Referendum Puts Italy's Government to the Test

By: STRATFOR

Forecast

• If Italian voters reject a raft of proposed constitutional reforms on Dec. 4, the government will likely resign.
• Should that happen, Parliament could avoid triggering early elections by appointing a caretaker government instead.
• The prospect of a victory by political parties that are critical of the eurozone will continue to create uncertainty in Italy and the rest of the currency area.

Analysis

At a time when Europe is still processing the results of the Brexit referendum and the U.S. election, Italy has become yet another source of uncertainty for the Continent. On Dec. 4, the country will hold a referendum on several constitutional reforms. The goal of the proposals, introduced in 2015 by Prime Minister Matteo Renzi's government, is to ensure that future Italian governments are made more stable by reducing the powers and size of the Senate, granting the Chamber of Deputies more authority, and transferring prerogatives from regional administrations to the central government in Rome. The idea behind those changes is to sever the link between political instability and financial fragility in Italy. Ironically, though, the reforms meant to reduce uncertainty in the country are raising questions about its future.

Renzi has promised to step down if the Italian people vote against the reforms. This has allowed opposition parties — and even some members of Renzi's center-left Democratic Party — to cast the referendum as a chance to force the prime minister's resignation. Several parties, including the anti-establishment Five Star Movement and the anti-immigration Northern League, have been campaigning against the reforms as a means of getting rid of Renzi. And in the eyes of many voters, the plebiscite is no longer a referendum on constitutional reforms, but on the prime minister's government. 

Most opinion polls show that Renzi is likely to lose the vote. But lately, polls have been unreliable bellwethers of election results, and many factors will influence the vote's outcome. For one, the polls show that more than a quarter of Italian voters have not made up their minds. For another, some polls suggest that opposition to the reforms is particularly strong in southern Italy, where voter turnout is generally weak (there is no electoral threshold needed to make the referendum valid). Finally, polls show that a significant number of Italians do not feel well-informed about the reforms, a factor that could also affect their decisions and overall turnout.

Should the reforms be rejected, Renzi's political power would be greatly weakened, and he would probably resign. The fall of his government would hurt investor confidence in the Italian economy, potentially leading to higher interest rates on the Italian government's debt. Italy's fragile banking sector could also face a more challenging environment and move closer to needing help from the state. Mistrust in the Italian economy may depress the value of the euro as well, which could lead to an uptick in European exports but also higher inflation over time.

More important, if Renzi's resignation leads to early elections, their outcome could affect the future of the eurozone. The Five Star Movement and the Northern League have promised to hold a referendum on Italy's membership in the currency union if they rise to power. A third opposition party, Forza Italia, is also critical of the currency area and may choose to support a referendum as well. Opinion polls suggest that of all EU members, support in Italy for the euro is one of the lowest, which means that in the event of a popular vote, its continued participation in the eurozone would not be guaranteed.

Early Elections Are Not Inevitable

Even if voters reject the reforms and Renzi resigns, early elections are not a given. Italian President Sergio Mattarella could ask Parliament to form a new government and appoint a prime minister, probably with the goal of introducing political and economic reforms. This scenario played out in 2011, when Silvio Berlusconi resigned as prime minister and former European Commissioner Mario Monti was appointed to craft the reforms needed to address the financial crisis in the European Union. The Five Star Movement has said it would not support a caretaker government, but the Democratic Party and its junior coalition partner still control enough seats in Parliament to appoint a new prime minister, provided that they stay united.

Several factors could influence a decision on whether to call new elections. First, there is uncertainty about which electoral law would be used in the case of early elections. In 2015, a new electoral law commonly known as "Italicum" was implemented. It introduces a two-round election and awards bonus seats in Parliament to the winning party. But the law, which has yet to be used, is facing a court challenge, and members of the Italian government are debating ways to change it. One of the main goals of a caretaker government, should one be appointed, would be to pass a new electoral law.

Moreover, opinion polls show that the Five Star Movement's popularity is close to that of the Democratic Party, giving it incentive to avoid early elections that could unseat it. In the meantime, the Democratic Party could tailor the changes in the Italicum to reduce the prospect of a government led by the Five Star Movement. For example, it could eliminate the two-round system outlined in the law. In a potential runoff election between the Democratic Party and the Five Star Movement, all opposition parties could side with the protest party to propel it to victory. This prospect might impel the government to change the rules while it still can. Lorenzo Guerini, the deputy secretary of the Democratic Party, said that in case of a defeat in the referendum, the party would try to modify the country's electoral laws so that new elections could be held in summer 2017.

A Decisive Year for Europe

Whether or not early elections are held, the possibility that the Five Star Movement will eventually triumph at the national level cannot be discounted, because more and more Italians have grown weary of traditional political parties. Decades of mismanagement and corruption have led to voter mistrust in the establishment parties' ability to turn around Italy's tepid economic growth and persistently high unemployment. But even if an upstart such as the Five Star Movement were to win an election, its first order of business would likely be political and economic reform — not an immediate referendum on eurozone membership. Furthermore, a government led by the Five Star Movement would face similar constraints to its predecessors. The Five Star Movement's problems with governing the city of Rome have highlighted its lack of experience with governing. Nevertheless, even the distant prospect of an Italian referendum on the eurozone would create significant uncertainty about the future of the currency area.

Should the constitutional reforms pass, Renzi could decide to capitalize on his victory and hold early elections in a bid to cement his position. And so, one way or another, Italy may face elections in 2017, as will France and Germany. (The French election is particularly noteworthy because of the rising popularity of the Euroskeptic National Front.)

Therefore, depending on the referendum's results, by late next year both France and Italy could be controlled by political forces that want to leave the currency union (and, in the case of the National Front, withdraw from the European Union). Under these circumstances, the bloc would face a massive restructuring effort to adapt to its new political reality. This would involve repatriating some prerogatives to national governments, and potentially ending the eurozone or replacing it with smaller regional currency unions. Though the complete dissolution of the European Union is still unlikely, it cannot be completely ruled out.

Opinion polls attempting to gauge the outcomes of elections have proved unreliable in recent months. The Italian government could still win the referendum, or, in case of a defeat, decide to cling to power. But no matter what happens on Dec. 4, and regardless of the electoral results in France and Germany next year, the anti-establishment forces that proved so strong in the United Kingdom and United States will continue to threaten the continuity of the European Union.

"A Referendum Puts Italy's Government to the Test is republished with permission of Stratfor."

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