What does Italy’s latest political crisis mean for the economy?

The potential collapse of Italy's government has thrown the post-pandemic recovery plan into doubt and brought back fears of a debt crisis - but how severe will the impact on the economy really be?

What does Italy's latest political crisis mean for the economy?
Banks in Milan’s Porta Nuova business district - Markets were down at the end of last week as the Italian government threatened to collapse. Photo by MIGUEL MEDINA / AFP

As Italy was plunged into a political crisis on Thursday, shockwaves immediately rippled through the markets: Milan’s stock exchange was down more than three percent over fears Prime Minister Mario Draghi’s coalition government could come crashing down and spark snap elections.

All eyes are now on borrowing costs after the ‘spread’ – the closely watched gap between German and Italian 10-year interest rates – widened further on Friday following Draghi’s attempted resignation amid the deepening crisis.

READ ALSO: Four scenarios: What happens next in Italy’s government crisis?

But President Sergio Mattarella refused to accept the prime minister’s resignation – instead urging Draghi to address parliament on Wednesday in an attempt to find a way forward.

The country now faces prolonged uncertainty, with no clear path forward.

“Any signal that Draghi would not survive the 2023 parliamentary elections, or even leave office before, is a cause for concern for the markets,” Gilles Moec, chief economist at the Axa group, told AFP.

Although political crises are nothing new in Italy, Galietti said “this one is unprecedented” because of geopolitical factors, citing tensions with Russia over its invasion of Ukraine.

Even without the current political instability, Italy’s economic outlook is suffering due to “the size of its debt, its low growth rate and its strong dependence on Russian gas,” Moec said.

Italy's Prime Minister Mario Draghi tried to tender his resignation on Thursday, but was asked by President Sergio Mattarella to stay.

Italy’s Prime Minister Mario Draghi tried to tender his resignation on Thursday, but was asked by President Sergio Mattarella to stay. Photo by Filippo MONTEFORTE / AFP.

Italy has a mammoth debt of over 2.7 trillion euros or some 150 percent of GDP – the highest in the eurozone after Greece – though the debt-GDP ratio is beginning to shrink.

The country has long lagged behind others in the eurozone: between 1999 and 2019, the economy grew by just 7.9 percent compared to 30.2 percent in Germany, 32.4 percent in France and 43.6 percent in Spain.

Italy’s gross domestic product increased 6.6 by percent in 2021, after a 2020 slump due to the coronavirus pandemic.

The Bank of Italy expects GDP to increase by 3.2 percent in 2022 – but that figure could drop below one percent if Russian gas supplies are cut off over the war in Ukraine.

READ ALSO: Italian PM says Russia’s excuses for gas cut are ‘lies’ as shortfall continues

After former European Central Bank chief “Super Mario” became prime minister back in February 2021, Italy’s 10-year borrowing rate fell below 0.5 percent.

It has now climbed to 3.4 percent.

Italy is counting on the European recovery fund to boost growth. It’s the biggest beneficiary of all member states, set to receive 191.5 billion euros if it ticks off a series of EU-requested reforms aimed at, among other things, improving creaking infrastructure and preventing large-scale tax evasion.

Draghi’s departure, however, would put those reforms at risk.

More than a thousand Italian mayors signed a petition on Sunday pleading with Draghi to stay on, saying the post-pandemic recovery plan required stability.

“Our cities… cannot afford a crisis today that means immobilism and division,” the petition said.

“We need stability, certainty and consistency in order to continue the transformation of our cities… Because without the rebirth of these, Italy will not be reborn either.”

But with Draghi’s grand coalition in disarray, the chances the country will head to snap elections after the summer are high.

READ ALSO: ‘We need stability’: Hundreds of Italian mayors plead with Draghi to stay

A far-right or populist win at the polls would weigh significantly on the spread, just as it did in 2018, when Matteo Salvini’s anti-immigrant League joined forces with the once anti-establishment Five Star Movement.

Public finances are however unlikely to be derailed as in the 2012 crisis, economic experts said.

“Interest rates would have to rise very sharply and durably for us to begin to observe solvency problems,” Natixis economist Jesus Castillo told AFP.

Italy’s bonds last on average over seven years, which means the rise in rates will not immediately be reflected in debt.

What’s more, banks are in better shape now than in 2012.

“Economic fundamentals remain compatible with long-term debt sustainability,” Castillo said.

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EXPLAINED: Why people in Italy might have to carry more cash from now on

Italian retailers will no longer face fines for refusing card payments on amounts lower than €60, after the government put the brakes on a recent push towards electronic payments.

EXPLAINED: Why people in Italy might have to carry more cash from now on

Italy’s new budget bill is set to add yet another controversial chapter to the country’s long and troubled history of card payment laws.

Under Italy’s new budget law, retailers will no longer be fined for refusing card payments for smaller amounts – a controversial move that is expected to have a knock-on effect for shoppers.

READ ALSO: Key points: What Italy’s new budget law means for you 

Fines for retailers refusing card payments on amounts lower than €60 will now be suspended until at least June 2023, according to a clause included in the text of the 2023 budget law published to media on Wednesday.

As set out by the bill, the six-month suspension will allow the newly created Ministry of Enterprises and Made in Italy to “establish new exemption criteria” and “guarantee the proportionality of the given penalties”.

And, though it isn’t yet clear what new exemptions the government is currently considering nor what exactly is meant by “proportionality”, what’s certain is that residents who had started to make more purchases by card will now have to repopulate their pockets with some good old banknotes because businesses – from taxi drivers to cafes and bars – might not accept card payments for small amounts.

Fines for businesses caught refusing card payments had been introduced by Draghi’s administration back in June 2022, with retailers liable to pay “a €30 administrative fee plus four percent of the value of the transaction previously denied”, regardless of the amount owed by the customer. 

Euro banknotes in a wallet

Under Italy’s new budget law, retailers will no longer be forced to accept card payments for transactions under €60. Photo by Ina FASSBENDER / AFP

The measure angered retailers who lamented having to pay hefty bank commissions on every electronic transaction – some business owners even went as far as openly defying the law and organised themselves into a protest group (Comitato No Pos, roughly meaning ‘Anti-point-of-sale committee’). 

Given the government’s new legislation, it seems like their efforts might just have paid off. 

But, while many business owners will no doubt be happy with the suspension, others have already raised doubts about the potential ripple effects of the government’s move.

Aside from shoppers having to carry more cash than they’re currently used to, many political commentators are warning that the suspension might be a “gift to tax dodgers” in a country where, according to the latest available estimates, tax evasion costs state coffers nearly €90 billion a year.

The same was said about another of the government’s recent changes: raising the cash payment limit from 2,000 to 5,000 euros.

READ ALSO: What’s changing under Italy’s post-pandemic recovery plan? 

A previous government led by Giuseppe Conte had introduced several measures aimed at encouraging the use of electronic payments, most of which have since ended or been rolled back.

The introduction of fines for businesses refusing card payments was one of the financial objectives set out within Italy’s Recovery Plan (PNRR), which expressly refers to the fight against tax evasion as one of the country’s most urgent priorities. 

It is therefore likely that the new cabinet will at some point have to explain the latest U-turn on Recovery Plan policies in front of the EU Commission.