Politically Italy

After ousting Prime Minister Letta, Matteo Renzi assures Italy it can count on him to stabilize Parliament. Source: Vittorio Zunino Celotto/Getty Images.

Italy’s long-running political saga took another twist Thursday, with Prime Minister Enrico Letta finally falling victim to a party power play. Over the past few months, a rift formed between Letta and his Democratic Party (PD) over their mounting frustrations with Letta’s do-little administration—he was able to hold the coalition together (no small feat), but that coalition couldn’t pass much in the way of economic or labor market reforms, and as the economy stayed shaky, the PD grew antsy. They elected a new leader, Matteo Renzi, in December, and he rallied party execs to dethrone Letta Thursday, putting himself in line to take over. To the casual investor, this all might sound a bit chaotic, but political upheaval is business as usual in Italy—and after Renzi took the party’s top post, most believed it was only a matter of time before he grabbed the premiership as well. This power shift could help Parliament push through much-needed electoral reforms—a longer-term positive—but for markets, impact is probably minimal.

Renzi’s rise was swift but unsurprising. Polls show Italians are increasingly tired of the political establishment, and while Renzi leads a major party, he’s also a fresh face—literally. At 39 years old, the current mayor of Florence would be Italy’s youngest PM ever, and he has never sat in Parliament. He has, however, made waves since becoming the PD’s leader in December, routinely upstaging Letta on the national scene. It was Renzi who worked with other party heads on national electoral reform—a task Letta was initially charged to do. His success there likely bolstered his case Thursday—PD bigwigs saw a decisive leader with a chance of getting more done. Whether they’re right over time remains to be seen, but for now, that expectation was enough to prompt another turn of Italy’s political door.

If President Giorgio Napolitano taps Renzi as PM (widely expected), his government would be Italy’s fourth in two years, and he would be the third straight PM not to win a general election. Renzi says he intends to make his government last for the entire mandate (2018), but given how fragmented the chamber is, it won’t be easy. First, he has to build his cabinet—almost surely a coalition of center left and right—and win a confidence vote in Parliament. Given the inherent instability in Parliament right now, snap elections are possible, but they’re also unlikely. Only Napolitano can call new elections, and he has all but said he won’t unless Parliament first passes electoral reform. Italy’s electoral system, as it stands, makes electing a legitimate majority government with a firm mandate almost impossible. It heavily favors smaller parties, making weak coalitions the most likely outcome. That’s a recipe for the same political malaise that has crippled Italian reform for years—not what Napolitano wants.

While Renzi’s electoral reform proposal has traction, it likely won’t pass terribly soon. The European Parliament holds elections in late May, likely hogging the major parties’ attention and keeping domestic politics on the shelf for a few months. When the European contest is done, however, Parliament could pursue Renzi’s proposal—and it likely would help promote stability. Under Renzi’s plan, the winning party would receive an automatic 18% majority premium, as long as it won 35% of all votes—no shaky coalition. If no one met the 35% minimum, the top two parties would hold a run-off, with the winner receiving 53% of the seats—there, too, no coalition necessary. The remaining seats would be proportionately allocated to parties meeting the threshold for parliamentary participation (5% for coalitions and 8% for single parties). And the Senate would lose legislative powers, effectively becoming a consultant.

PD and Forza Italia’s broad support for the measures raise the likelihood of their passing, though perhaps with some light modifications. The New Centre Right Party, which supported Letta’s government, is undecided about supporting Renzi as PM and may not be so keen to aid this plan’s passage. They were involved with Renzi’s plan, but they were hesitant about some of the provisions that would reduce their influence as a small party. It also probably goes without saying that comedian Beppe Grillo’s anti-establishment 5-Star Movement likely opposes it—the reforms would severely limit their likelihood of ending up in Parliament as spoilers again (which is rather the measure’s intent). Though they’re likely too small to hold up the proposal alone. As long as Forza Italia—the party led by former PM (and convicted tax fraud) Silvio Berlusconi—is on board, electoral reform is likely. Earlier this week there were rumblings Berlusconi disapproves yet another unelected administration, but his grumblings likely won’t influence much. He’s currently embroiled in another political corruption trial, and—rather incongruously—he’s reportedly mulling a run for European Parliament. Throwing a wrench in domestic politics is likely far down his to-do list these days.

Of course, fixing the electorate system is an important step, but it won’t solve all of Italy’s ills. To keep the wolves at bay, Renzi will need to pass meaningful economic and labor market reform—which will likely stay difficult for as long as Italy has a broad coalition government. Renzi has called himself Italy’s Tony Blair, but many wonder whether he has the clout to pull off big structural changes—charisma only goes so far, and Renzi might not have much political capital with opposing politicians—they might raise a skeptical eyebrow at recent events. After becoming party leader, Renzi said he wouldn’t become PM without an election, conspire with Berlusconi’s party or, for the sake of friendship and dignity, oust Letta. Going against previous statements likely doesn’t gain Renzi trust or friendship—necessary tools in politics.

But while Italy would benefit from ironing out its structural issues over time, for now, cyclical factors (and investors’ low expectations) are likely good enough to propel Italian stocks forward. Italy’s economy has started picking up in the last couple of months, returning to growth in Q4 2013—the first time since 2011—after months of scattered improvement in various metrics. That’s likely good enough to surprise the many folks who expect the less competitive areas of Italy’s economy to be a big-time drag.