How to form a government

The centre left coalition under Pier Luigi Bersani has managed to acquire an absolute majority in the House of Representatives, but the 310 sits of the Senate are divided between the four parties in a way that nobody has an absolute majority. In the Italian political system a government has to have a majority in both Houses.

In any case the initiative is now in the hands of Bersani who needs a government partner with enough votes in the Senate, to be added to his own 121. This has to be either Silvio Berlusconi, whose centre right coalition got 117 Senate sits or Beppe Grillo’s “5 star movement” with its 54 senators. As for the outgoing Prime Minister, Mario Monti, his centre party got only 18 Senate sits, with a quite disappointing overall performance in this election. Probably it didn’t do any good to Professor’s political party the backing he got from Brussels. Berlin had the wisdom not to openly support him.

Low alarm in markets

It goes without saying that capital market fund managers have the most pressing and vested interests for a swift conclusion of negotiations over the formation of a government in Rome. It was encouraging however to see yesterday the bond market to regain confidence after some initial highs. Despite the large losses of 4.5% in the Milan stock exchange, the yield of 10 year benchmark Italian sovereign bond increased only by 31 basic units (0.31 percentage points), meaning that investors asked only for a small increase in the risk premium they demand, to continue holding such securities.

Understandably bond investors have all the reasons of the world to expect a swift solution in the Italian political stalemate, being it a grand coalition between Bersani and Berlusconi or a minor coalition between the centre left and Beppe Grillo. In either option the stakes will be very high. The first to know the news will have the prerogative in the market. Capital markets however kept their composure yesterday, but what if the new government comes out with a programme diverging widely from Monti’s austerity policies? In such a case the selloff of the Italian bonds could take large proportions. In reality markets are much more interested in the content of a possible government programme, rather than in the names undesigning it.

What if?

Returning to the introduction of this article the fact that the Italian debt has reached the region of the €2 trillion feels like a Damocles Sword above the entire Eurozone. If Italy starts looking incapable, of taking care of its own problems by itself, the Entire Eurozone will be again in peril. In such a case there will be no other solution than an intervention by the European Central Bank in the capital markets of Italy and Spain. The ECB can use its unlimited resources, in order to keep the lending interest rates for those two countries at sustainable levels. The central bank has already stated some months ago it could undertake such action. Why not now if developments reach a risky conjuncture? The volume of the Italian debt is so huge that in an emergency, there will be no other way available to refinance it, than with the freshly printed money of ECB’s.

In such an eventuality the Eurozone will face a long period of increased inflationary pressures. Such a prospect though apart from some negative effects on nominal idle wealth, will have positive repercussions on real growth, through the weakening of the euro parities. A cheaper euro however will help everybody to export more to third countries. Italy will be the first Eurozone economy to profit from such an eventuality.

If such a prospect materialises the entire atmosphere in the Eurozone will change and the euro will return to the low region of 1.25 with the dollar or maybe lower. This will be the best news for many including the Italian exporters and the tourism business. What else the Italian and all Eurozone exporters could pray for?

From the Europeansting.com [by permission]

Italy’s FTSE MIB index fell 4.7%, while London’s FTSE 100 shed 1.5% and share markets in Frankfurt and Paris also fell more than 2%. In New York, the Dow Jones Industrial Average fell 1.55% and Asian markets lost between 0.7% and 2.2%. The yield on Italian government bonds rose sharply, implying markets are more wary of lending to Italy.

What happened in Italy?

Pier Luigi Bersani’s centre-left bloc won the lower house vote but has failed to secure a majority in the Senate, and control of both houses is needed to govern. A protest movement led by comedian Beppe Grillo won 25%, and a bloc led by current Prime Minister Mario Monti came fourth, with only a 10%.

The outcome of the election, which finds Italy in deep recession and tough austerity measures, was so close that the margin of victory was less than 1% in both houses of parliament. Centre-left leader Pier Luigi Bersani commented to BBC correspondent Katya Adler :”It is clear to everyone that a very delicate situation is emerging for the country,”

Mr Berlusconi ‘conceded’ to his opponents the lower house; however,  he stated that he would not associate with Mr Monti’s centrist bloc because the prime minister’s poor showing was down to popular discontent with his austerity measures.

The final equilibrium is very fragile: Bersani has the majority, as the winning bloc is guaranteed 340 seats, but the margin is extremely small. Therefore, on a final exam, Italy is walking on a fine line, and stability is not what the country seems to go for.

The results produced a mixed reaction in Europe.

From Bruxelles the president of the European Parliament, Martin Schulz, stated RAI radio that the result is very difficult for Italy, e for Europe: “There is a need for a stable government” because Italy is a member of G8 and therefore a strong player in Europe.

In Germany, the Minister for Foreign Affairs, Guido Westerwelle, hopes for the creation of a functional government in the interest of the whole Europe; he also urged Italy to continue its reforms, and called for a government to be formed “as quickly as possible”.

Garcia-Margallo, his Spanish counterpart, expressed “extreme concern” about the financial consequences of the Italian elections.

It is a mystery where Italy is going. The only man that might make sense of it is Grillo; the Genoese comic, who toured around the country throughout the election campaign and based his speeches on insults against a discredited political class.

“We’ve started a war of generations,” Mr Grillo said in an audio statement on his website,(www.beppegrillo.it) : “They are all losers, they’ve been there for 25 to 30 years and they’ve led this country to catastrophe.”