The strange-bedfellows alliance of the center-left PD and the center-right PdL has been weakened by votes of no-confidence in both houses of Parliament. Nevertheless, it has survived the ordeal, despite fears that the PD’s refusal to help the PdL’s founder, Silvio Berlusconi, to escape his latest legal troubles could bring an early end to the parties’ marriage of necessity.

However, even if the government remains intact, the ability of its constituent members to achieve consensus on a coherent policy agenda remains doubtful, especially against the backdrop of economic uncertainty that is contributing to a heightened risk of social instability.

The lack of reforms seen as key to Italy’s long-term economic health in the budget for 2014 highlights the political constraints operating on the coalition government. Mario Monti, an outspoken advocate of aggressive fiscal reform, resigned as leader of Civic Choice, a junior partner in the coalition government, following approval of the budget.

On current projections, a freeze on public-sector spending, including wages, will narrow the fiscal deficit to 2.7 percent of GDP in 2014, while the structural deficit is forecast to shrink to just 0.7 percent of GDP next year. Italy also stands to benefit from a significant reduction in long-term borrowing costs from the highs reached during the worst of the euro-zone debt crisis, assuming expectations of an improvement in regional conditions are realized.

However, the public-sector debt burden is projected to peak at 134 percent of GDP next year, a full 15 percentage points above the level recorded in 2010. Hopes of reversing the upward trajectory hinge on stemming significant losses from inefficiency and corruption at all levels of government.

The appointments of Carlo Cottarelli, the former director of the IMF’s Fiscal Affairs Division, and Daniele Franco, a former central bank official, to lead that effort are a positive development. But resistance from vested interests, including powerful criminal organizations and an uncooperative bureaucracy will likely be fierce.

Some tangible results are likely, but the savings is unlikely to come close to what is required to ensure long-term fiscal sustainability. Nor is a crackdown on wasteful spending likely to be sufficient to quell public outrage over state-sector opulence that along with heightened labor militancy is a key source of turmoil risk.

The move reflects a desire to block business deals that have negative implications for employment.

The government is pushing legislation that would give the authority to veto the takeover of domestic firms by foreign companies and otherwise limit the stake of foreign investors in strategic sectors of the economy companies. The move reflects a desire to block business deals that have negative implications for employment, an issue that is growing in importance as a rising unemployment rate (which reached 12.5 percent in September, and is running above 37 percent among Italian youth) reinforces existing political tensions.

Given the country’s dependence on foreign finance amid severe domestic capital constraints, the danger that the government might abuse such a power is low. However, investors will need to consider the possibility of blocking moves by the government, particularly where large takeovers are concerned. 

The economy contracted by slightly less than 2.4 percent (year-on-year) in real terms over the first half of 2014, but with the ECB confirming its intention to stick with a loose monetary policy and signs of improving economic conditions in key European markets, export performance is forecast to strengthen in the second half of the year, holding the full-year contraction to less than 2 percent. However, a combination of fiscal tightening, balance sheet adjustments in the private sector, and labor-market conditions that discourage household spending all but precludes a significant positive growth contribution from domestic demand this year or next, a prospect that points to a very tepid recovery, at best, in 2014.


The PRS Group
About The Author The PRS Group
The PRS Group is a leading global provider of political and country risk analysis and forecasts, covering 140 countries. Based on proprietary, quantitative risk models, the firm's clientele includes financial institutions, multilateral agencies, and trans-national firms.

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