Will Italy pose a threat to the euro zone after the election?

She also doesn’t ask any questions about the party’s post-fascist identity. The blockade of refugee boats in North Africa, which makes Meloni a prominent campaign issue: not an issue in the interview. “We are very sure where Italy needs to be to defend its interests,” Meloni said at the end of the conversation. “The West can count on us.”

Is this the new sound of Meloni, who is poised to become Italy’s first woman prime minister? Does she want to reassure international partners and markets that not too much will change with her in office? Almost three weeks after the resignation of Prime Minister Mario Draghi, the country is in a state of limbo.

Several rating agencies have lowered their outlook. The risk premiums for Italian government bonds have tightened. Important decisions by the provisional government, such as the sale of the state airline ITA Airways to Lufthansa, are blocked.

How is the third largest economy in the euro zone really doing – and how is the political unrest affecting companies, debt and reform efforts? Could Italy, too big to fail, become a risk for the entire euro zone after the new elections on September 25? Or do the bright spots prevail in the corporate world and on the job market?

Melonis Fratelli d’Italia are ahead in polls

Anyone who looks at the latest poll knows why Meloni is so sure of victory: her party once again gained popularity in August and now has 23.4 percent of the votes. Behind them are the Social Democrats with 22.1 percent, followed by the right-wing Lega (13.2 percent). As of today, there would be a majority in the right-wing camp. The center-left camp, which actually wanted to continue in the name of Draghi, is divided and fragmented. Instead of forging a broad alliance that could prevent Meloni, there have recently been above all: exits from the party, splits, recriminations.

The markets react nervously to the developments. Goldman Sachs has downgraded its growth expectations. Standard & Poor’s left the rating for Italy at BBB, but changed the outlook from “positive” to only “stable”. The rating agency Moody’s followed suit at the end of last week and lowered the outlook for Italy’s government from “stable” to “negative”. While growth and fiscal developments in 2021 and earlier this year provided “upside surprises,” the risk to Italy’s credit profile has increased recently, the analysts write.

Moody’s cites the economic consequences of the Ukraine war and recent domestic political developments as reasons. Both could have “significant credit impacts.” In the case of the latter, there is an increased risk that structural reforms will be hindered. And also those who are so important for the further payments from the EU recovery fund.

Italy’s recovery plan includes 58 reforms. Draghi’s priorities were public administration, the judiciary and boosting competition in the country. So far, all the goals set have been met on time, and two payments have already flowed from Brussels. The next tranche of 19 billion euros is to come this year – but that also depends on how the reforms are pushed ahead.

Meloni’s party, then still in opposition, voted against the reconstruction plan. In the election campaign, the parties are now outdoing each other with demands for a lower retirement age and tax cuts – without really addressing the financing of the plans. While Draghi’s government was still intent on reducing debt over the long term and setting up frugal budgets, the tight fiscal policy could now come to an end.

A mountain of debt with 13 digits

Italy already has liabilities of more than 2.75 trillion euros. You have to see the number written out to understand its explosive power: 2,750,000,000,000. The country thus bears a good quarter of the total debt burden in the euro zone.

For comparison: Greece, which triggered the euro crisis more than ten years ago, had a debt of 366 billion euros at the end of 2021, according to the International Monetary Fund. Italy is on a completely different scale: the country is the eighth largest economy in the world, behind only Germany and France in the euro zone.

In relation to economic output, Italy reached a new record in the corona year 2020: the debt was 156.8 percent at the time. Thanks to surprisingly strong growth, the rate fell to almost 151 percent last year. For the current year, Eurostat expects debt to be around 148 percent of gross domestic product (GDP).

According to the government, the combination of high inflation and strong growth could even reduce debt to 145 percent of GDP by the end of the year. That would be a reduction of more than ten percentage points in two years – something like this has never happened in Rome before.

Italy’s debt sustainability will therefore by no means collapse like a house of cards. In the recent phase of low interest rates, the country stocked up on long-dated bonds. As a result, debt service has fallen to a historically low level. “It will remain there for the time being, even if yields rise, because only one eighth of the outstanding government bonds have to be replaced every year,” explains economist Christian Kopf from Union Investment. On average, government bonds have a term of more than seven years. In the early 1990s it was two to three years. Even if the debt is at a record high: debt service is in the middle of an all-time low, averaging just 2.5 percent.

The ECB has already intervened

Almost exactly a year ago, yields on ten-year government bonds were lower than they had been for a long time: 0.62 percent. The interest rate differential to German government bonds (spread) leveled off between 100 and 120 basis points. Draghi was able to govern at the time, his “coalition of national unity” acted without political cross-shooting, growth was booming, and there was no trace of nervousness on the markets.

After Draghi ceased to be a guarantor of stability, bond yields rose to up to 3.7 percent. The spread increased up to 234 basis points. The economist Roberto Tamborini recently described his country as suffering from heart disease, with blood pressure continuing to rise. The spread has now fallen back to 213. The bonds have reached an interest rate level of three percent.

This is probably mainly due to the European Central Bank (ECB) and its latest crisis instrument called TPI: The mechanism, which was only introduced in July, enables the central bank to buy bonds from individual euro countries in a targeted and unlimited manner in order to reduce the interest rate differential to German government bonds.

The rating agency Scope is therefore sticking to the previous rating (BBB+). Italy is very relevant for Europe’s economy and financial markets and has the political weight as a founding member of the EU. This underpins the expectation of “extraordinary support from European institutions in stress scenarios”.

In addition to the high level of debt, Scope cites the aging population as weaknesses. Italy’s population is getting older, while at the same time the number of people in work is declining – this will continue to burden public finances in the future. In addition, the political environment is “unsteady and fragmented” and there is a risk of a longer phase of paralysis due to the new elections.

Is there a threat of an Italy based on Orban’s example?

If there is currently positive news, then it comes from the companies: The second quarter went surprisingly well, the economy grew by one percent. For the current year, the national statistics office, Istat, is again anticipating an increase of 3.4 percent – ​​significantly more than initially expected.

The entire first half of the year was an extremely strong one for Italy’s listed companies: The net profit of the companies listed in the Milan stock market index FTSE Mib was almost 40 billion euros – more than 15 billion euros above the previous year’s figure. Despite its business in Russia, the major bank Unicredit has just had a record half year. The fashion brand Moncler has almost quadrupled its profit compared to the previous year. The sports car manufacturer Ferrari has increased its profit by 19 percent. Not to mention the state-owned energy company Eni, whose profits have increased almost sevenfold during the energy crisis.

The labor market is also booming: the number of people in work has recently grown to 23 million, with 400,000 more in the past year alone. At more than 60 percent, the employment rate is as high as it was last time in 1977. But companies are also getting more and more nervous: Enrico Carraro describes the election as a “leap into the dark”. Carraro is President of the Industry Association in Veneto, one of the economically strongest regions in the north of the country. There would be “serious consequences” for businesses, exports, jobs and families if Italy joined Viktor Orban’s Hungary as part of the “pariah of Europe”.

How close Meloni’s ideas come to those of Orban only became apparent in June in Andalusia. Videos show how she supports the right-wing Vox party there in the election campaign: “Yes to the natural family, no to the LGBT lobby,” she shouts at the viewers in Spanish. “Yes to secure borders, no to mass immigration.” And in the end: “Yes to the independence of the peoples, no to the bureaucrats in Brussels.” It sounds like a warning to the EU – and anything but state-supporting.

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