Italy: markets act as the boy who cried wolf

Political uncertainty in Italy has caused market turmoil with significant spillover effects within but also beyond the Eurozone. Contagion within the eurozone was of a different nature than in 2011. With a new government in place, attention will now focus on its economic policy, in particular in terms of public finances.

Italy has seen a strong pick-up in growth and in 2017 real GDP increased 1.5%, the fastest pace since the crisis. This has translated into a significant drop in the unemployment rate and considerable job creation. In 2017, the country had a current account surplus of 2.8% of GDP, and in recent years its net foreign asset position has improved significantly, reaching a very low -7% of GDP. Since 2014 the public sector deficit has been below 3% of GDP. Most importantly, European Union data show that since 1995 the country has been running a primary fiscal surplus for 22 years (only the year 2009, in the depths of a worldwide recession, saw a small primary deficit). Most (65%) of public debt is domestically held. Admittedly, the country faces many economic challenges - it’s not alone in that respect –a key one of which is boosting potential growth. Nevertheless, it is worth keeping these numbers in mind when observing market behaviour over the past 10 days. It showed that the spread’s widening reflects an increase in worries rather than a deterioration in fundamentals.

The source of these worries was the uncertainty about how the coalition-government-in-the making would handle a number of issues (allowing a considerable increase in the public sector deficit, its relationship with ‘Brussels’). Following the proposed appointment of Professor Savona, who is considered to be a eurosceptic, as Treasury Minister, markets went so far as to start to doubt Italy’s commitment to the eurozone. All this is reminiscent of the fable about the sheperd boy who cried wolf, frightening the villagers with the danger that their flock of sheep would be attacked by wolves whereas nothing happening.Indeed, it is worth remembering that in the 57-page contract for the new government signed by 5 Star and the Northern League no mention is made of the issue of abandoning the euro.