Investment Research
The Not So Dolce Vita
An Analysis of the Causes of Italy’s Sovereign Debt Crisis and
the Potential Outcomes
Giuseppe Ricotta, CFA, Vice President, Portfolio Analyst, Lazard Multi Strategy Team
Gian Luca Clementi, PhD, Associate Professor of Economics, Department of Economics, Stern School of Business, New
York University¹
Over the past decades, the Italian life style has been commonly referred to as La Dolce Vita (“The Sweet Life,” from the
title of Federico Fellini’s 1960 cult movie): good food and wine, nice clothes, low stress levels, the continuous search for
happiness. In mid-2010, the development of the euro zone sovereign debt crisis sounded an alarming wake-up call for
the entire country.
The main purpose of this paper is to identify the scenarios in which the Italian economy may find itself in the short-tomedium term, and to evaluate the likelihood of occurrence. We begin with a brief summary of the main causes of the
Italian malaise. This is followed by an assessment of the effect of reforms introduced by the current government and an
analysis of the likelihood that the government elected in the 2013 general election will enact the badly needed policies in
order for the country to regain credibility in debt markets and return to the path of prosperity.
2
As is now well known, Italy became deeply involved in the euro zone
sovereign debt crisis in the late spring of 2010, when the yield spreads
between its sovereign bonds and German bunds rose substantially
from the near-zero level to which they were relegated for most of the
past decade.
Somewhat tautologically, the crisis was triggered by a deterioration
in market expectations of the Italian government’s ability to continue
servicing its debt. This change in sentiment was not prompted by a
sudden worsening of the fundamentals of the Italian economy, but
rather by fading market expectations that the other major European
economies would support the Italian government in case of trouble.
As such, the likelihood of this happening is relevant only because
Italy’s fundamentals have been deteriorating at a steady pace for a long
time now. While the past five years have been particularly difficult,
resulting in a cumulative loss of about 8% of GDP per capita, as
shown in Exhibit 1, and two-thirds of stock market value (as measured
by the FTSE MIB Index), economic growth has been anemic for
approximately twenty years.
Exhibit 1
Growth in Italian GDP per Capita, 1971–2011
Italy’s post-World War II economic performance can be divided
into three separate periods, which we will re-label as fast growth,
slowdown, and stagnation. For each period, Exhibit 2 illustrates the
contribution to growth in GDP per capita from the following components: the employment rate, growth in capital per worker, education,
and total factor productivity (TFP).
During the fast-growth period, which ran from approximately 1950
to 1974, real GDP per capita grew at an average yearly rate of 4.8%,
a figure very close to that of Japan and Korea. Such rapid growth was
largely the result of fast-rising TFP, which in turn was fueled by a
quick reallocation of capital and labor away from agriculture toward
manufacturing. Such reallocation was made possible by extremely flexible labor markets, a modest regulation burden, and low taxes.
The policy picture began to change in the early 1970s, when a series
of reforms introduced considerable rigidity in the labor markets and
the welfare state substantially increased. The large rise in government
expenditures was financed by an increase in both taxes and debt. In
the 1980s alone, tax revenues grew from 34.4% to 41.8% of GDP,
while the national debt rose from 56% to 95% of GDP.
From 1975 to 1995, economic growth slowed substantially, but the
average yearly growth rate remained a respectable 2.2%. The data
indicate that, with TFP essentially flat, growth resulted from improvements in education and persistent capital deepening.
(%)
8
4
In the past 15 years, growth has slowed to a trickle—about 0.5% on
average—and TFP has fallen at a rate of 1% per year. This turn of
events is due in large part to the country’s inability to capitalize on two
major changes that characterized the global economic landscape beginning in the 1990s: the proliferation of web-related technologies and
the decision by developed countries to open up trade with China and
other developing countries.
0
-4
-8
1971
1979
1987
1995
2003
2011
For the period 1971–2011
Source: Eurostat
Exhibit 2
Contribution to Italian GDP Growth per Capita, 1950–2010
(%)
5
GDP per Capita (a+b+c+d)
Employment Ratio (a)
Capital per Worker (b)
Education (c)
TFP (d)
4
3
2
1
The adoption of internet usage in Italy has been slow among businesses and the population alike. For example, according to Eurostat
data on e-commerce, in 2010 Romania was the only other European
Union (EU) country with a lower percentage of companies making
purchases via the internet than Italy. In addition, Internet World
Stats reports that as of the end of 2011, internet penetration was only
58.7% in Italy, compared to 92.9% in Sweden (see Exhibit 3).
Similar to other developed countries, over the past twenty years Italy
has lost a large fraction of manufacturing jobs to lower-cost locations.
Unlike many other developed countries, however, it did not swiftly
reallocate capital and labor to new, high-tech sectors. According to
Eurostat, in 2011 only 13.1% of Italians aged 15 to 64 were college
educated, in contrast to 33.3% in the United Kingdom, and 23.6% in
the EU, and the share of value added generated by low-skill industries
may have even increased in recent years.²
In our view, potential causes of this situation include:
0
-1
The Roots of the Crisis
Fast Growth
1950–1974
Slowdown
1975–1995
For the period 1950–2010
Source: Penn World Table, authors’ calculations
Stagnation
1996–2010
• The inefficiency of Italy’s financial sector, which amounts to a
sometimes insurmountable obstacle for start-ups in new sectors.
According to AIFI (Associazione Italiana del Private Equity e
Venture Capital), in 2005, the most recent peak year for the industry, there were only 56 early-stage deals, worth about €30 million.³
3
Exhibit 3
Internet Penetration Rates in the European Union
(%)
100
80
60
40
20
Romania
Greece
Bulgaria
Portugal
Cyprus
Italy
Lithuania
Poland
Malta
Hungary
Spain
Ireland
Latvia
Czech
Republic
Slovenia
Austria
France
Estonia
Slovakia
Belgium
Germany
United
Kingdom
Finland
Denmark
Netherlands
Luxembourg
Sweden
0
As of 31 December 2011
Source: Internet World Stats
The inefficiency of the resolution of contractual disputes within the
judicial system is likely among the most important reasons for the
lack of development in the venture capital industry. The World Bank
ranks Italy 160 out of 185 countries for ease of enforcing contracts.
• The rigidity of Italian labor markets.
• The inadequacy of higher education: there are no Italian universities
in the top 250 in the Times Higher Education World University
Rankings for 2012–2013.
• Extensive government red tape: according to the World Bank, Italy
ranks 84 among all countries globally for ease of starting a new business. The cost of starting a new venture in Italy is 16.5% of GDP
per capita, a far cry from the expenses incurred by Danish (0.2% of
GDP per capita) or French entrepreneurs (0.9% of GDP per capita).
• Sizable tax and regulatory burdens.
The data are in and they speak loudly. Italy’s economic problems
are a reflection of the government’s failure to reform labor markets;
introduce authentic competition in financial markets, as well as in key
markets for both final goods and intermediate products; revamp the
public university system; and cut taxes and red tape.
Mario Monti’s Government
The government led by former academic Mario Monti was sworn in
on 16 November 2011. Because of the dramatic events that led to its
rise to power, Monti’s cabinet has enjoyed wide support in parliament
and was able to push through a wide array of measures. In particular,
Mr. Monti’s policy was aimed at decreasing the government budget
deficit with a series of spending cuts and tax hikes, reforming the labor
market, boosting infrastructure construction, and improving the allocation of resources by means of market liberalization.
Pension Reform
One of the very first legislative initiatives by Mr. Monti’s government
was the pension reform prepared by welfare minister Elsa Fornero
and voted into law by parliament just before Christmas of 2011. The
reform raised the retirement age and extended to all workers a formula that calculates retirement benefits based on contributions made
throughout a person’s working life, rather than based on their contribution in the few years before retirement.
Ms. Fornero’s reform implies savings in the short- and mediumterm—as little as 0.2% of GDP in 2012 but as much as 1.5% in
2020, according to Ragioneria Generale dello Stato, a department of
the Ministry of Economics and Finance (MEF). However, over the
long run, the reform has little to no lasting effects, as the reduction
in the number of beneficiaries will eventually be entirely offset by an
increase in the value of the average pension.
According to the projections in the “2012 Ageing Report”4 issued by
the European Commission (EC), the Italian public pension system is
currently the most onerous in the entire EU. According to the same
report, the reforms enacted over the past few years will eventually
reduce expenditures to levels observed in other large EU countries.
The Ragioneria Generale estimates that Italy’s average retirement age
will increase from about 60 over the 2006 to 2010 period to 67 in
2030 and almost 69 in 2050. As a consequence, the ratio between
outlays and GDP will drop from 15.7% in 2012 to 2014 to 14.4%
in 2027 to 2031. The aging population brought about by the demographic transition will cause that ratio to rise again to 15.4% in 2050
and then decline to 13.8% in 2060 5 (see Exhibit 4).
Local Government
In its first year in power, Mr. Monti’s cabinet has sought to reduce
government outlays in a wide variety of ways. One that has received a
great deal of media attention is the attempt to curb the overhead costs
of political activity. One little-known peculiarity of Italy is that the
country is organized into three levels of local government, including
20 regions, 110 provinces, and about 8,000 municipalities. Each level
of government has its own legislative and executive branch, for a grand
total of more than 125,000 elected officials, a large number of which
are handsomely compensated for their services. Mr. Monti has so far
managed to reduce the number of provinces to 74 and has introduced
legislation that offers substantial financial rewards to regional govern-
4
Tax Evasion
Exhibit 4
Ratio between Outlays and GDP, 2000–2060
The size of Italy’s underground economy—the income not reported
to the tax authorities—is estimated to be between 15% and 20% of
GDP. Monti’s government was responsible for re-energizing the fight
against tax evasion, in particular by providing enforcement agencies
with new means of tax-fraud detection. The most publicized was
the banning of cash for transactions greater than €1,000, a measure
designed to improve the government’s ability to trace transactions. The
head of Agenzia delle Entrate (the tax collections agency) recently estimated that in 2012 it will recover about €13 billion in unpaid taxes.6
(%)
16
15
14
13
2000
2010
2020
2030
2040
2050
2060
As of 31 December 2012
Estimated or forecasted data are not a promise or guarantee of future results and are
subject to change.
Source: Ragioneria Generale dello Stato
ments that reduce overhead expenses, and to small municipalities that
merge activities. While these reductions are steps in the right direction, the reforms have not yet reached their full potential. In our view,
there is room for further local government consolidation, for example
by eliminating the provincial level altogether.
Mr. Monti’s cabinet has also introduced legislation to eliminate several
redundant government agencies—among them the agency for the promotion of horse racing—and to reduce the ranks of management-level
government employees by 20%, and non-management-level employees by 10% in all functions excluding education, law enforcement, and
the judiciary. The organization of the judiciary was also substantially
revised, with the suppression of many peripheral courthouses.
Unfortunately, it appears that the vast majority of redundancies will
be eliminated by attrition. Retirees will not be replaced with new
hires. As a result, we expect the savings associated with this measure to
be limited and to take some time to materialize.
Spending Review
Law 52, passed on 6 July 2012, has created the new office of
Commissario Straordinario per la razionalizzazione della spesa, a sort
of czar for expenditure reduction. The new position was offered to
Enrico Bondi, a business executive with vast experience in cost-cutting
and rationalization in the private sector. Mr. Bondi was assigned the
task of reconsidering all government purchases and identifying costcutting measures by setting standard unit prices for all such purchases.
He acted swiftly and creatively, summoning the help of ordinary
citizens. In a matter of a few weeks, he identified savings of over €4
billion. The challenge will be enacting them.
In spite of Mr. Monti’s ambitious cost-cutting agenda, much of the
recent improvement in the government budget is due to an increase
in revenue. According to the MEF, during the first eight months
of 2012, tax revenues were €268.7 billion, up 4.1% from the same
period of the previous year, in spite of a substantial drop in economic
activity. This rise in revenues was due to a decline in tax evasion and to
the introduction of new taxes.
Monti’s cabinet was responsible for broadening the base and moving
forward the application of IMU (imposta municipale propria), a real
estate tax introduced by the previous government, from 2014 to 2012.
As of June 2012, IMU revenues were €9.5 billion and projected to
increase to about €19.2 billion by year end. Mr. Monti also increased
taxes on gasoline (which now amount to about 60% of the retail
price), on leisure boats, private aircraft, and luxury cars, and proceeded
to tax illegal capital outflows that benefited from an amnesty introduced by former Prime Minister Silvio Berlusconi’s government.
Privatizations
Early in his term, Mr. Monti also introduced legislation to allow for
the creation of real estate funds tasked with selling a large fraction of
the government’s real estate portfolio. In 2011, the MEF estimated
that the central and local governments own more than two billion
square feet of commercial and residential space, as well as three million
acres of land. The MEF valued these holdings between €250 and €370
billion. The government does not project any revenue from this legislation in the fiscal year of 2012.
Labor Reform and Market Liberalization
Mr. Monti’s cabinet was not confined to measures to reduce the
budget deficit. Rather, they embarked on an ambitious program of
regulation overhaul and market liberalization. A centerpiece of Mr.
Monti’s cabinet activity is the labor market reform enacted with Law
92 on 28 June 2012. Italy’s employment rate, at 56.9% in 2011, is the
lowest among all OECD (Organisation for Economic Co-operation
and Development) countries. The main reason for such abysmal performance is regulation introduced in the 1970s that essentially made
it impossible for employers to lay off workers for reasons other than
improper conduct (the infamous Article 18). This high level of protection, which essentially resulted in lifetime contracts for employees,
acted as a clear disincentive for employers to hire. In the 1990s, a
series of reforms allowed companies to employ workers with temporary contracts, exempt from the Article 18 regulation. This resulted
in what today is essentially a two-tier system—i.e., most workers over
the age of 40 have essentially tenured contracts, while the majority of
their peers under 40 are employed with temporary contracts that have
almost no guarantees.
Mr. Monti’s reform allows all labor contracts to be terminated, with
the exception of discriminatory reasons. Laid-off workers are due a
severance payment, which increases based on seniority. The new regulation, which boils down to a reduction in firing costs, is expected to
have a positive effect on employment and provides a greater incentive
for the development of occupation-specific skills.
5
It is too early to pass judgment on this labor market reform.
Unfortunately, during the ratification process, an amendment introduced the possibility for laid-off workers to appeal the employer
decision in court, putting the success of the reform in jeopardy, as
Italian courts are notoriously slow and labor judges have been known
to consistently interpret the law in favor of plaintiffs. The reform also
introduces a modern unemployment benefits system, known as ASPI
(Assicurazione Sociale per l’Impiego), with benefits that start at 75% of
the last salary earned and that decline over time, lasting for a maximum
of 12 months for individuals below age 55, and 18 months for workers
55 and older. Until this point, unemployment benefits were made available on a case-by-case basis under the CIG system (Cassa Integrazione
Guadagni) and only to workers covered by lifetime contracts.
Mr. Monti’s cabinet took steps toward market liberalization on a
variety of fronts. For example, the government struck down anticompetitive practices common in professional services, such as those
provided by attorneys and notary publics. Such practices include the
policy of setting floors for prices and the prohibition of a notary public
offering his or her services outside a narrow geographical region.
Our view is that this agenda is the one in which Mr. Monti achieved
the least success. Strong opposition from allied parties in parliament
prevented him from implementing further-reaching reform measures.
For example, the government failed to liberalize entry into the pharmacy, notary service, and taxicab industries. In all cases, it managed
only to negotiate an increase in the number of companies allowed to
operate. Entry in all such markets, however, remains strictly controlled
by incumbents.
Public Administration
Mr. Monti also pushed for a broader use of web-based communication across the entire public administration, and reduced red tape in a
variety of industries, including construction and energy extraction. In
a mandate for public university reform passed by the previous government in 2010, Mr. Monti introduced a system of accreditation and
made funding conditional on research output.
Overall, our assessment of the results achieved to date by Mr. Monti
and his cabinet’s activity is mixed. It is interesting to note that the
most effective reforms, in our opinion, were passed early in his mandate—the pension reform, for example—when there was a broadly felt
sense of urgency to save Italy from disaster. At that stage, the newly
appointed technocratic government could count on a huge majority
in parliament—possibly the largest majority any Italian parliament
has ever had in the country’s democratic history. As time progressed
and the markets calmed, in large part due to external factors such as
the European Central Bank’s (ECB) decision to authorize unlimited
purchases of sovereign bonds, that sense of urgency dissipated and
the ideological and political differences of the three main parties
supporting the government—from the center-left to the centerright—re-emerged. Due to lengthy negotiations required to obtain
multi-partisan approval, passing effective reforms became increasingly
difficult. In hindsight, Mr. Monti should have done more earlier in his
mandate.
Future Scenarios
In the third and final section of this paper, we analyze five scenarios
which we believe are likely to address Italy’s future in the short-tomedium term. Italian GDP shrunk severely in 2012 (the consensus
estimate is for a decline of approximately 2.5%); the economic outlook for the next five years and beyond depends dramatically on the
outcome of the next election, slated for February 2013. In particular,
it hinges on the next government’s willingness and ability to enact
much-needed and long-overdue reforms. The political landscape in
Italy is complex, as described by some key developments in recent
months (in Exhibit 5 we summarize the current political landscape):
• Mr. Berlusconi has decided to stage yet another comeback and
resume leadership of the People of Freedom Party (PdL). He is
working on revitalizing the center-right coalition of parties that won
the 2008 election, currently in complete disarray with its ranks ravaged by corruption scandals.
• Prompted by Mr. Berlusconi, the PdL withdrew support for Italy’s
current cabinet. Mr. Monti took immediate notice and announced
his intent to resign to President Giorgio Napolitano as soon as the
parliament passed the budget law. Right before Christmas (on 21
December 2012), he resigned. Mr. Monti, who is a senator for
life (he does not need to be a candidate in the next election) and
enjoys great popularity, has announced his availability for the prime
minister position of a coalition supporting his political agenda 7 for
a full term.
• A center-left coalition composed of the far-left SEL (Ecology and
Freedom party) and the more moderate PD (Democratic Party)
held its primary election. The current head of PD, former communist Pier Luigi Bersani, won by a comfortable margin against
Matteo Renzi, a younger and reform-minded candidate.
• Several groups of entrepreneurs, professionals, and academics with
strongly pro-market programs are trying to enter the political arena.
The latest businessman to do so is Luca Cordero di Montezemolo,
whose think tank Italia Futura is urging support for a second Monti
government.
• UDC (Union of the Center) and FLI (Future and Freedom), former
allies of Mr. Berlusconi, also support a second term for Mr. Monti.
• The only novelty in the Italian political landscape, the Five Star
Movement, is rapidly gaining favor. After just three years since its
establishment, the creation of comedian-turned-politician Beppe
Grillo is now credited with 20% to 25% of popular support. In
Sicily’s recent regional election it was the most popular party
(although a center-left coalition was the overall winner), with
14.9% of total votes.
Forecasting the election outcome is particularly complicated due to
Italy’s peculiar electoral law. Designed by a minister in Berlusconi’s
cabinet before the 2006 general election, the current electoral law has
four important features:
1. Voters choose among parties (or a coalition of parties), but candidates are selected by the parties themselves.
2. The law awards 55% of seats in the House (Camera dei Deputati)
to the party or coalition of parties that obtains the majority of the
popular vote nationwide.
6
Exhibit 5
Summary of Italy’s Political Landscape
Wing
Name
English Translation
Acronym
Leader
Comments
Right
La Destra
The Right
LD
Francesco Storace
Formed by the most extreme members of Gianfranco Fini’s former Alleanza Nazionale (AN - National Alliance) party, before AN
became more moderate and merged into the PdL.
Right
Lega Nord
Northern League
LN
Umberto Bossi/
Roberto Maroni
Independentist party. Recently scarred by a corruption scandal in
the Lombardia region.
Center-right
Popolo della Libertà
People of Freedom
PdL
Silvio Berlusconi/
Angelino Alfano
In disarray following Mr. Berlusconi’s resignation in November
2011 and the results of Sicilian elections in October 2012. Biggest party in the center-right.
Seceded from PdL one year ahead of Mr Berlusconi’s resignation.
Center-right
Futuro e Libertà
Future and Freedom
FLI
Gianfranco Fini
Center
Unione di Centro
Union of the Center
UDC
Pier Ferdinando Casini Heir of the old Christian Democratic Party, which governed Italy
for more than 40 years after WWII. An ally of PdL until 2008.
Center
Italia Futura
The Future Italy
IF
Luca Cordero
di Montezemolo
Recently founded by Luca Cordero di Montezemolo, Ferrari’s
Chairman and a former Fiat’s Chariman, in an attempt to form a
more moderate center-right coalition as an alternative to the one
led by the PdL.
Center-left
Italia dei Valori
Italy of the Values
IdV
Antonio Di Pietro
Founded by Antonio Di Pietro who, as a prosecutor, played a key
role during the 1992 “Tangentopoli” corruption scandal, which
ultimately led to the demise of the so-called “first republic.” Berlusconi's biggest foe.
Center-left
Partito Democratico Democratic Party
PD
Pier Luigi Bersani
Heir of the old Communist Party. Governed with Romano Prodi,
Massimo D'Alema, and Giuliano Amato from 1996 to 2001 and
again with Prodi from 2006 to 2008. Largest party in the centerleft.
Left
Sinistra, Ecologia e
Libertà
Left, Ecology, and
Freedom
SEL
Nichi Vendola
Started in 2009 by Apulia Governor Nichi Vendola, a former
member of the Communist Party and the Communist Refoundation party.
Five Star Movement
M5S
Beppe Grillo
“Anti-establishment” movement started and led by comedianturned-politician Beppe Grillo. The movement operates mainly
online and meets in public assemblies. Beppe Grillo has repeatedly said that he will not run for the prime minister position at
next general election, because he was found guilty of vehicular
manslaughter in 1980. The internal rules of the M5S forbid any
convicted individual to be a candidate.
Alternative/
Movimento 5 Stelle
Revolutionary
As of January 2013
For illustrative purposes only.
Source: Lazard
3. Senate seats are awarded on a regional basis. The party or coalition
that wins the majority of votes in a given region obtains more than
50% of the seats assigned in that region.
4. In order to win any seat, a party needs to receive at least 4% of the
popular vote nationwide in the house, and at least 8% of a regional
vote for the Senate.
An initial observation is that the electoral law gives parties strong
incentives to form coalitions. It follows that the final outcome will be
dictated by voter preferences, as well as by parties’ strategic behavior.
An additional consideration is that while the party or coalition that
wins the popular vote will command a comfortable majority in the
House, it may enjoy much slimmer support, or may even be in the
minority, in the Senate. This is indeed what happened in 2006, when
the center-left coalition, headed by Romano Prodi, won nationwide
but lost in several large regions and ended up with only a one-vote
majority in the Senate.
With this in mind, we have identified five potential scenarios that we
believe are most likely to occur following the election. The probability
assigned to each scenario is based on analysis done by Lazard’s Multi
Strategy team on the assessment of the situation as of 1 February 2013
and is subject to change.
• Scenario I: A Center-Left Government
• Scenario II: A Second Government Led by Mario Monti, for a
Longer Term
• Scenario III: A Center-Right Government
• Scenario IV: A Populist Government
• Scenario V: Another Electoral Round is Needed
Scenario I: A Center-Left Government
Current opinion polls indicate that the center-left coalition has strong
support in the electorate. We attribute a 50% probability to this scenario. The factor that may work against this outcome is the substantial
difference between the economic policy agendas of the major players
in the coalition.
On one hand, both the SEL party and PD’s leader Mr. Bersani are
quite critical of Mr. Monti’s stance and show little interest in introducing structural reforms, such as reducing the government’s role in
7
the economy. On the other hand, the moderate wing of PD, headed
by Florence Mayor Matteo Renzi, supports an ambitious program of
pro-market reforms.
We believe that there is a 25% probability that Monti will remain in
charge following the election. In such case, we would expect the events
to unfold according to the following timeline:
The primary election gave Mr. Bersani a clear mandate to run for
office on a left-leaning platform.
1. The government continues on its path of pro-market reform and a
reduction in scope;
Should the center-left coalition obtain control of both houses, it will
pledge to continue the current government’s effort to reduce the budget
deficit, but it will also likely shift focus away from spending to revenue.
It will likely impose a new wealth tax, modeled on the French ISF
(impôt de solidarité sur la fortune), raise marginal income tax rates for
the top brackets, and reverse some of the cuts to education and health
care implemented during the Berlusconi and Monti governments.
2. Sovereign yields gradually moderate;
We also project that the pro-market reform activity initiated by Mr.
Monti will slow down and, in the case of selected markets, come to a
screeching halt. This will definitely be the case for the labor market,
in which a reversal of some of the recent reforms described previously
could occur.
Scenario III: A Center-Right Government
We would expect the changes to the tax code and to the major spending programs to take place in the fall of 2013, when the cabinet will
be required to pass its first budget. Barring sizable external shocks, we
would expect sovereign yields to rise thereafter. By how much would
depend on external conditions.
We have strong doubts that a PdL-led government—which would
almost certainly include the Northern League—will be able to enact
the structural reforms that Italy needs to restore growth. After all, a
center-right coalition has led the country for at least half of the past 18
years, often with a large majority in parliament, without achieving any
significant results in these key policy areas.8
Most likely, Mr. Bersani would react to worsening borrowing conditions by raising taxes further, possibly sending Italy into a downward
spiral, which could then lead to a quick demise of his government.
Scenario II: A Second Government Led by Mario
Monti, for a Longer Term
3. Gradual structural readjustment ensues, with slow growth, persistently high unemployment, and social unrest;
4. Foreign direct investment slowly increases, corporate profits
improve, and new sectors develop; and
5. The country is back on track in the next five to eight years.
In spite of the rather low support PdL currently has—around 15%
of the electorate according to the latest polls—we assign a 10% probability to the outcome of a center-right coalition, headed by Mr.
Berlusconi, winning the election.
In this case we would expect a scenario in which it is likely that:
• Markets will immediately revise downward their stance on Italy and
sovereign bond yields would increase;
• The government will cut key spending programs;
There could be two paths leading to another government headed by
Mario Monti:
• Capital outflows will intensify and sovereign yields would increase
further; and
1. A coalition of Mr. Monti’s backers—namely UDC, Luca Cordero
di Montezemolo’s Italia Futura, Gianfranco Fini’s Futuro e
Libertà, as well as moderate supporters of both PD and PdL
(unhappy with their leaders)—win the majority of seats in both
houses, gaining the right to designate Mr. Monti as the new prime
minister. In this scenario, Mr. Monti would not head a technocratic cabinet with a narrowly defined program and conditional
parliamentary support, but rather a government with a full and
ambitious political agenda supported by a cohesive coalition.
• After that, two likely scenarios are:
2. No party or coalition wins a commanding control of both houses.
The ensuing market pressure may prompt either the center-left or
center-right coalition to strike an alliance with Mr. Monti’s backers
and support a second, longer-term government led by Mr. Monti
himself. Similar to his first run, much of the support for his policies
would come from financial markets rather than the popular vote, in
the sense that many of the members of parliament supporting him
will not have embraced his agenda during the electoral campaign.
The market would likely welcome either scenario, and the reaction
could be euphoric in the former.
–– The government falls, the European Stability Mechanism (ESM)
and International Monetary Fund (IMF) come in, and new elections are called; or
–– The country exits the euro zone and a new currency is
introduced, followed by a spike in inflation and a relevant depreciation with respect to the euro.
Scenario IV: A Populist Government
In this scenario, the Five Star Movement stages a surprise victory in
the general election and is asked by President Napolitano to form a
government. In spite of this success, the fact that Mr. Grillo’s party
will likely run in isolation dramatically limits the probability to 5%, in
our view, that it will actually gain control of parliament.
Mr. Grillo capitalizes on many Italians’ profound discontent with the
parties and political figures that have run the country over the past
two decades. Unfortunately, along with much-needed reforms, such
as the liberalization of energy, transportation, and media markets, his
economic policy program advocates a reversal of labor market reforms,
a return to protectionism, the ban of leveraged buyouts, and opposes
cutting major government spending programs. Perhaps more tellingly,
8
Exhibit 6
Multi Strategy Team Economic Context Assessment on Italy
Scenario
Probability Potential
(%)
Prime Minister
Expected Market
Reaction
6-to-12 Month Potential
Multi Strategy Team
Economic Impact
Economic Context Asssessment (%)
P
D
E
M
Scenario I: A Center-Left Government
50
Pier Luigi Bersani Neutral
Negative
12.5
45.0
35.0
7.5
Scenario II: A Second Government Led by Monti
25
Mario Monti
Positive
5.0
22.5
50.0
22.5
Scenario III: A Center-Right Government
10
Scenario IV: A Populist Government
Scenario V: Another Electoral Round is Needed
5
10
Very Positive
Silvio Berlusconi
Negative
Very Negative
22.5
45.0
25.0
7.5
?
Very Negative
Very Negative
25.0
45.0
25.0
5.0
NA
Extremely Negative Extremely Negative
35.0
45.0
15.0
5.0
15.0
39.0
35.0
11.0
As of January 2013
Source: Lazard
Mr. Grillo has repeatedly called for Italy to exit the euro zone and
unilaterally restructure its sovereign debt.
Needless to say, we view this scenario as potentially very troubling.
Should it materialize, we would expect that:
• Markets will immediately revise their stance on Italy downward and
sovereign bond yields increase significantly;
• The government reacts by introducing capital controls and a new
wealth tax;
• Italy abandons the euro zone and a new currency is introduced,
followed by a spike in inflation and a substantial depreciation with
respect to the euro;
• Italy is denied market access and the IMF is called in; and
• A massive depression is possible, which will set the country back
decades.
Scenario V: Another Electoral Round is Needed
In the last scenario, there is no clear winner in next spring’s election
and the parties represented in parliament fail to agree on a new technocratic government. Given the current political landscape and the
electoral rules in place, we assign a 10% probability to this event.
Market reaction would be very negative, with the yield spread likely
widening and increased risk of contagion to other countries in the
European periphery, such as Spain. In addition, we would expect that:
• Sovereign bond yields increase significantly;
• Parliament works to reform the electoral law;
• To stave off the impending crisis, the caretaker government passes
new austerity measures;
• Social unrest reaches new highs;
• Capital outflows intensify and sovereign yields increase further; and
• New elections are scheduled for the fall of 2013.
In all but scenarios II and IV, we envision a non-zero possibility
that Italy formally applies for a bailout from the European Stability
Mechanism (ESM). The most relevant features of such a program
would be a sovereign loan in addition to the ECB’s commitment
to support Italian sovereign bond prices via large purchases on the
secondary market (or outright monetary transactions). This gives way
to questions of what is the likelihood that an application would be
granted and how much the program would cost for the ESM and ECB.
According to the treaty establishing the ESM, as well as repeated statements by ECB Chairman Mario Draghi, an application for support
will be granted only to countries whose governments commit to a
clear path to reform. It follows that in all relevant scenarios (I, III, and
V, specifically) the only applications with a chance of success would
come from interim cabinets that, similar to Mr. Monti’s, are put into
place to avert catastrophe. We would also expect the troika (the EC,
ECB, and IMF) to condition any bailout on an overhaul of the electoral law which empowers citizens to select their representatives.
The strict conditionality of the bailout program leads us to believe
that the cost to the ESM and ECB would be limited. Should help be
granted on the basis of a detailed reform plan, the role of the ESM and
ECB would be to take on aggregate risk if Italy fails to restore confidence on its ability to service its debt due to outside circumstances,
such as a global recession. If the country were unable to implement a
credible commitment to reform, the application for bailout would be
rejected, leaving a structured partial default as the most likely alternative and the exit from the euro zone a less likely event.
Exhibit 6 summarizes the five scenarios we have introduced applying the Economic Context Assessment (ECA) framework utilized by
Lazard’s Multi Strategy team.9 The ECA defines the macroeconomic
environment using four contexts: Panic, Differentiation, Expansion,
and Mania. Under each of the five scenarios, we assign a weight to the
four contexts. The probability-weighted average of the contexts is the
ECA, which represents our market and economic forecast for Italy
over the next 6 to 12 months.
For Italy, the ECA analysis based on the five political scenarios we
have discussed shows that the probability of the two tail contexts
(Panic and Mania) is relatively subdued (at 15% and 11% respectively), while the highest probability is in the “muddle-through”
Differentiation (39%) and positive Expansion (35%) contexts.
9
Conclusion
In this paper, we have provided a brief summary of the main causes
of Italy’s economic crisis and then assessed the effect of reforms
introduced by the current government. Finally, we have attempted to
identify the scenarios in which the Italian economy may find itself in
the short-to-medium term and evaluate their likelihood.
We do not know if the Italian people will be able to go back (or continue, for some) their Dolce Vita life-style in the longer term. In our
view, Italy’s future critically depends on the potential for the future
government, thrust to power in the 2013 general election, to enact the
policies necessary for Italy to regain credibility in debt markets and
return to the path of prosperity. Until then, we will closely monitor
how the political situation, currently characterized by a high level of
uncertainty, evolves.
Notes
1 Lazard has compensated Gian Luca Clementi for the time and effort dedicated to the analysis included in this paper.
2 Source: “The Euro and Firm Restructuring,” Matteo Bugamelli, Fabiano Schivardi, and Roberta Zizza.
3 Source: “Il Mercato Italiano del Private Equity e Venture Capital nel 2005,” Anna Gervasoni, 2006 Annual Convention of AIFI, http://www.aifi.it/IT/PDF/Statistiche/Analisimercatoitaliano05.
pdf.
4 Source: http://ec.europa.eu/economy_finance/publications/european_economy/2012/pdf/ee-2012-2_en.pdf
5 Source: “Le tendenze di medio-lungo periodo del sistema pensionistico e socio-sanitario,” http://www.rgs.mef.gov.it/_Documenti/VERSIONE-I/Attivit--i/Spesa-soci/Attivit--d/2012/NDA-Letendenze-di-m_l-periodo-del-s_p_e-s_s-Rn.13.pdf)
6 Source: http://www.ilsole24ore.com/art/notizie/2012-09-11/lotta-evasione-preventivo-miliardi-131758.shtml?uuid=AbxIdqbG
7 Available at www.agenda-monti.it
8 In mid-November 2012, the Head of the PdL, Angelino Alfano, announced that his party’s primary election would be held in mid-December. However, by the beginning of December the primaries were cancelled and Berlusconi announced he will be the candidate for the prime minister position.
9 The ECA is a proprietary framework developed and used by Lazard’s Multi Strategy team.
Important Information
Published on 1 February 2013.
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