Italy’s Referendum – D-Day approaches – what you need to know

On 4 December, Italians are set to vote on the constitutional reform proposed by Prime Minister Matteo Renzi, in what could be the third political black swan event for 2016.

It is widely believed that the Italian referendum will be a turning point for Europe. If Italy’s citizens vote against the reforms, then the European Union as we know it today may soon cease to exist. However, if the reforms are passed it could signal a stronger desire by European citizens to make the European project work and Italy’s economic recovery may finally take hold.

Italy’s Referendum: What It Means For Investors

The outcome of the referendum is of high importance for the Italian economy and European market sentiment. If accepted, the bill could boost confidence in the recovery of the Italian economy, create political stability and reduce uncertainty about the future of the euro area.

Italy's Referendum italy photo Italy's Referendum: What It Means For Investors
Italy’s Referendum Photo by skylark (Pixabay)

Italian GDP has still not returned to its pre-crisis level and the country is coping with a large public debt — at 132.7% of GDP — and deficit — at -2.6% of GDP — as well as a high share of non-performing loans (18% of total loans). Further, Italy has  Europe’s fifth highest unemployment rate (11.7%), and more than 37% of the country’s youth are unemployed.

Accepting the bill should boost the government’s ability to cope with these issues. According to the Italian government and other economists, 2017 growth will fall from 1% to around 0.6% without the budget and growth-measures suggested.

Italy’s Referendum will ask voters if they support Renzi’s new Italicum electoral law. The aim of Italicum is to prevent governments of unstable coalitions, as Italicum gives the party winning at least 40% of the votes in the first round or winning a second round between the two biggest parties, a large number of bonus seats to ensure it has a 54% majority (340 out of 630 seats) in the lower house. Supporters argue that this law will bring much-needed political stability (Italy has had 63 governments since 1945) and allow governments to push through important growth-enhancing reforms. However, critics argue the government will become too powerful. Technically, Italicum entered force in July but the constitutionality of the new law has been challenged in the constitutional court and a final ruling is not expected before early next year. A ‘no’ vote would increase pressure on the government to reconsider the bill while a ‘yes’ vote would reduce pressure on the government to amend the Italicum.

And a ‘no’ vote on Italy’s Referendum could have a greater impact on Italy than a government setback. Analysts at Danske Bank believe a ‘no’ vote will result in:  

“Prolonged uncertainty for global investors and trigger political turmoil. Uncertainty on ‘what is next’ is likely to cause elevated volatility and further shake confidence in the European project. A ‘high’ political risk premium is already priced in the Italian government bond market with Italy having underperformed Spain by 30bp since early September, mainly on political woes. Renzi himself said that he expects high market volatility in the run-up to the referendum. Given Italy’s sizable government debt (130% of GDP) and the possibility of a slowdown in reforms and growth, questions about the direction for Italy (and Europe) have the potential to drive global risk sentiment around the referendum date. These fears could spill over to other periphery countries. The political impasse would also heighten concerns about Italy’s banking system, with its large share of non-performing loans. Economic and political uncertainty would weigh on the EUR and depress investments and future potential growth. This said, the market reaction is very dependent on the political path following the ‘No’ vote. As spreads have already widened significantly ahead of the referendum, we do not rule out that we could see tightening even in a ‘No’ scenario (‘sell the rumour – buy the fact’).”