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What’s next for Italy

 
 
The political truce in Italy following Berlusconi’s sentence last week remains fragile1 and many uncertainties of a legal nature make the situation particularly complex. We present an update on the most important issues regarding Italy for the next few weeks. We see little of a substantive nature in August apart from political manoeuvring, whereas September might be a crucial month. We continue to assume that, despite some bellicose rhetoric, no party really has an incentive to seek early elections and that president Napolitano would continue to strongly oppose such an outcome.
1) Vote on Berlusconi’s loss of Member of Parliament status
This is seen as key by many members of the centre-right coalition and the fate of the government might depend on whether Berlusconi will be stripped of his MP title. Despite the sentence on Berlusconi’s ban from public office being sent back to the Court of Appeals for another trial, a law introduced by the Monti government rules that a definitive prison sentence of more than two years prompts a procedure of a loss of MP status. As discussed in a previous note2, in order to strip an MP of their title, there has to be a vote by a Parliament subcommittee on a proposal, followed by a vote in Parliament, and historically it has been usual for the vote to be delayed for quite a long time.
A proposal produced by a centre-right member has been scheduled for discussion on 9 September, with a vote to follow shortly. If approved by the subcommittee, the proposal could be then voted in Parliament. According to the media, if the proposal is voted down by the subcommittee, a new member will be tasked to produce another proposal, further lengthening the time of the procedure.
Adding to the confusion, some media speculated that the law introduced by the Monti government might not apply to crimes committed before its approval. 3 If true, this would allow Berlusconi to keep his MP title even when serving his prison sentence until the Court of Appeals takes a decision. This should take a few months at least and would help lower the political tension. We do not take a view on this hypothesis.
There is little controversy around Berlusconi’s prison sentence. As discussed previously, the effective term is one year, most likely spent in house arrest or in social services.
2) Change to the electoral law
Over the past few years there has been no agreement on how to change the controversial electoral law (referred to as “Porcellum”) that was introduced in 2005 and used in the 2006, 2008 and 2013 elections. A Parliament subcommittee is expected to discuss changes to the law in September with the theoretical possibility of a vote in Parliament on a proposal as early as October. However, keeping in line with the historical tradition, there seems to be no agreement among parties on how to change the law.
However a stall on the electoral law is not a long-term option as a Constitutional Court ruling is scheduled for 3 December. The court has been asked to rule on whether some parts of the entire electoral law are constitutional. In the former case the Parliament might be tasked to revise the law, whereas in the latter case, the previous law might automatically become the new law. The previous law is referred to as “Mattarellum”, and was used in the 1994, 1996 and 2001 elections. 4 At the moment, it is unclear how the mapping from votes to seats in Parliament would change in the case of a move from the current law to the old one in the situation of new elections, but we believe that at the margin it should favour the probability of avoiding a hung Parliament situation. Media articles5 have recently speculated that elections might not be held before December because of the risk of the election been deemed “illegal” after the Constitutional Court ruling, but there is no official confirmation.
3) Centre-left leadership
A new secretary of PD has to be elected after Bersani’s resignation in the spring, but there is an ongoing discussion about the date and rules to elect the new secretary and potential PM candidate in the situation of early elections. The interim secretary announced yesterday that the PD National Assembly will be held on 20-21 September, but no official date for the party congress has been set despite some indication last night that this could take place on 24 November. Some domestic media describe the impasse within PD as an internal struggle between Renzi, popular but politically isolated within the party, and the old guard. According to most polls, Renzi would have fared better than Bersani in the February elections and remains one of the most popular politicians across the political spectrum. Therefore, Renzi’s nomination as PM candidate might reduce the appeal of seeking elections for the centre-right.
4) Possible dates for elections in 2014
There are some soft constraints on elections also in 2014. Italy will take the rotating presidency of the EU in 2H14 and having elections during that period might be far from ideal from the point of view of running the EU agenda. Also in June-July a new European Commission will be elected after the vote for the European Parliament on 22-25 May, and the lack of a government might hamper Italy’s ability to negotiate with the other countries. Pending the Constitutional Court decision on the electoral law, this would make a vote in the spring the most likely.
5) Rating agencies (S&P: BBB Neg, Moody’s Baa2 Neg, Fitch: BBB+ Neg, DBRS: A low Neg)
Although a political stalemate might still be considered a satisfactory result for financial markets, rating agencies might not be as patient. There are two important thresholds to pay attention to: 1) A fall to sub-investment grade, which could trigger some forced selling, although recent measures adopted at European and Italian levels are an attempt to avoid automatic selling triggers; 2) A decline in the DBRS rating below the A area, which would prompt a 5% additional haircut on Italian sovereign securities funded at the ECB (Exhibit 1).
We see limited risk of a fall below investment grade, especially given the recent pick up in the macro indicators. S&P downgraded Italy two notches above sub-investment grade in July6, with limited impact. Moody’s reaffirmed Italy’s rating at the end of April and in May it stated that Italy’s stronger budgetary performance still justifies a better rating compared to Spain. Fitch downgraded Italy in March after inclusive elections, but the rating is still three notches above sub-investment grade.
The risk of a DBRS downgrade is more concrete: a few days ago the rating agencies stated the probability of a downgrade of Italy (and Spain) is higher than 50% over the next 12 months and further political uncertainty might not be a welcome development. The negative implications should be contained and felt more at the short end of the curve. The latest Bank of Italy Financial Stability Review shows that around 50% of the almost €400bn assets pledged by Italian banks with the Eurosystem are dependent on the Italian sovereign rating. Mechanically a 5% average haircut increase on almost €200bn would imply additional collateral needs of €10bn, but we highlight that: 1) only around 3/4 of the assets pledged are used for ECB funding and 2) free ECB eligible collateral in the Italian banking sector amounts to more than €200bn (as of February 2013, unlikely to have changed dramatically since).
6) Bond supply dynamics
Italy has issued €161bn of bonds year-to-date covering 2/3rd of their 2013 gross bond funding needs of €243bn, based on our forecasts (Exhibit 2). Italy has also covered more than 70% of its net-funding needs for 2013 (based on our forecasts) putting them in a good position for rest of the year. Italy has also made good progress in tackling the issue of declining weighted average maturity of debt in 2013 as it issued nearly a quarter of its total conventional issuance in the ultra-long end. As discussed previously, primary and secondary market statistics have improved significantly in 2013.
In conclusion, we continue to monitor the political situation with attention, but, for the time being, we remain positioned for a further compression of peripheral spreads. For details on our trade recommendations, see Global Fixed Income Markets Weekly, Euro Cash, published later today.
1 See Italy update: Government likely to survive regardless of legal decision on Berlusconi, G. Salford, 1 August and Italy update: Berlusconi conviction has limited implications, hold intra-EMU tighteners, G. Salford, 2 August.
2 See Italy update: Government likely to survive regardless of legal decision on Berlusconi, G. Salford, 1 August.
4 3/4 of the seats are allocated with a first past the post system and the remaining 1/4 with a proportional system. Compared to the current law, “Mattarellum” tends to result in a more similar seat allocation in the Lower and Upper house.
6 See Expect limited impact from Italy downgrade, G. Salford, 10 July.
 
Exhibit 1: A DBRS rating downgrade below the A area would trigger a 5% additional haircut on Italian sovereign securities funded at the ECB
Haircuts on Category I collateral used at ECB funding operations*;
GPSWebNote Image
* The ECB uses the best rating of S&P, Moody’s, Fitch and DBRS to determine the rating threshold.
Source: ECB
 
Exhibit 2: Italy has covered a good part of its 2013 funding needs already
YTD realised and J.P. Morgan forecast of 2013 Italian gross and net issuance*; €bn
GPSWebNote Image
* We track supply on auction date basis rather than on settlement date basis.


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