A Draghi Government would have Longer-Term Implications not Only for Italy but Europe at Large

The former ECB president has accepted “with reservation” the responsibility of seeking to form a “government of national unity” to lead Italy out from the crisis as well as to ensure a robust spending and reform programme in exchange for EU recovery funds.

Draghi’s decision has reduced the likelihood of snap elections, which we have considered unlikely and which would otherwise consume government time and energy amid a severe public-health crisis. At time of writing, Draghi appears on route to consolidating a majority in Parliament and to forming a new government in the period ahead.

Draghi’s mission is to ease political uncertainty and enhance Italy’s budgetary response to this crisis, ensure efficient implementation of Italy’s share of EU recovery funds and produce a more effective strategy on vaccination – where Italy and the EU have lagged. According to a recent poll, more than half of Italians want Draghi to remain as prime minister until 2023, when the next general elections are due.

Italy needs an effective and stable government to remain in place for the duration of the current legislature till the middle of 2023. After 66 governments over roughly the past 75 years, Italy cannot afford to continue with policy paralysis. A very short Draghi administration only before presidential elections of 2022 would similarly maintain political uncertainty.

Ratings implications for Italy as well as for the remainder of the EU

With Italy’s debt at record levels of around 160% of GDP, the new government will need to emphasise a sustainable policy framework that favours recovery near term through the strategic investment of EUR 209bn of EU funds and that defines a vision for fiscal discipline longer term. How any Draghi premiership manages this difficult balancing act will inform credit-ratings implications; however, short term, a resolution of political uncertainty, accelerating a path out of crisis and any sustained easing of Italian borrowing rates would be positive for ratings.

Draghi has the advantage of his high standing with investors as well as with Italy’s EU partners. The support of European institutions has been fundamental in facilitating the ever-lower borrowing rates that Italy has benefitted from despite higher debt. The spread on Italy’s 10-year government bonds is currently trading below 100bps over Germany’s – the narrowest in more than five years.

Draghi is, moreover, well placed to ensure Italy’s voice is heard in regard to institutional reform in the EU, including as it pertains to the EU’s fiscal framework, such as the Stability and Growth Pact, or with relation to a common euro budget – this bears implication not only for Italy but for the remainder of the EU.

No easy political path

The scale of any parliamentary majority Draghi gains will be critical for ensuring the longevity of an administration and its capacity to undertake required regulatory and administrative reform in partnership with the European Commission.

Any very broad unity government with competing for internal policy preferences alongside a part-technocratic, part-political composition could, however, ensure also the same discordance over time that curtails governability.

Italy’s economy contracted 8.9% in 2020, less severely than the 9.6% slump Scope had anticipated. Italy has historically a weak track record for the efficient deployment of EU structural funds: over the 2014-20 EU budgetary period, Italy spent (only) 43% of allocated monies.

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Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.