Pioneer Senior Economist, Andrea Brasili and Head of European Government Bonds, Cosimo Marasciulo contributed to this content. Click here to download a PDF.
On Sunday, December 4, Italian voters will be asked to confirm, or not, a set of reforms that will significantly change the Italian institutional framework. A summary of the proposed reforms and their potential impact follows.
- Why is this Referendum Taking Place?
In April 2016 a set of proposed constitutional reforms were approved by the Italian Parliament. This constitutional bill was designed to overcome the perfect bicameral institutional framework, making the legislative process smoother and more efficient.
Any change of constitutional law, according to Italian legislation, has to be passed by a two thirds majority in the Parliament; if such majority is not reached, a combination of repeated approval (twice in each Chamber) plus a popular confirmation via a referendum is required.
As a two thirds majority was not achieved, the government was forced to call a referendum, which has been scheduled for December 4. In this referendum, Italians will be asked to confirm the proposed reforms by stating “Yes” or “No”. The result will be valid irrespective of turnout.
- What are the Italians Being Asked to Confirm?
The proposed changes to the constitution can be summarized into two main items, plus an “external” addition:
- A dissolution of the perfectly balanced two chamber system – reducing the role, competencies and number of representatives in the Senate.
- A re-centralization of some functions that have been attributed to regions.
The Senate will become the Chamber of the Regions and consist of 95 members, who have been elected by the regions. The Senate will operate as a link between Central government and local authorities. Senate approval of each ordinary law will no longer be required, although the Senate could ask for changes. The Senate will no longer be asked to express a confidence vote to the government.
These changes were proposed with the aim of speeding up the creation of ordinary laws and reducing the cost of politics by significantly cutting the number of representatives.
A number of areas like environmental issues, port and airport management, transport and shipping, energy production and distribution will be managed by the central government, as the responsibility for these competences to local authorities proved to be inefficient and not cost effective.
The “external” addition is a new electoral law named “Italicum”, which is subject to ordinary legislation. The debate about this is ongoing, even inside the Democratic Party (headed by Renzi), with its opponents suggesting that the law could give excessive advantage to the winning party within the new institutional framework, which is centered mainly on the Lower Chamber
In principle, the objectives of the reforms are positive: a more efficient legislative process, a more stable government, an adjustment to local/central responsibilities in areas that clearly need it. Supporters of the “No” campaign mainly cite the excessive concentration of power that the reforms could bring and the general lack of clarity of the new institutional framework. Clearly, the implementation of these objectives could also pose big challenges for the government.
- What Do the Polls Say at the Moment?
At the moment the “No” vote appears to be leading by a small amount, but there is a high number of undecided voters and doubts regarding the possible turnout; so the final result is a close call, particularly if Renzi is able to win over his own party by accepting changes to the electoral law. But it is still unclear if this will happen.
- What About the Political Outcome of the Referendum?
Until recently, Renzi linked his personal fate as Prime Minister to the referendum (which he was fairly confident about winning), saying that he would resign if there was a ”No” outcome. But this communication strategy has now changed and Renzi is progressively trying to disconnect the referendum from his own persona, and from the government, given the opposition is positioning referendum as a vote against Renzi, regardless of the actual agenda.
If “Yes” wins: Renzi’s position as premier will be reinforced, at least temporarily, and given all parties are undergoing a reorganization process, to varying degrees, it is likely that the next vote would not take place until the natural end of legislation, in Spring 2018. As a stronger premier, Renzi will probably attempt to keep “Italicum” intact.
If “No” wins: It is not clear whether the government can survive a “No” victory. It is possible that Renzi will look for a stronger mandate in the 2018 elections (but he has to solve his party’s internal divisions first) and a caretaker government could be implemented for the next year to prepare some changes to the electoral law. In our view, one of the reasons that the referendum was postponed to early December was to ensure the approval of the budget in October.
It is clear that a “No” victory would interfere with a number of current issues, such as the Monte dei Paschi recapitalization plan which the Treasury is following closely, and the relationships and negotiations with the EU Commission and European partners on the issues of migration and the flexibility in public accounts.
- What Are the Possible Investment Implications?
Renzi is internationally perceived as the instigator for structural reform and changes in Italy. While it is difficult to judge the content of each action, a quick look at the recent assessment prepared by the EU Commission Directorate for Economic and Financial Affairs or by the OECD would confirm Italian progress in terms of reforms; the most recent plaudit in the ECB bulletin on the job market reform supports the actions of the current government. If Renzi’s main effort fails, the international community’s confidence in the possibility of reforming Italy will be severely hit. From the perspective of foreign investors, a “No” victory could jeopardize the political capital necessary to introduce changes in the years ahead.
This is why we believe uncertainty will probably persist as the electoral campaign goes on and will tend to keep volatility high.
In the Fixed Income market we are generally positive on peripheral spreads, which will likely continue to benefit from the ECB’s purchasing program. However, we think that present prices are not as appealing as they were just after the Brexit referendum, when fears of a contagion of euro-skeptic movements opened buying opportunities in Italian government Bonds. We believe it would be wise to stay on the sidelines, as we expect some volatility and better entry levels to come.
From a Multi Asset perspective, we think that Italian assets are pricing in scenarios of very depressed growth. A “Yes” win could boost Renzi’s reform efforts and markets would probably start to discount a rosier future for Italy.
A Striking Underperformance by Italian Equities
Source: Bloomberg, data as September 28, 2016. Both indices have been rebased to 100 at September 28, 2016
We believe that, on the equity side, many buying opportunities have emerged in the past few months, which could be interesting regardless of the referendum outcome, as political crises seem manageable and negative surprises seem deeply discounted in current valuations.