The consensus for the Letta government is crumbling. Political shocks are adding to paralysis and economic stagnation.

Shocks

  • On July 30th the Supreme Court (Corte di Cassazione) will have the last say on Berlusconi’s recourse against the Appeal Court which sentenced the ex Prime Minister to four years in prison and to a five/three years ban from pubblic offices/private companies’ appointments, on charges of tax fraud in the Mediaset affair. The speed of the decision, unusual for Italy, has averted the risk of a prescription. A likely confirmation of the previuos two sentences against Berlusconi will send shock waves to the coalition government from the right.
  •  the mismanagement of the “Kazhak affairs” where the spouse and daughter of dissident Ablyazov where forcedly re-patriated with Interior Minister Alfano (PdL segretary) claiming not to be informed, is likely to further undermine the government support from left.
  • The Democratic Party is also deeply divided between the “old appartcniks” clunching to the Letta government in the quest for survival, and Renzi’s supporters, the Florence’s major who is threatening to take-over the party (and possibly the government).
  • Foreign Shocks from Greece and Spain may raise sovereign yields and make fiscal choices harder

Paralysis

–  The Governent has shown that  an agreemeent between the right and left is elusive: when hard choices had to be made,  e.g. what expenditures to cut in order to finance the planned reduction in the property taxes and to avoid the planned VAT rate increase,  the only feasible solution was postponing the decision to September;
–  reforms such as electoral law, spending review, privatizations of public utilities, credit market, are  now off-the table: they are too controversial;

–  political consensus is similarly elusive. The racist comments of Senate vice-chairman Calderoli aroused outrage and request of resignationsfrom the centre-left, but prompted only mild reproaches from the centre-right. As usual, nothing happened.

Economic Stagnation
The economy is worsening: growth forecast are revised downwards ( -2% in 2013), unemployment is escalating (with youth unempolyment closed to 40% and the number of young not in education, training, employment at 2,25 million), firms are closing down (more than 4000 in the first quarter of 2013, +13% year to year) under the grip of the fall in consumption and of the persistent credit crunch; exports are not picking up. Inevitably, all this will weaken the budget position by end end of the year possibly requiring additional fiscal consolidatation and adding to political and economic strains.

Scenarios

  1. If the political shocks above materialize and the Letta government falls (my subjective probability is above 50%) , a confidence crisis in public debt may materialize and send spreads through the roof, requiring Mario Draghi’s OMT to step in.

What comes next depends on what happens in Italy and what happens in the EU:

        a) If a new leadership (Renzi) snaps the new elections and restore confidence, and Draghi OMT survives politically the inevitable German miscontent, things may go back to “normal”;
         b) If either of this condition fail, Italy may be forced  to restructure the debt

    2.      If the Letta goverment survives the shocks, it may kick the can down the road for some time.

Advice
The Letta government should concentrate on a snap electoral reform that may enable a stable government to emerge in case scenario 1 materializes. By so doing, it would prevent  the catastrofic default outcome 1b.