In Italy Politics Shake the Markets

The specter of a financial crisis came back to haunt Italy on Tuesday.  And Italian markets plunged.

There are fears that Italy is heading toward another referendum on whether to stay in the euro common currency.

An election held in March was inconclusive. However, the two populist parties, the anti-establishment 5-Star Movement and the anti-euro League, got the most votes.

Carlo Cottarelli, a former IMF official, was tapped as premier of a non-political government of technocrats after an attempt by two populist parties to form a government foundered.  The president, who in Italy appoints the premier and ministers, had opposed the populists’ choice of a euroskeptic economics minister.

Thus, the populists have been emboldened by the president’s dismissal of their government in favor of an unelected group of technocrats.  They say it shows the establishment ignores the popular vote.

That could raise the stakes for the next election by making it more clearly about whether the country should reconsider its membership in the #euro.

“Italy will be wrapped in a long drawn-out period of wrangling that will feature intense anti-establishment and euroskeptic tones.”  This according to political analyst Wolfango Piccoli. He said that while he doubts either populist party would embrace a clear euro-exit platform, they would be more combative toward Brussels.

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Sovereign Debt

These developments have also had a very harmful effect on Italy’s #sovereign debt.

The country’s credit rating is already just two notches above junk level.  Italy’s national debt now stands at 132 percent of GDP. Ratings agency Moody’s has threatened to reduce the rating further if the next government doesn’t present a budget that puts Italy on a trajectory to reduce its debt.  This is the second highest rate of debt in the eurozone after Greece.

And the country’s sovereign debt suffered a major selloff this week.  Their sovereign debt is now seen as riskier than corporate bonds. After this week’s selloff, 90% of the country’s high-grade corporate bonds now earn a lower yield than government paper. This according to an analysis by Bank of America Merrill Lynch.

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Threat to the #EU

Investors are worried about the potential for another Italian election within a few months.  In particular, they’re worried that a win for populist parties could lead to the euro zone’s third-biggest economy leaving the shared currency.

Matteo Salvini is the League party’s head.  He is already framing the ballot as a way for voters to show their support for leaving the euro.

“It won’t be an election,” Salvini said Sunday.  “It will be a referendum between Italy and those on the outside who want us to be a servile, enslaved nation on our knees.”

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Moreover, concerns about the health of the European Union were not limited to Italy.  Spain’s Prime Minister, Mariano Rajoy, is facing a no confidence vote over his leadership of that country. As a result, Spain’s IBEX index fell.

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Meanwhile, financial jitters have extended even as far as China.

China Energy Reserve & Chemicals Group (CERCG) said it failed to repay a US$350 million (S$469 million) bond that matured earlier this month. They attributed this to “tightening in credit conditions.”

This is part of a recent wave of corporate debt defaults in China amid a broad government-led campaign to crack down on risky financing. Furthermore, the default highlights growing funding strains on Chinese companies as Beijing increases scrutiny of riskier types of financing and rising debt. Some outside agencies have warned that this could lead to a banking crisis.

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