ANALYSIS: Italy now the real threat not Brexit

Added 2nd September 2016

The Italian constitutional reform referendum this autumn will, or rather should, cause European investors to hold their breath more anxiously than they did on the morning of 24 June.

ANALYSIS: Italy now the real threat not Brexit

Citigroup has called the referendum “the single biggest risk to the European landscape this year,” bigger than the United Kingdom’s leave vote.

Prime minister Renzi leaving, which he said he will do if he loses, could pave the way for the euro-sceptic Five Star Movement, potentially leading to a political crisis on top of its economic crisis.

On the other hand, a Renzi win could lead to proper structural reform in Italy. The referendum is essentially about streamlining the senate from 315 to 100 members in order to drain it of some of its power.

The senate’s ability to bring down governments is one of the reasons why Italy has had so many in the post-World War era.

Much needed political reform aside, two other major issues that Italy needs to deal with is the inefficiency of its economy and the related liquidity issue of the country’s banking system.

Capital injection

According to Gero Jung, chief economist at Mirabaud Asset Management, the main issue is that Italian banks need some capital injection. Estimates range from €30bn to €40bn (£33.5bn, $44.6bn), which is about 2% of Italy’s GDP. But, Jung said, that is likely to be a hurdle that can be stepped over.

However, the problem is that in Italy a large majority of bank bonds are held within the retail sector. And a third of senior bank debt are held within retailers; one half is subordinated debt held within the retail industry. In Italy a lot of the bank debt is actually held by private investors, which creates a lot of complications.

“That means that if banks will need to take a haircut then there will be suffering,” said Jung.

In Jung’s view, political risk abounds everywhere today; the US elections in November, elections in France and Germany next year. What Europe really needs is structural reform and the economy must become more efficient, Jung noted.

“Productivity gains cannot be accomplished if structural reforms in the labour markets and in services are not done,” he said. “Given the fact that we have so many political deadlines, it is difficult to be extremely optimistic about Europe in the medium-term.”

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