughtful policymaking must prevail to balance debt management with expansionary policies. Italy’s debt to GDP is floating around 130 percent, and its budget deficit around 2.5 percent. European debt standards as set by the European stability and growth pact (ESP) are 3 percent in deficit targets for total government budgets annually and debt to GDP of 60 percent annually. This means that in order for Italy to comply with targets, they must find a way to cut taxes, reform the tax system, and overhaul the pension system while also holding annual debt to GDP and budget deficits at or below their current levels. The problem is that both the northern League and 5-star may not have any political will to do this.
High debt is nothing new for southern Europe, nor is the threat to the breakup of the Eurozone in recent times. Budget deficits and non-performing loans have plagued countries like Italy, Spain, and Greece since the beginning of the Eurozone debt crisis, and were the cause of austerity policies being pushed in debtor countries to preserve the euro. In 2015, many experts thought Greece would exit the European single currency all together with a “no” vote on their austerity referendum. And Italian austerity policies have been equally unpopular, especially among young people who were among the citizens hit the hardest under such measures during the crisis. With the recent wave of populism in Italy, current debt to GDP at alarming rates, and a political mandate to launch a stimulus, there is a real probability that Italy will increase its deficit. This has the potential to cause uncertainty in the market, among other scenarios, which would again endanger stability in the Eurozone.
If Italy can in fact form a populist coalition between the northern League and the 5-Star movement, there are several likely scenarios that could play out in Italy and the Eurozone. The first is that the coalition will follow through on expansionary measures, while at the same time scoffing at Eurozone targets. This could lead to turmoil both for Italy and for the Eurozone, and could also lead to market volatility or a potential crisis. The second scenario is that the coalition works with Eurozone leaders to steer towards sustainable debt to GDP standards while also creating responsible fiscal policies and reforms of the pension system. This would most likely lead to relative market confidence in Italy, and slow economic growth, as forecasted by most current models. The third likely scenario is that Italy’s coalition government doesn’t get much accomplished at all. This could lead to sustaining relatively high debt to GDP levels for the country, a budget on target with the ESP, and slow growth over the short/medium term.
Without a doubt, the populist movement in Italy will usher in a new era for Eurozone politics, for better or worse. A silver lining may come in the form of the new Eurogroup head, Portugal’s Mario Centeno. Centeno may bring a new energy and new ideas to the group by bringing in perspectives on cooperation, sustainability, and targeting from a debtor country’s perspective (Portugal’s current debt to GDP is 130 percent). Centeno’s task is hefty, one where he must try to build bridges with the Italian populists while also maintaining sound yet fair guidelines at the Eurogroup level. Success in this task could mean that Italy’s coalition leaders feel represented at the Eurozone level, and it could help bring them to the table as they form their expansionary policies. Regardless, the Eurozone once again finds itself at a crossroads.