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Dec 29, 2017 | 18:35 GMT

3 mins read

Italy: The Countdown to a New Government Begins

(Stratfor)
Forecast Update

In Stratfor's 2018 Annual Forecast, we explain that Italy will be one of the main sources of risk in the eurozone. While we don't expect the country to exit the currency area next year, some of the major political parties competing in the elections are critical of the European Union and are threatening to make unilateral moves unless the continental bloc is reformed.

The date for one of the most important political events in Europe in 2018 has been revealed. On Dec. 28, the Italian government announced that the country's general elections will take place on March 4. On that day, millions of Italians will make a decision that could influence not only the future of the third largest economy of the eurozone, but also that of the entire currency area.

From the eurozone's perspective, Italy is in a particularly fragile place right now. The country's debt stands at roughly 130 percent of its gross domestic product, the second highest ratio in the eurozone after Greece, and its banks are still dealing with high levels of non-performing loans. In addition, the EU Commission has predicted that the Italian economy will grow by 1.3 percent in 2018 — almost half the average growth predicted for the European Union (2.1 percent). Finally, making the eurozone even more nervous are recent surveys showing that a high number of Italian voters are not happy with the political and economic situation in their country. If a dissatisfied Italian electorate chooses to put an anti-eurozone party in power, the government could disrupt and destabilize the currency zone.

Right now, Italy's political landscape is broken into three groups of relatively similar size: the center-left, which includes former Prime Minister Matteo Renzi's Democratic Party and its smaller allies; the center-right, which includes former Prime Minister Silvio Berlusconi's Forza Italia party and the anti-immigration Northern League; and the anti-establishment Five Star Movement. Surveys suggest that none of these groups will win enough seats in parliament to govern alone, which means that they will likely need to form a coalition government. And if they fail to do that, Italy could face another election in late 2018, further compromising the country's ability to improve its economic situation.

One of the major topics of campaign rhetoric in Italy over the next two months will be the country's role in the European Union. The Five Star Movement and the Northern League have threatened to hold a referendum on Italy's membership in the eurozone if the union is not reformed to allow its member states to increase public spending. Forza Italia, for its part, has toyed with the idea of introducing a parallel currency to coexist with the euro. And while these campaign statements are unlikely to materialize, their existence alone shows the extent to which parties are trying to court an electorate that feels disappointed with the common currency after years of low growth and high unemployment.

In a speech on Dec. 28, Italian Prime Minister Paolo Gentiloni warned his country's political parties against dramatizing Italy's risk of instability and reassured voters that the country is economically and politically secure. The Italian economy is growing again, and the eurozone is more stable now than it was when Italy held its previous general elections in 2013. But the country is still vulnerable to financial shocks, and there is a possibility that Euroskeptic parties will win. Moreover, if the elections result in political fragmentation, Italy may struggle to introduce much-needed economic and institutional reforms, compromising the stability of the eurozone in the process.

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