The outcome of the Italian referendum held December 4, 2016 could have potentially significant implications for both Italy and the European Union (EU). On that day, voters opted to reject reforms proposed by Prime Minister Matteo Renzi that would have overhauled several aspects of the European nation’s government.1)Retrieved 11 December 2016 http://www.cnbc.com/2016/11/30/italys-referendum-explained-what-you-need-to-know.html

In light of this rejection, Renzi has stated his plans to resign, which kicked off a scramble to create an interim government that will be in place until Italy holds elections once again in Spring 2018.2)Retrieved 11 December 2016 http://www.euronews.com/2016/12/11/italy-s-fm-gentiloni-tipped-to-form-next-government As a result, Italy was faced with significant political uncertainty at a time when the nation suffered from numerous challenges including a troubled banking system, very low productivity and lackluster growth.3)Retrieved 11 December 2016 http://www.businessinsider.com/morgan-stanley-research-on-italian-economy-and-reform-referendum-2016-11

While Renzi’s reforms would have made it easier for the Italian government to enact legislation aimed at overcoming the nation’s challenges, some analysts warned that failure to approve the referendum could make it very difficult for Italy to form a government majority.4)Retrieved 11 December 2016 http://www.businessinsider.com/italys-political-and-economic-crisis-threatens-europes-stability-2016-7?r=UK&IR=T Past that, Renzi’s defeat has provoked concerns about Italy’s future status in the EU.

Italy’s Referendum

On December 4, 2016, Italian voters participated in a referendum that asked whether they wanted to approve (or say “yes”) to comprehensive constitutional reforms.5)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0 By consenting to these changes, voters would have approved the alteration of 47 of the constitution’s 139 articles. Before these proposals went before Italy’s voters in the form of a referendum, they received approval from the European nation’s parliament.6)Retrieved 12 December 2016 https://www.theguardian.com/world/2016/nov/30/italy-referendum-all-you-need-to-know-about-renzis-crunch-vote

The most radical proposals would greatly reduce the power of the Senate in an attempt to enable easier passage of legislation.7)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0 As of this writing (December 2016), Parliament consists of 945 elected members, with 315 sitting in the Senate and the remaining 630 residing in the Chamber of Deputies.8)Retrieved 12 December 2016 https://www.senato.it/documenti/repository/istituzione/costituzione_inglese.pdf Renzi proposed reducing the Senate to 95 elected members and five members nominated by the president.

Of those elected, 21 would be selected from mayors and 74 would be sourced from representatives of Italy’s 20 regions.9)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0 Renzi failed to provide detail on who would be selected and how they would be chosen, noted Nicola Chelotti, a fellow at the London School of Economics and Political Science and an expert on Italian politics.10)Retrieved 12 December 2016 http://www.euronews.com/2016/11/28/renzi-reform-and-the-paradox-of-italy-s-referendum

In addition to cutting the Senate’s total headcount, Renzi’s reforms would reduce the legislative body’s power from a practical standpoint. This is because most bills would only require the approval of the Chamber of Deputies for passage.11)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0 This situation would diverge significantly from the current one, where both the Senate and the Chamber of Deputies must produce bills with the exact same wording to create a law.

Italy is one of few European nations where both the higher chamber (the Senate) and the lower chamber (the Chamber of Deputies) have the exact same purpose, according to Chelotti.12)Retrieved 12 December 2016 http://www.euronews.com/2016/11/28/renzi-reform-and-the-paradox-of-italy-s-referendum

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Further reforms proposed by Renzi would eliminate provinces and return powers currently held by regions—for example, those involving transportation and infrastructure—to Rome’s central government.13)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0 This shift of power would return authority that was given away by the nation’s central government more than 10 years ago. Finally, the referendum would make a few other changes such as revising the process used for electing the nation’s president and judges.

Advocates of the referendum, including those in the yes campaign, asserted that enacting the proposed reforms would enable Italy’s government to bring about changes that are important and necessary. These supporters have emphasized that the reforms would expedite Italy’s lawmaking process.14)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0

Those representing big businesses in the nation, including Italian chamber of commerce Confindustria, have noted that the proposed changes would make it easier for Italy’s government to enact reforms and also reduce political uncertainty.15)Retrieved 12 December 2016 https://www.theguardian.com/world/2016/nov/30/italy-referendum-all-you-need-to-know-about-renzis-crunch-vote

Those not in favour of the proposed changes have cited numerous reasons for their opposition.16)Retrieved 12 December 2016 https://www.theguardian.com/world/2016/nov/30/italy-referendum-all-you-need-to-know-about-renzis-crunch-vote One major concern was that the reforms would place too much power in the hands of the prime minister.

In addition, all those who oppose Renzi politically have gathered to push back against the proposed reforms, a major driver of this situation being their desire to force him to resign.17)Retrieved 12 December 2016 https://www.theguardian.com/world/2016/nov/30/italy-referendum-all-you-need-to-know-about-renzis-crunch-vote Some opponents argued that the changes brought about by the referendum would create new problems or stated that the planned overhaul of the Senate was overly complicated.18)Retrieved 12 December 2016 http://www.nytimes.com/2016/12/02/world/europe/italy-referendum.html?_r=0

One major opponent of the proposed reforms was the Five Star Movement (5SM), a populist party founded by former comedian Beppe Grillo and internet entrepreneur Gianroberto Casaleggio. The party became quite outspoken about its opposition to the reforms.19)Retrieved 12 December 2016 https://www.theguardian.com/world/2016/nov/30/italy-referendum-all-you-need-to-know-about-renzis-crunch-vote

Francesco Oggiano, who wrote “Beppo Grillo Parlante,” outlined why he believes 5SM is opposed to the proposed reforms when speaking with CNBC on November 14. “According to the 5SM, people won’t be able to choose their own representatives in the parliament and this is the most important point,” he stated.20)Retrieved 12 December 2016 http://www.cnbc.com/2016/11/30/italys-referendum-explained-what-you-need-to-know.html “The result (of a ‘yes’ victory) would be a parliament full of bureaucrats chosen from their parties that, once elected, will just get to satisfy their leader instead of people’s needs.”

At any rate, the referendum failed, because more than 59% of voters voted to reject the change.21)Retrieved 12 December 2016 http://elezioni.interno.it/referendum/scrutini/20161204/FX01000.htm

Renzi Offers To Resign

On Monday, December 5, Renzi met with President Sergio Mattarella and stated that he wanted to resign.22)Retrieved 12 December 2016 http://www.quirinale.it/elementi/Continua.aspx?tipo=Comunicato&key=2351 Renzi had previously indicated that the referendum would give voters the opportunity to provide a vote of confidence on his time serving in office.

When Renzi informed Mattarella of his intention, the president asked Renzi to remain in his current post until the nation’s parliament passed a 2017 budget.23)Retrieved 12 December 2016 http://www.quirinale.it/elementi/Continua.aspx?tipo=Comunicato&key=2351 On December 7, parliament succeeded in approving this budget, and Renzi officially resigned from his post on that same day.24)Retrieved 12 December 2016 http://www.usatoday.com/story/news/world/2016/12/07/matteo-renzi-italy-prime-minister/95100336/

Gentiloni Forms New Regime

In the aftermath of this event, Mattarella summoned Italian Foreign Minister Paolo Gentiloni, a Renzi backer, to his presidential palace on December 11, where he asked Gentiloni to form a new government.25)Retrieved 12 December 2016 http://www.euronews.com/2016/12/11/italy-s-fm-gentiloni-tipped-to-form-next-government Gentiloni provisionally accepted the request and quickly got to work, speaking with members of different political groups in order to create this new regime.

Following this meeting, Gentiloni spoke with reporters and emphasized the difficult nature of the situation. “During the negotiations, we noted the reluctance of the opposition parties to share the responsibilities of the new government,” he said.26)Retrieved 13 December 2016 http://www.euronews.com/2016/12/11/italy-s-fm-gentiloni-tipped-to-form-next-government “Therefore, we are not doing this by choice, but rather because we have the duty to do it. And so, we will proceed with the government and the current majority.”

It was noted at the time that if Gentiloni proved unable to garner the needed support from existing political parties, the president could ask another person to develop the needed consensus.27)Retrieved 13 December 2016 http://www.euronews.com/2016/12/11/italy-s-fm-gentiloni-tipped-to-form-next-government

Following this meeting, Gentiloni quickly assembled a cabinet. Many members of the previous cabinet retained their positions, including Defense Minister Roberta Pinotti and Justice Minister Andrea Orlando.28)Retrieved 12 December 2016 http://www.dw.com/en/italys-new-prime-minister-paolo-gentiloni-unveils-new-government/a-36743677

Italian Finance Minister Pier Carlo Padoan, who spent years before the referendum working with the nation’s banks in an attempt to shore up their financial positions, also retained his position.29)Retrieved 13 December 2016 https://www.bloomberg.com/news/articles/2016-12-13/padoan-returns-with-monte-paschi-risks-stalking-italy-s-banks By staying in his post, Padoan had the responsibility of navigating both lackluster economic conditions and helping the nation’s banks overcome their capital challenges.

On December 11, Gentiloni was sworn in as Prime Minister of Italy.30)Retrieved 13 December 2016 http://www.efe.com/efe/english/portada/paolo-gentiloni-sworn-in-as-italy-s-new-prime-minister/50000260-3123018

Most of the ministers who served under Renzi kept their positions, with Gentiloni appointing new heads for the Education, Interior and Foreign Ministries.31)Retrieved 13 December 2016 http://www.efe.com/efe/english/portada/paolo-gentiloni-sworn-in-as-italy-s-new-prime-minister/50000260-3123018

Italy’s Troubled Banking Sector

In his first speech to parliament since ascending to the role of Prime Minister, Gentiloni addressed the nation’s fragile banking sector, stating that the government was willing to get involved to support these financial institutions. “I want to say very clearly that the government … is ready to intervene in order to guarantee the stability of banks and the savings of our citizens,” he told the Chamber of Deputies the day after being sworn in.32)Retrieved 13 December 2016 http://www.reuters.com/article/us-italy-politics-idUSKBN142146?il=0

Italy’s banks currently have €360 billion (US$383 billion) worth of sour loans on their books, a figure that accounts for one-third of the value of such loans in the eurozone.33)Retrieved 13 December 2016 http://www.reuters.com/article/us-italy-politics-idUSKBN142146?il=0 This burden is placing constraints on the lending activities of these banks and providing the nation’s economy with additional headwinds.34)Retrieved 13 December 2016 https://www.bloomberg.com/news/articles/2016-12-09/ecb-said-to-reject-monte-paschi-request-for-more-time-on-capital

Banca Monte dei Paschi di Siena S.p.A. (MPS), Italy’s third-largest lender, has been struggling to improve its capital position after failing a stress test in July.35)Retrieved 13 December 2016 http://www.investors.com/news/italys-monte-paschi-capital-wiped-out-in-european-bank-stress-test/ The lender provided plans to eliminate bad loans, and then later sought €5 billion (US$5.3 billion) worth of capital to bolster its financial position.36)Retrieved 13 December 2016 https://www.bloomberg.com/news/articles/2016-10-25/monte-paschi-to-cut-2-600-jobs-sell-units-in-rescue-plan

However, when Renzi resigned, MPS had still not raised the needed capital, prompting it to appeal to the European Central Bank (ECB) for an extension.37)Retrieved 13 December 2016 https://www.bloomberg.com/news/articles/2016-12-09/ecb-said-to-reject-monte-paschi-request-for-more-time-on-capital If granted, this request would have given MPS until January 20, 2017 to meet its capital requirements instead of the previous deadline of December 31, 2016.

But the ECB denied this request, increasing the odds that MPS would require government assistance.38)Retrieved 13 December 2016 http://www.wsj.com/articles/ecb-denies-monte-paschi-more-time-to-raise-capital-1481291260 Late in the week ending Friday, December 23, MPS announced that its effort to raise €5 billion worth of capital from private investors had failed.39)Retrieved 17 January 2017 http://www.marketwatch.com/story/italy-creates-20-billion-fund-to-back-troubled-banks-2016-12-22 Italy’s government quickly responded to this situation, approving the creation of a €20 billion fund for the nation’s banks on December 23, 2016. As part of this package, Italy also announced that the state was guaranteeing bank debt.40)Retrieved 8 February 2017 http://www.reuters.com/article/italy-monte-dei-paschi-bonds-idUSI6N1FA006

The nation’s government may have taken this action at just the right time. MPS’ tough situation took a turn for the worse when the ECB wrote a letter to the Finance Ministry on December 26, 2016 stating that the Italian bank actually needed €8.8 billion worth of capital instead of the prior figure of €5 billion.41)Retrieved 17 January 2017 https://www.ft.com/content/60576ada-cbbd-11e6-864f-20dcb35cede2

In the following weeks, the Italian bank took action to bolster its financial position, announcing on January 25, 2017 that it had issued €7 billion worth of bonds guaranteed by the state.42)Retrieved 8 February 2017 http://www.reuters.com/article/italy-monte-dei-paschi-bonds-idUSI6N1FA006 The bank revealed that it had sold two separate bonds, one maturing in January 2018 and the other maturing in January 2020. MPS also revealed that it may sell notes in the secondary market.

Despite this sale, the Italian bank remained on track to become nationalised.43)Retrieved 8 February 2017 jQuery("#footnote_plugin_tooltip_43").tooltip({ tip: "#footnote_plugin_tooltip_text_43", tipClass: "footnote_tooltip", effect: "fade", fadeOutSpeed: 100, predelay: 400, position: "top right", relative: true, offset: [10, 10] }); At the time, it was expected that Italy’s government would take a 70% interest in the financial institution in exchange for an investment of €6.6 billion.

Italy’s Credit Rating

Following the defeat of the referendum, some market observers voiced concerns that Italy could suffer a credit downgrade. On December 5, 2016, credit ratings agency DBRS announced that Italy’s credit rating, which was already at risk of being reduced, had higher chances of being lowered following the failure of the referendum to achieve passage.

“This is certainly credit negative,” Fergus McCormick, chief economist and co-head of Sovereign Ratings at DBRS, told Reuters.44)Retrieved 13 December 2016 http://www.reuters.com/article/us-italy-referendum-ratings-idUSKBN13U0ZS “We would expect less government stability and greater political uncertainty in the near term … and this could affect investor appetite for bank equity in this period of very imminent restructuring and recapitalisation.”
Moody’s Investors Service, another ratings agency, announced December 7 that it was changing its outlook on its current rating for Italy (Baa2) to negative.45)Retrieved 13 December 2016 https://www.moodys.com/research/Moodys-changes-outlook-on-Italys-Baa2-issuer-rating-to-negative–PR_358690 Moody’s provided two main justifications for changing its outlook on Italy’s debt to negative:

1. The credit ratings agency emphasized the “no” vote will only slow Italy’s already stagnant movement toward economic and fiscal reform.

2. Moody’s cited an increased risk that the nation will further postpone efforts to alleviate its debt burden, which will make the country’s economy vulnerable to “unforeseen shocks” for longer than before.

Political Uncertainty

Following Renzi’s departure and the installment of the interim government, political analysts began speculating on when Italy would hold elections next. Federico Santi, who works for Eurasia Group as a Europe analyst, predicted that the nation’s government would not hold elections until March.46)Retrieved 13 December 2016 http://www.cnbc.com/2016/12/09/italy-will-have-to-wait-until-march-for-elections-analyst.html

Santi, who accurately predicted the creation of an interim government before Gentiloni formed his cabinet and was sworn in as Prime Minister, stated that following the referendum’s defeat, the government would need to take a few steps before holding elections. “The president will want to put in place a government that can oversee changes to that system to make sure that an election can be held,” he told CNBC.47)Retrieved 13 December 2016 http://www.cnbc.com/2016/12/09/italy-will-have-to-wait-until-march-for-elections-analyst.html

Renzi also weighed in on the situation, predicting that Italy will hold elections in June 2017. “The next elections, presumably in June, will be held with a proportional voting system,” he said in an interview.48)Retrieved 13 December 2016 http://www.reuters.com/article/us-italy-politics-vote-idUSKBN1411BX

Summary

Since the Italian referendum was unsuccessful, the country failed to enact the proposed reforms, leaving its process for passing legislation unchanged. The nation did swear in a new prime minister, Gentiloni. However, the new prime minister is a Renzi supporter and retained much of his predecessor’s cabinet.

Because Italy failed to enact comprehensive reform, it has been placed in a position where it might lack the mobility required to effectively address its challenges. It is uncertain when Italy will once again hold elections, so the new government may not have a lengthy window of time for confronting these issues.

Even if a different political party gains majority control of the Senate and House of Chambers following the next election, the obstacles the legislature faces in passing new bills could make it difficult for a new regime to swiftly address the nation’s issues.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

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