Sergio Mattarella was re-elected president of Italy on the 29th of January. It took 6 days and eight ballots to the electoral college and the legislators to make this decision. Sergio Mattarella is 80-years old and he said repeatedly that he did not want a second term. However, his re-election has been well received, as the fears of an early election were haunting the governing coalition.
With this in mind, we had the insights from Scope Ratings and MFS Investment Management, who have analysed the implications and effects of the re-election of Sergio Mattarella in the markets.
Dennis Shen and Giulia Branz, analysts at Scope Ratings
After a tumultuous week of negotiations over the Italian presidency, the decision to re-appoint Sergio Mattarella has mitigated immediate re-emergence of political instability and improved the likelihood of reform for Italy (BBB+/Stable) this year. However, uncertainty looms after the 2023 elections – representing one core rating constraint.
A continuation of Mario Draghi’s national unity government to at least 2023 – as we assumed – is expected to further advancement of crucial reform regarding public procurement and competition law, underpinning economic recovery and ensuring a continued inflow of vital funding from the EU’s Recovery and Resilience Facility.
Italy front-loaded reforms, upon which receipt of funding from the 2021-26 EU Recovery Fund is conditional, to 2021 and 2022 – Draghi’s assumed window as prime minister. This includes overhaul of public administration, the judiciary, budgeting and pensions.
Nevertheless, Draghi’s space for significant reform is finite, given the support he requires in parliament to govern might weaken as parties step up electoral campaigns before 2023 elections, although he possesses a possible trump card of threatening to pull the plug on government should parliament become gridlocked.
Even so, the credit rating relevance for Italy and the EU more broadly of even a single additional year of Draghi as prime minister ought not be understated. Draghi could leave a lasting mark upon European economic governance by adding his respected voice to EU deliberations around changes of the Stability and Growth Pact and regional budgetary rules.
Still, the re-election of Sergio Mattarella as president in the absence of any other candidate with a majority backing of electors did illustrate how difficult consensus-building remains in Italy, which might foreshadow possible complications in formation of a government after elections of 2023.
The forthcoming 2023 election remains, moreover, a risk due to possibility of a skew to the political right after the election – were Italy to elect a (first) far-right prime minister (of the post-war era),” says Shen. “This said, especially under an alternative scenario in which the right were to come up short, we also do not rule out possibility of Draghi being called on to prolong a prime ministership under scenario of a hung parliament.
For now, the Draghi administration has been responsible for comparatively stable and prudent policy, boosting domestic economic sentiment, anchoring a recovery that has as well benefitted from pent-up demand and raised public- and private-sector investment.
An official estimate with respect to 2021 economic growth was printed of an above-consensus 6.5% – near Scope’s December estimate for 6.6% for last year. In 2022, Scope expects growth of a robust 4.5%, prior to 2.1% during 2023.
Prudent policy making is especially significant given the recent increase in yields on Italian government bonds to a nevertheless still accommodative 1.4% – equivalent to 136bps spread to Germany – from a low of around 0.5% last August. Minimising unnecessary sovereign risk premia associated with domestic politics is crucial for the state’s long-run debt sustainability, as the ECB pulls back on support in debt capital markets amid a sharp pick-up of inflation,” says Shen.
Scope assesses Italy’s debt trajectory as remaining on an upward trend over the long run (factoring in rises during future crises).
Enhanced stability of the national government and momentum behind a robust programme of reform supported Scope’s announcement of a revision of an Outlook concerning Italy’s sovereign credit ratings to Stable, from Negative, in August of 2021. The next scheduled review date of Italy’s sovereign ratings is 11 February.
Annalisa Piazza, Interest rates strategist at MFS Investment Management
The outcome of the Italian Presidential election (Mattarella re-elected and Draghi remaining PM) is the best-case scenario for Italy in the next 12 months. As such, BTPs should benefit from the expected stability and the integrity of the two major political figures. In the short term, we see chances of a modest tightening in spreads vs Bund.
We remain relatively optimistic on Italy’s recovery story (GDP to remain well above potential for a few years); reforms and the implementation of the Recovery and Resilience programme are key supportive factors; Italy’s fiscal outturns improved due to the combination of positive tax receipts and the more structure of its debt. The long-term picture remains optimistic for Italy and we expect further improvement in its debt sustainability. Valuations are relatively fair for BTPs but we see chances of some spreads compression as investors see more stability now risks of early elections lessened.
What are the major risks at the current stage – Although the outcome of the elections is the best case for Italy in the coming months, we still see some possible risks. Indeed, On the negative side, he current large coalition Cabinet could be reshuffled in the coming weeks as party’s coalitions showed increasing weaknesses during the Presidential elections. Talks within the major parties will start today (Salvini already called for a party meeting and news flow talk about some clarification needed between the 5SM Conte and DiMaio).
BTPs might also suffer should the ECB start to flag a ‘return’ to more orthodox monetary policy (i.e. hinting at an earlier than expected hike). This could lead to some temporary rewidening of periphery/Bund spreads as it would imply QE ends soon. This is not our baseline scenario, but risks are non-trivial, given the hawkish ECB raising their voice and ‘peer’ pressure from other Central Banks. In addition, the medium-term impact of the Recovery Fund could be less than optimal (hard the measure) should Draghi find a lot of opposition with the unity government in the coming months as parties start their electoral campaign soon. In that eventuality, investors might re-focus on Italy’s long term issues (low growth and low potential GDP).
On the positive side, risks of early elections are close to zero now and the weakness of political counterparts will allow Draghi to continue with the ongoing reforms programme. In addition, with political risks now reduced, rating agencies will continue their gradual upgrade for Italy
Political risks on the side for now – the Mattarella-Draghi duo provides the much-needed stability why the Mattarella-bis is the best case for Italy. Although the political parties negotiations over the past week confirmed more than ever how the Italian Parliament is highly divided, the reelection of Mattarella as President and Draghi maintaining his role as PM provides the much needed stability to the country, at a time when the Covid emergency state is still on (at least until March 31) and the country needs to focus on reforms and the implementation of projects that are needed to continue to receive the tranches of the Recovery Fund. Short-term volatility in the Cabinet cannot be ruled out as the weakened coalitions (especially the centre-right) that emerged from the runup of the election of the President might lead to some reshuffle. However, we would expect Draghi to gain even more power in pushing in the direction of reforms now that political parties need to pick up the remaining pieces of their own programmes ahead of 2023 elections.
In the next 9-12 months we will watch: how reforms progress, the progress of the electoral law (that could define the shape of the next Parliament in 2023) and if there is any hint Draghi is willing to take Mattarella’s ‘job’ after his role as PM expires next year.
