National budget planning usually isn’t the most exciting thing in the world, but it is the source of great drama in Italy these days. Coalition partners The League and Five Star Movement (M5S) are at odds with each other, Economy Minister Giovanni Tria, President Sergio Mattarella and the European Commission over spending priorities, just weeks ahead of when the country is due to submit its budget to the European Commission for review. The impasse has sparked fears of a too-lavish budget triggering an Italian fiscal crisis—or splintering the government. While it is too soon to predict how this saga ends, neither Italy’s fiscal situation nor a snap election should be catastrophic for stocks, in our view.
The League/M5S partnership has been precarious from the start. The two have largely different voter bases and frequently conflicting policy priorities. These differences are coming to the fore in budget talks, as are the challenges of fulfilling ambitious campaign proposals. At various times, the two parties—jointly or separately—have espoused a universal basic income for all Italian citizens, a flat income tax, lower taxes for small businesses, closing tax loopholes, canceling a planned sales tax increase, overhauling pension reforms passed in 2011 and tightening immigration controls. Most of these would lift Italy’s budget deficit, possibly pushing it above 2% of GDP—though all the major political players say they don’t intend to breach the EU’s 3% debt-to-GDP limit.
While party leaders bicker, Tria is reportedly hard at work “finding the cash” required to fund M5S/League promises.[i] But, math being what it is, we suspect he may struggle to give everyone what they want. He has kept promises vague thus far while noting he aims to keep the deficit around 1.6% of GDP.[ii] Tria doesn’t have forever: The Italian government is legally bound to present official economic and fiscal forecasts by September 27.[iii] These will inform spending plans, as growth rates (and tax revenue) may determine how much spending is feasible. The government must then present a budget to the European Commission for approval (or, theoretically, rejection) by October 15, and a final budget bill is due by the end of 2018.[iv]
We won’t predict what it will look like, but a pretty watered down version wouldn’t surprise us, as the customary post-election process of walking back campaign promises seems to be well underway. The government has already scuttled several election-season pledges—like negotiating around or ignoring[v] the EU’s 3% debt-to-GDP limit.[vi] An M5S plan to shut down a steel plant accused of environmental violations bit the dust earlier this month when the government dropped its opposition to a proposed merger with another steel firm.[vii] In September, they U-turned on plans to drop mandatory vaccine requirements for schoolchildren.[viii] And an Italexit, once a major rallying cry, now seems all but forgotten. Dialing back more proposals—particularly the more radical or costly—would be par for the course for this government, in our view.
A hard-fought budget deal isn’t the only possible outcome, though. If party leaders can’t agree, the M5S/League coalition could fall apart, bringing snap elections that some fear would roil Italian politics and eurozone stocks. We think concerns about the fallout are overstated, but snap elections seem a definite possibility. The League—initially the coalition’s weaker member—has surged in post-election polls and now surpasses M5S, which is getting nervous and annoyed.[ix] The League might see new elections as a way to gain power—even (who knows?) a surprise parliamentary majority for their right-leaning alliance with Silvio Berlusconi’s Forza Italia. However, polls presently project a vote would produce another hung Parliament—more gridlock.[x] So while a snap election could spark jitters and lift political uncertainty in the short term, we believe extending gridlock would be bullish. Gridlock tends to reduce the risk of radical legislation that stocks typically dislike. Voters seldom appreciate pols’ inaction, but over time, markets tend to.
Italian and European markets will probably be fine for other reasons, too. Italian bond yields—which never rose that high this summer, despite all the hoopla—remain plenty low today at 2.88% for 10-year debt.[xi] That is over 20 basis points below 10-year US Treasury yields—and down markedly from 3.22% at August’s end.[xii] If there were an actual risk of politicians blowing a hole in Italy’s budget and causing major economic ripples, we suspect yields would be nowhere near this tame. Meanwhile, Italy is growing modestly, while the budget back-and-forth has helped keep sentiment pretty dour. We aren’t saying all is hunky dory, but reality still seems better than widely thought—bullish.
One more thing: As evidenced by the fact you are reading about this right now, Italy’s budget travails are very public! Which means markets are well aware of them—likely no surprise power here. Italian fiscal fireworks may put on quite a short-term show, but we still don’t believe they pose a material danger to the European economy or the global bull market.
[i] “Tria working to find budget solutions,” Staff, ANSA, 9/21/2018.
[ii] “Italian Data Revision Gives Tria Final View for Populist Budget,” Lorenzo Totaro, Bloomberg, 9/20/2018.
[iii] “Italy Faces Crunch Time on Budget,” Giovanni Legorano, The Wall Street Journal, 9/19/2018.
[iv] “Tria's Balancing Act Leaves Investors Concerned About Government,” Lorenzo Totaro and Maria Ermakova, Bloomberg, 9/18/2018.
[v] “Italy’s new populist government plans to give out free money—and tax cuts,” Eshe Nelson, Quartz, 5/18/2018.
[vi] “Italy’s Salvini pledges to respect EU deficit rule,” Jacopo Barigazzi, Politico, 9/6/2018.
[vii] “ArcelorMittal reaches Ilva deal with unions, opening way for takeover,” Massimiliano Di Giorgio, Reuters, 9/6/2018.
[viii] “Italy does a U-turn on compulsory vaccine law... again,” Staff, The Local, 9/6/2018.
[ix] “Markets Call Five Star Bluff in Italian Budget Brinkmanship,” John Ainger, Bloomberg, 9/26/2018.
[x] “The Government of Change After the First 100 Days,” Staff, Demos & Pi, 9/15/2018.
[xi] Source: FactSet, as of 9/25/2018. 10-year Italian government bond yield on 9/25/2018.
[xii] Ibid. 10-year US Treasury yield on 9/25/2018 and10-year Italian government bond yield on 8/31/2018.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.