The Italian government has announced the date for the referendum on Constitutional Reform as December 4. This had been touted as a key event as Matteo Renzi publicly stated he would resign if it does not get passed: an all too credible risk given the rise of populist politics, a general backlash against austerity and the rise of the Five Star Movement in Italy. However, he has recently backed away from his statement about resigning emphasising that the referendum should be about the issue of reform and not a confidence vote on him per se; a wise move given the vote looks to be a close call with a large portion (35-40 percent depending on the poll) undecided (indeciso). There is no constitutional obligation for Renzi to immediately resign on the back of a ‘no’ vote.
The aim of the constitutional reform is to streamline the government law-making process so the Lower House (Camera) becomes the main law-making body and the downsized Senate will have more limited powers, a much more consultative role. Proponents of the reform allege that the bicameral system currently makes it difficult to get any laws and reforms passed and by removing the veto power and confidence vote from the senate it will make the government more stable. These reforms come with a proposal for a new electoral law, Italicum, which would award a majority premium to the party that gets 40 percent of the votes; although the Italian Constitutional Court still has to ratify/reject/amend the proposal. Having had 63 governments since World War II Italy lacks political stability.
From an economic point of view there is certainly a need for Italy to do something: the IMF’s July review talked of ‘two lost decades’ of growth as the economy is not expected to return to the pre-GFC levels of output until the mid-2020s. Italian growth faces a lot of headwinds: an ageing population, high debt levels, low productivity growth, weak levels of technological innovation, high youth unemployment and a weak banking system beleaguered with non-performing loans.
The constitutional referendum is timed after parliament has voted through the budget suggesting Renzi is likely to be looking to try and find ways to incentivise voters to vote yes. But his options appear limited: the government has been forced to downgrade its GDP estimates to 0.8 percent for this year and growth of 1 percent next year. With public debt still lingering around 132 percent of GDP and the EU restrictions on budgetary deficits Italy has little scope for fiscal stimulus.
The drag from the low-growth environment is compounded by high levels of bad debts on banks’ balance sheets constricting new lending. Estimates put Italian non-performing loans (NPLs) at €360bn or ~18% of total loans and ~22% of GDP although ‘sofferenze’ or the severely delinquent bad loans are closer to €200bn. Net of provisioning estimates put the figure closer to €85bn. Under the new EU rules subordinated debt must be converted into equity before state aid can be given and if banks are placed into resolution by the national central bank or the ECB then the senior bank bonds can also be subjected to losses. Italian banks have high levels of retail debt ownership so this has complicated any recapitalisation. This week Unicredit, Italy’s largest bank, released a statement that it intends to release a plan to boost its capital ratios on December 13 with reports suggesting a target of up to €10bn. Yet another recapitalisation of Banca Monte dei Pachi di Siena, this time for €5bn against a market capitalisation of ~€550m, remains ‘work in progress’ with reports now talking about a debt to equity swap for a large portion of its subordinated debt.
European bank recapitalisation is becoming a pressing issue as concerns about the health of Deutsche Bank, particularly after Angela Merkel’s recent comments seemed to back away from government support. The IMF’s June annual review of the German financial sector noted ‘Deutsche Bank appears to the most important net contributor to systemic risks in the global banking system’ which was before the USD14bn fine from the US DoJ. This week Tidjane Thiam, CEO of Credit Suisse, described the European banking sector as ‘fragile’ and ‘not really investable as a sector’ with some of the leading banks in the world only generating 8 percent return on equity. He sees a lot of uncertainty and added ’In life you should only worry about the bad outcomes. ….If you raise capital and you're wrong, it's ok. If you don't raise capital and you're wrong, you die.’ Clearly, European banks need to act swiftly and shore up their capital levels.