Italy and Spain Rattle the Eurozone

6 MINS READMay 29, 2018 | 19:22 GMT
An Italian police officer in riot gear watches an anti-fascist counterdemonstration against a far-right meeting.

An Italian police officer in riot gear watches an anti-fascist counterdemonstration against a far-right meeting.

  • Italy's political crisis has deepened, significantly increasing the likelihood that another round of elections will be held soon. Should that happen, Euroskeptic parties will likely perform strongly again.
  • In Spain, the government faces a vote of no confidence. Even if it manages to stay in power, the minority government in Madrid will be increasingly ineffective.
  • While Euroskeptic politics in Italy represent a much more urgent threat to the eurozone than those in Spain, the countries using the currency are so deeply interconnected that financial risk from either country could easily spread.

Political turmoil has returned to Southern Europe. The governments of Italy and Spain are facing crises that raise questions about the future of much-needed economic and institutional reforms and that could lead to early elections. In Italy, the country's continued use of the euro could be under threat. Because of these concerns, the second half of 2018 will be filled with economic uncertainty for the two countries, which are the eurozone's third and fourth largest economies, respectively.

In Italy, the coalition between the anti-establishment Five Star Movement and the right-wing League, which was close to forming a government, collapsed after President Sergio Mattarella refused to appoint a Euroskeptic candidate to the post of economy minister. Instead, Mattarella opted to appoint Carlo Cottarelli, a former International Monetary Fund official, to lead a caretaker government. Cottarelli and his government will soon face a confidence vote in Parliament, where he is likely to be defeated because the Five Star Movement and the League, which control a majority of seats, have already refused to work with him. If Cottarelli loses, new elections will follow as early as August. However, Mattarella will play a large role in deciding the date, and he could postpone the vote to give Parliament more time to write a new electoral law. 

The Big Picture

Stratfor's 2018 Annual Forecast said that Euroskeptic forces in Italy would present the greatest risk to the eurozone in 2018 and that Spain's minority government would struggle to pass legislation. Recent events show political uncertainty in both countries is once again creating concern in financial markets and raising questions about the euro's future.

In Spain, a vote of no confidence against Prime Minister Mariano Rajoy is scheduled for May 31 and June 1. Because Rajoy leads a minority government, he will need support from other parties in parliament to survive. The main opposition party in Spain, the Socialists, proposed the vote after a court convicted several people who were linked to Rajoy's party of corruption. Still, Spain's opposition is divided, and it will probably be a close vote. If Rajoy loses, the opposition will appoint a new prime minister, who will decide whether to call for early elections. But even if Rajoy wins, his government will find it increasingly hard to secure the votes to pass legislation, and the pressure for him to resign will only intensify.

Similar Starts, Different Destinations

In some ways, the crises in Spain and Italy have similar origins. After the economic crisis of the late 2000s, the traditional party system in both countries collapsed. In Italy, mainstream political forces progressively lost ground to their populist rivals, including the Five Star Movement and the League. These emerging parties performed strongly in the general elections on March 4, and they reached an agreement to form a government that would aim to cut taxes, increase public spending and abolish the reforms of its predecessors. While the agreement did not include a pledge to leave the eurozone, it did call for a renegotiation of EU targets on debt and deficits.

Like their Italian counterparts, Spain's traditional parties also lost ground to emerging rivals, including the left-wing Podemos and the centrist Ciudadanos. This shift caused Spain's political landscape to become so fragmented that two general elections were required before a government could be formed.

Italy's Five Star Movement and the League are extremely critical of the European Union and have even flirted with the idea of leaving the eurozone.

The similarities end here, however. Italy's Five Star Movement and the League are extremely critical of the European Union and have even flirted with the idea of leaving the eurozone. These parties will likely maintain, or even deepen, their anti-austerity rhetoric. Moreover, they will accuse Mattarella and the European Union of blocking the will of Italian voters. The markets were already worried that a coalition between the Five Star Movement and the League would lead to higher deficits in Italy, where government debt already exceeds 130 percent of the country's gross domestic product. And those concerns will likely continue, because the Five Star Movement and the League are likely to perform well in the next election, which markets may come to view as an unofficial referendum on the euro and Italy's membership in the eurozone.

In Spain, on the other hand, three of the country's four most popular parties (the conservative Popular Party, the center-left Socialist Party and the centrist Ciudadanos) are openly supportive of the European Union, and the fourth (the left-wing Podemos) has significantly toned down its criticism of the bloc. Should Spain hold early elections, topics such as corruption, public spending and Catalonia's possible secession will dominate the campaign. Spain's role in the European Union, however, is unlikely to come under question. Still, Spain is not out of the woods. Even if he manages to remain in power, Rajoy's government will be too weak to easily pass meaningful legislation. And if an early election takes place, the political paralysis will continue as a likely fragmented parliament engages in long negotiations to form a government. To make matters worse, Catalonia's calls for secession are unlikely to end anytime soon, meaning the issue will continue creating political and economic uncertainty.

The Price of Political Risk

Italy and Spain are both going through political crises at a time when their economies are growing after years of stagnation. Spain's recovery has been particularly strong, as annual growth has been above 3 percent since 2015. Italy's recovery has been much more modest, but the country has grown every year since 2014. However, political uncertainty will threaten these gains for several reasons.

Fragmented parliaments and weak governments will make it hard for Italy and Spain to introduce the economic and institutional reforms necessary to secure sustainable economic growth. This will be made all the more difficult by emerging parties in both countries, which will promise to reverse the austerity measures enacted by their predecessors. Because the eurozone is so deeply integrated, the instability in either country can easily spread across the bloc. Italy represents a much larger threat to the eurozone's stability than Spain right now, but as Europe has learned in recent years, political and economic events in one country can easily lead to a crisis in others.

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