Wednesday, May 30, 2018

The Italian Crisis

Italy is in the throes of a crisis that has roiled the global financial markets and reignited the uncertainty about the EU project that appeared to have subsided after the twin victories of Emanuel Macron and Angela Merkel. 

President Sergio Mattarella rejected the nomination of avowed anti-European Paolo Savona as Finance Minister of the coalition government of Five Star Movement and Northern League. With the chances of Carlo Cottarelli, the former IMF official nominated by the President as caretaker Prime Minister, to form a government being slim in a Parliament where the Five Star movement and Northern League have the majority, snap polls appear inevitable. 

The extraordinary spike in Italian two year bond yield, to its highest ever recorded, puts the market panic in perspective.
Or does it? Is the situation worse than 2012 when Greece stood at the brink of default and exit, and contagion to the PIIGS, which included Italy, appeared only a matter of time?  Is it a case of the typical market over-reaction? I am inclined to think so!

It is very difficult to not expect Italy's membership of Eurozone to not be a major topic in the forthcoming polls. To that extent the high stakes brinkmanship over Paolo Savona may have had the effect of allowing Italian exit become a political topic. Should Mattarella have allowed the coalition to engage with EU and let matters play itself out rather than intervene pre-emptively against the formation of a coalition government? It is anybody's guess how this will impact the different parties and coalitions and which option would have been more appropriate.  

Further, as Bill Emmott has argued any exit is unlikely to help the country. Unlike Greece, Italy enjoys a 3% current account surplus and therefore does not suffer from any competitiveness problem to benefit from an exit and devaluation. And despite a massive 132 percent debt-to-GDP ratio, Italian borrowing costs remain low thanks to its membership of the Eurozone.

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