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Italy dealt the latest anti-establishment blow after voters rejected plans to reform the country’s constitution, creating more problems for Italian banks, say Robeco’s experts.
The 60-40 vote was essentially further revolt against ‘the establishment’ amid a rise in populism following the shock Brexit referendum in June and Donald Trump’s victory in November, says Chief Economist Léon Cornelissen. The vote makes it harder to solve the Italian banking crisis, says equities fund manager Mark Glazener, while Italian bonds should be underpinned by the European Central Bank, says portfolio manager Olaf Penninga.
The euro initially lost a cent and a half versus the dollar before recovering, while Italian stocks fell 1.2% and 10-year Italian bond spreads widened 12 basis points against benchmark German bonds.
The referendum had sought to downsize the Italian Senate, which currently has equal status with the lower house of parliament. Any Italian government needs to win the confidence of both houses, and frequent rebellions have produced 63 governments in the last 70 years. With the resignation of Prime Minister Matteo Renzi following the result, Italy is now forming the 64th.
“It was a crushing defeat for Renzi, but it wasn’t unexpected,” says Cornelissen. “There is a great irony because you could argue that Renzi’s proposed reforms were anti-establishment, and now the anti-establishment brigade has voted against them.”
“But this was also seen as a vote about Renzi and his pro-EU policies, so in that sense it’s another populist revolt. The main winner here will be the populist and anti-euro Five Star Movement, headed by former comedian Beppe Grillo.”
‘The new government will probably reform Italy’s election law’
“In practical terms this probably doesn’t mean too much, though the pressure on the Italian president to call new elections has increased, so he will probably play for time. The most likely scenario remains that the president will appoint a caretaker government under the leadership of Pietro Grasso, the anti-mafia magistrate who currently is president of the Senate, or Pier Carlo Padoan, the internationally respected finance minister.
“The new government will probably reform Italy’s election law, thereby diminishing the chances of a populist majority in the next elections which have to be held no later than 23 May 2018.”
Renzi had been Prime Minister of Italy since February 2014 as the leader of the center-left Democratic Party. Elected at the age of 39, he was the youngest national leader in the EU and the G7. He was the chief architect of the constitutional referendum and had staked his political career on it.
Cornelissen says there is far greater concern about presidential elections in France in April 2017 and the risk of far-right candidate Marine Le Pen getting elected. In a separate vote on 4 December, voters in Austria rejected the far-right candidate for president, though unlike in France, the Austrian presidency is a non-executive, ceremonial role.
“There was a brief period of relief in Brussels when the Green candidate won the Austrian presidential elections, but this was short-lived,” says Cornelissen. “The main worry is this continuing defeat of centrist politicians in the Eurozone, with the next eye on France.”
Cornelissen says that while constitutional reform could be seen as arcane, the day-to-day problems facing the next Italian government are real. “In the short term, the biggest issue is how to handle the banking problem and recapitalization – Banca Monte dei Paschi di Siena alone needs EUR 5 billion.”
‘Economically, Italy is a problem child within the Eurozone’
“But it’s likely that this will be solved without using the new European bank bail-in rules, because too many Italian households hold subordinated bank debt. If people who thought they had a safe investment get a massive haircut when the debt is devalued under a bail-in, then you would get a real populist revolt. So they’ll handle it without the bail-in rules.”
“Economically, Italy is a problem child within the Eurozone because of its structurally low growth rates and ongoing banking crisis, but as long as Italy has a government which nominally subscribes to EU rules, the ECB will act as a guardian for the Italian bond market.”
“With the no-vote, the focus is back on Italian banks which have amassed EUR 300 billion in bad loans,” says Mark Glazener, portfolio manager of the Robeco NV fund which had sold Italian stocks ahead of the referendum.
“These bad or non-performing loans account for 18% of all bank loans outstanding in Italy. More than 75% of these loans are to companies. Since the sovereign debt crisis, other countries in the Eurozone have come to grips with their bad debt problem, but bad loans in Italy have kept rising.”
“One of the reasons why the loan problem has ballooned is the slow judicial system and laws that are out of date. Of all the loans, 40% is backed by collateral, but it takes banks ages to repossess this collateral and sell it to pay down the loan. A ‘yes’ vote would have brought a better and more efficient judicial system, making collecting the collateral a lot easier. With no or lackluster growth in the Italian economy the banking problem is here to stay. That is why we were not invested in Italy prior to the referendum.”
‘It will put pressure on several smaller struggling banks’
He says after the ‘no’ vote, plans to recapitalize the 544-year-old Banca Monte dei Paschi di Siena – “the poster child of Italian banking in this day and age” – will be in doubt. It had agreed a bail-out package with the ECB, and if that doesn’t pass, a bail-in that would be politically unacceptable to the Italian government will be needed.
“It will lead to a struggle between the European bureaucrats and the Italian government and it will put pressure on several smaller struggling banks," Glazener warns.
“The ECB will continue to support the Italian bond market through its purchase program,” says Olaf Penninga, portfolio manager of the Euro Government Bonds fund which owns Italian sovereign debt.
“Italy is the third-largest economy in the EU, and the biggest sovereign bond market in the Eurozone, so the ECB is well aware of its vulnerability. If anything this will strengthen the case for the ECB to extend its bond purchasing program beyond March 2017 to curb further excessive increases in Italian bond yields.”
“Furthermore, many investors have strongly reduced their positions in Italian government bonds in recent weeks, heightening the possibility that they will re-enter the market to benefit from the significant yield pick-up that Italian governments offer over other fixed income assets.”
“This strong technical backdrop provides a clear counterbalance to Italy’s weak fundamental outlook, and this is why last week we closed our underweight position in Italian government bonds in the Euro Government Bond fund and our short position in the Global Total Return Bond fund.”