“Political risk is never far away from the eurozone,” says Julian Callow of Barclays Capital. A fortnight ago, Italian bond yields, or borrowing costs, hit a two-year low. The government headed by Mario Monti, appointed in November 2011, had restored calm and he had made a start on economic and structural reforms to boost Italy’s chronically slow growth.
But now investor jitters have returned. Monti’s discredited predecessor Silvio Berlusconi has withdrawn his centre-right group’s support for Monti’s caretaker government, and intends to seek office again. Monti has resigned, bringing forward by a few weeks parliamentary elections that were due by April.
“The unique toxicity of the former prime minister” was clear from the 2.9% jump in ten-year yields on Monday, says Sam Fleming in The Times. That was one of the worst one-day performances for ten-year Italian bonds in over 20 years. Berlusconi is unlikely to win, but he has openly questioned Italy’s place in the eurozone and has positioned himself as the anti-austerity candidate.
But even without Berlusconi and a U-turn on fiscal discipline and euro membership, there could be plenty of upheaval ahead amid a return to “business-as-usual in Italian politics. Chaos, backbiting and brokenpledges” would rattle investors again, severely denting confidence that Italy can ever grow fast enough to work off its debt mountain, worth 125% of GDP.
In this context, the key is to reform inflexible labour and product markets. Monti has taken “a step in the right direction”, says The Economist, instituting a pension reform to extend working lives, making its slightly easier to get rid of workers, and shaking up cossetted professions by abolishing minimum fees and encouraging new entrants. “But there is a long way to travel.” For instance, thanks to “determined lobbying”, Monti had to reduce the number of new pharmacy licences he planned to grant.
The worry now is that, with Monti’s exit, “the window for economic liberalisation… seems likely to close”, says The Wall Street Journal. Centre-left front runner Pier Luigi Bersani has said he won’t overturn Monti’s changes, but he will be beholden to Italy’s far left if he wins.
However, there is talk of Monti being persuaded to stand in the election. In the meantime, the deepening recession, exacerbated by austerity, makes growth, and hence debt reduction, seem an ever more distant prospect. As of this week, investors in Europe have another major headache to deal with.