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"Italian reforms will come to standstill"

Italy’s dismissal of Matteo Renzi’s reform package sent a clear signal to the other member states that Rome is incapable of solving its economic woes alone, Paweł Tokarski says in an interview.

Point of View, 15.12.2016 Research Areas

Italy’s dismissal of Matteo Renzi’s reform package sent a clear signal to the other member states that Rome is incapable of solving its economic woes alone, Paweł Tokarski says in an interview.

Does the EU risk plunging deeper into an existential crisis after the Italian referendum?

Paweł Tokarski: The referendum was not only a vote of confidence against the head of the government, but also against its structural reform programme. The programme is neither perfectly designed nor implemented, but was urgently needed and more far-reaching than anything seen by Italy since it joined the euro. A transitional government will go up to the 2018 election just concentrating on the most urgent issues and the reform programme will come to a standstill. That’s a problem for the EU too.

What economic problems does Italy actually have?

The scale of the challenges is immense. The most important problems are low economic growth, stagnating productivity and rising labour costs, which have undermined competitiveness. Private and state budgets are laden with debt, unemployment is high and the banking sector is in a precarious state. There are also large differences between economic development in the North and South of the peninsula. Unfortunately, Renzi’s reforms have not brought any tangible economic benefit to the country’s woes. In July, the IMF estimated that the Italian economy would only reach its pre-financial crisis level by  the mid 2020s.

Should we worry about Italy leaving the eurozone then?

There is no need to panic. The eurozone’s situation is more stable than it was in July 2011. At the time, a conflict between then-Prime Minister Silvio Berlusconi and his Minister of Economy, Giulio Tremonti, catapulted the eurocrisis into a new phase. However, we have to make it clear that an exit from the monetary union is not necessarily the end result of a deliberate political decision, for example after a referendum. The big risk is that the chaos could gain momentum and get out of control. In Greece, the growing distrust of the general public led to people withdrawing their savings and exacerbated the crisis in the banking sector.

Is that a possibility in Italy?

Yes. Particularly in view of the potential election victory of Beppe Grillo’s Five Star Movement; the only clarified point of Grillo’s economic programme is to take Italy out of the eurozone. The Five Star Movement is, for example, more radical than the Greek Syriza coalition, which has never openly considered a “Grexit”. That would create distrust in future direction of economic policy.

After the ‘No’ vote, negative reactions on the financial markets were expected. So far, things have been quiet in that regard. How do you interpret that?

The financial markets remained quiet, mainly because a negative result in the referendum was long expected. It is also clear that the European Central Bank (ECB) would help Italy out if necessary. However, investors understand that in uncertain political times, necessary reforms to stabilise the banking sector may not materialise. This lack of trust damages the investment environment and decreases the chances of banks attracting new capital. Speculation about new elections complicates the stabilisation of the sector as well.

What would happen in the event the banks risk becoming insolvent?

The so-called “bail-in” rules of the banking union ensure that, generally, private investors have to make losses before the state or the eurozone’s ESM bailout fund can be involved. In Italy, a third of bank investors are private investors. That means that people’s distrust in state institutions will continue to flag, because the state  has not been able to supervise the banks efficiently. Populist parties know these problems well and use them to their advantage. Then we have a dilemma: should the rules of the banking union be strictly applied in order to build credibility? This could have negative political consequences.

What needs to happen to get things under control?

The most important thing that the coalition has to do now is to ensure a relatively smooth switch towards a stable transition government, which can effectively protect the process of restructuring and recapitalising the banking sector. This will also depend on the new head of government keeping up the trust of the financial markets. Italy will also need external support in order to stabilise its debt market, which has continued to experience difficulties based on political trust. After all, the ECB has announced on 8 December a continuation of its loose monetary policy and will be ready to buy up Italian government bonds. However, it will be difficult to deal with long-term political instability, because the purchases per country are limited. The ECB has also signalled in the past that it does not want to continue with this policy for long.

What does this referendum mean for the future of the eurozone?

In order to build trust in the eurozone, significant reforms are needed in the crisis countries. In Italy, however, things are likely to come to a standstill now. On the other hand, more fiscal or economic competences will have to be transferred to the supranational level. But the large support enjoyed by Eurosceptic parties in many eurozone countries, as well as the distrust in place between the north and south, make this impossible. The Italian ‘no’ will be interpreted in many northern countries as vote against reform and a preference for the status quo, as well as suggesting that Italy cannot solve its economic woes by itself. Then again, Rome’s politicians will be telling the people that the EU will leave them alone with their problems. It’s a complete standoff.

Interview conducted by Candida Splett, Online-Editor.

This is an updated translation of the original German version; translated by Samual Morgan, EurActiv.com.