April 15, 2020
Italy’s coalition disagrees about the ESM
It looks to us that the Italian establishment is closing in on a deal with the ESM, although we are still struggling to a see a majority for it in the Italian parliament so long as Five Star remains opposed. Corriere della Sera has an inside story about the open conflict on this issue between the two main coalition partners. The pro-ESM lobby includes some unusual bedfellows, like Silvio Berlusconi and the former PD leaders Pier Luigi Bersani, Romano Prodi and Matteo Renzi, as well as the current PD leader Nicola Zingaretti. The latter is quoted as saying that the situation was more desperate than it appears, and that Italy would not be able to refinance its debt without an ESM loan.
But, for now, that position does not enjoy majority support. What would have constituted a grand coalition only a couple of years ago is nowadays a political minority. Five Star and the Lega are no longer in government together, but the two account for a majority in the Italian parliament. The outcome will therefore depend on Five Star's actions in the event of an oncoming crisis. We think it is possible that they will fold, if only because they don’t have a plan B.
The ESM comes with stigma attached in Italy, a legacy of the 2010-2015 financial crisis. A new opinion poll on whether Italy should trigger Art. 50 to leave the EU has a margin of 51% against and 49% in favour. We believe that an ESM loan, followed by the inevitable austerity, would lead investors to question Italy’s insolvency. We have calculated that an increase in Italian debt by 20% and a fall in GDP by 20% would result in the debt-to-GDP ratio approaching 200%. What concerns us is not the headline amount of debt. Japan can live with these levels of debt easily. But Italy lacks a central bank of its own, and has weaker growth dynamics. As Wolfgang Munchau wrote in his FT column on Monday, there is now a clear path towards another eurozone crisis. A crisis is by no means the only scenario, but it is a real enough threat for the eurozone to want to hedge against it.
The Corriere article is clearly written from the perspective of, and in sympathy with, the PD. We have seen it many times in the last few years that the Italian centrist establishment is prone to misjudging political trends. Five Star suffered a dramatic decline in its public support before the crisis came, but the current political leaders like Giuseppe Conte and Luigi Di Maio have seen a resurgence in their popularity. If Five Star folded on the ESM, we think that would be the end of the party. There are many political scenarios under discussion, including, as always, that of a technical government. The issue is not whether Mario Draghi would be leading it, as Italian newspapers keep speculating, but whether there would be a majority in parliament to support a technical coalition. The political instincts are the same as they always were, but the political realities and majorities are different.
As we were saying all the way through the eurozone crises of 2010-2015: if you are not prepared to default on your debt, or introduce a parallel currency; if you have not created effective political alliances inside the EU, or built up blackmail potential; your position is weak.