Italy: Institutional, Political, Market Constraints to Ensure Broad Post-election Policy Continuity

The centre-right coalition led by far-right leader Georgia Meloni’s Fratelli d’Italia (FdI), Matteo Salvini’s Lega and Silvio Berlusconi’s Forza Italia (FI) holds a significant lead in opinion polls, with over 45% of support according to most recent surveys (Figure 1).

While the stated pre-electoral policy preferences of this coalition could weaken Italy’s economic and fiscal outlook, we believe constraints any Italian government faces once in power will significantly curtail its room for manoeuvre and thus ultimately facilitate a narrower set of economic policy options.

Figure 1. Opinion polls on Italy’s 2022 general elections*
% of voters’ support

Still, the coalition partners’ talk of revising the country’s Recovery and Resilience Plan conflicts with sustained progress Italy needs on economic reforms to address long-standing economic bottlenecks. They are also vital to enable swift absorption of the EU recovery programme funding in support of the medium-run economic outlook.

In addition, some of the coalition’s ambitious fiscal proposals would likely prove costly, including introduction of a flat tax and tax amnesty, higher pension benefits and lowering the retirement age limit. This contrasts with Italy’s requirement for prudent fiscal policies aimed at gradual return to a primary budget surplus over the coming years to ensure sustainability of high public debt of around 150% of GDP. This is critical given the weakening outlook for growth due to an ongoing energy crisis, rising inflation and tighter monetary policy.

Italy Likely to Stay Broadly on Reform Track

We believe risks that Italy postpones or even reverses reforms and prudent fiscal policy making over the coming 12 to 18 months are manageable. This is because of the domestic and European, political and economic constraints any Italian government faces once in power.

First, domestically, a lasting far-right coalition able to implement its policy agenda over several years is not a given even if the parties win a parliamentary majority, considering significant policy differences in many areas and rivalry between their leaders. For example, Lega is pushing for higher deficits while FdI is committed to fiscal prudence.

Under an inconclusive political scenario, a unity government with technocratic leadership could yet again emerge. In addition, as close to 40% of the electorate is still undecided, surprises are possible and might affect government formation. We as well note that post-election alliances and coalition configurations could easily shift within Italy’s fluid political environment and may thus curtail capacity of the far-right alliance to implement its agenda over the coming years.

Secondly, Italy’s political system retains important checks and balances. A two-thirds parliamentary majority is needed to change the constitution. In addition, President Sergio Mattarella holds an influential role in crisis management and has proven resolute in the past, vetoing appointment in 2018 of a euro-sceptic finance minister during the Lega-Five Star government, appointing the Mario Draghi government during the Covid-19 crisis and calling for early elections at short notice this July.

Thirdly, Italian public opinion is at odds with some of the far-right’s more radical party preferences. Most Italians continue to support the euro (71%), favour economic stability and remember previously voted populist governments floundering only several years before. Indeed, Meloni has moderated her stance over recent weeks, committing to economic and fiscal prudence and to support the Europe-centric geopolitical positioning of Italy.

Strong EU, Market Incentives to Challenge Fiscal Activism

At European level, Italy’s position as leading beneficiary of the Next Generation EU programme, expecting to receive EUR 191.5bn in funding by 2026 (or around 10% of Italy’s GDP) provides strong incentives for implementation of reform on which EU disbursements are conditional. Reassessing parts of the recovery programme may be justified at the margins, but the European Commission will not allow Italy to set a precedent of renegotiation of core substance of the programme.

Secondly, an incoming government knows that eligibility of Italian bonds for the ECB’s Transmission Protection Instrument will hinge, among other factors, upon the country’s prudent economic and fiscal policies. Indeed, any indication Italy is wavering in its commitment to sound economic policy making is likely to be jumped on by investors and result in further rise of yields within Italian government bond markets.

Public debt is to remain high – around 145%-150% of GDP over the coming years, or about 15-20pp above pre-Covid levels, resulting in elevated annual gross financing needs of circa 25%-30% of GDP. With the 10-year BTP already at around 4%, this implies very limited, if any, fiscal space for Italy’s next government given the economy’s weak medium-run growth outlook.

Under these circumstances, it is unlikely that a new Italian government deviates significantly from current reforms and fiscal policies such as to place at risk Italy’s strong relations with the European Union. Instead, we ultimately expect broad policy convergence and continuity of ties with the EU such as to retain access to exceptional support from European institutions. These assumptions support a Stable Outlook for Italy’s BBB+ credit ratings from Scope Ratings.

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Alvise Lennkh-Yunus is the Deputy Head of Sovereign and Public Sector ratings at Scope Ratings GmbH. Giulia Branz, Senior Analyst at Scope Ratings, contributed to writing this commentary.