Italy: The King is Dead, Long Live the King
Italian stocks and bonds have rallied strongly on ideas that the Italian situation can only get better. It is exactly such time, when so many observers are nearly euphoric, that the smart money may want to take some profits.
Florence Mayor Matteo Renzi has been formally offered the opportunity to see if he can put together a government that can win a vote of confidence. It is not much of an issue in the Chamber of Deputies, where the PD has a majority, but in the Senate where it does not.
The market, which has taken 10-year Italian yields to new 8-year lows and equities to new three year high, is vulnerable to buy the rumor sell the fact type of activity as it becomes clearer that regardless of how fast Renzi wants to run, Italian institutional arrangements will slow things to a crawl. Specifically, although Renzi apparently has been plotting for some time to take the reins of government, he does not have much of a very specific economic program. Nor do reports suggest that the youthful Renzi had made much plans for a new cabinet.
Without going to the polls, Renzi will confront the same coalition as Letta and the same configuration in parliament. Alfano, the head of the center-right party and junior coalition partner, has struck a deliberative tone, wanting to negotiate a new formal agreement before casting its support for Renzi. Recall that the electoral reform package Renzi and Berlusconi agreed to would raise the threshold of parliamentary representation. This increases that risk that Alfano, and the rump of the PdL that followed him, in the break from Berlusconi, will not be represented in a new parliament, without joining forces with others.
The media has touted Renzi’s 100-day legislative agenda. Monti also had a bold legislative plan, but much of his successes was owed to ruling by decrees, which bypass parliament. This weakens democratic legitimacy and encourages politicians such as Berlusconi and Renzi to appeal to people directly, through the conventional media Berlsuconi owned, or through the social media (Renzi and his supporters).
First and foremost on Renzi’s to-do list is electoral reform. The exiting system was designed by Berlusconi and his allies in 2005. It was ruled unconstitutional last year. It is not immediately clear whether the reforms by Renzi and Berlusconi adequately overcome the constitutional short-comings. Even if a party does not win 50% of the vote (but more than 37%), it is still given a bonus in seats to assure a majority, for example.
Renzi and his supporters want to blame Letta for the slow progress of the electoral reforms, but in truth the process was stalled by the submission of at least 200 amendments to the bill. Some would argue that the constant snipping at Letta’s heals by center-left critics, including Renzi, weakened the already vulnerable Letta-Alfano government. It is not clear how Renzi will expedite the process.
Renzi has promised that on the heels of electoral reform, new labor market reforms will be introduced in March that will be aimed at stimulating hiring. Monti tried this with little success. Renzi’s effort appears to be focused on part trickle down (cut corporate taxes to induce more hiring) and have the state increase its income subsidy programs (e.g. unemployment compensation). Unlike Monti and Letta, Renzi does seem more inclined to directly challenge the orthodoxy of the European Commission.
Italy is hungry for change. Berlusconi often campaigned as an agent of change. Monti and Letta pushed reform agendas. Grillo’s 5-Star Movement also positioned itself as a force of change and appealed to young people. Renzi promises change.
The desire for change is understandable. The economy has, for all practical purposes, been stagnant for more than a decade. Average quarterly growth over the 40 quarters through the end of 2013 was minus 0.1%. Italy is so stagnant that it did not even have a housing market boom like Spain and Ireland. It did not have a post-EMU binge on cheap credit. It has also been slower than Spain and Portugal (and Greece, for that matter) in implementing labor reforms and adopting competitive measures, no matter how reluctantly. Real exports growth has trended lower over the last three years. The most recent employment data is for Q3 13, and it was at a post-EMU high of 12.3% and youth unemployment was twice as high.
Yet, wanting and having are two different things. Assuming Renzi is able to form a government, it is but another unelected government, the third since Berlusconi was forced to resign in late 2011. Since 1992, only two prime ministers have been elected, Berlusconi and Prodi. The turn over in government strengthens the hands of the bureaucrats and rent seekers.
Many of Renzi’s supporters emphasis his youth. It may turn out to be a case of old wine in new skin. Just like Renzi found common ground with Belusconi over electoral reform, he is likely to draw support from the Old Guard and industrialists who have eaten well at the public trough. Watch the composition of the cabinet and see the political and economic interests that are represented. Watch the appointments to the state own companies and agencies and see if this is really a generational transfer of power and the passing of old ideology as some observers suggest.
The European parliamentary elections will be held on May 25, a bit less than 100-days from now. As Mayor of Florence, Renzi could rule more by command than he will as prime minister. He may want to run, but the institutional arrangements and political realities will likely slow him down. Italy seems so desperate for change, the direction of movement seems almost secondary. The lack of immediate gratification may work in Grillo’s favor for the protest vote. It may ultimately work in Berlusconi’s favor if the center-left shows it is better in opposition than in government in May.
Italian stocks and bonds have rallied strongly on ideas that the Italian situation can only get better. If Renzi succeeds, it favorable for investors. If he fails, things are unlikely to get worse, as the cyclical recovery, no matter how modest, is under way. The positive Q4 GDP report last week and Moody’s improved outlook (stable from negative) suggest there is some momentum of favorable developments. It is exactly such time, when so many observers are nearly euphoric, that the smart money may want to take some profits.