Global Insight: EU keen to see if Italy’s coalition will stay on right path

Italy’s coalition government, in its first week in office, has moved into the post-austerity era and markets have been forgiving, so far. But should this forced political marriage also turn its back on economic reforms, then the eurozone’s credibility could be tested again.

Deciphering the vague and sometimes contradictory messages emanating from the left-right coalition led by Enrico Letta, who visited Berlin, Paris and Brussels last week, requires less of a grasp on the debate over fiscal consolidation in heavily indebted countries and more of an understanding of the dynamics of Italian politics over the past few months.

Mr Letta’s Democrats had expected to romp home in parliamentary elections in February. But after a grey campaign that failed to address voters’ concerns, the centre-left coalition only narrowly beat Silvio Berlusconi, former prime minister, even though his centre-right People of Liberty lost 6m votes compared with the last elections in 2008.

The true winner was the anti-establishment Five Star Movement, which has gone from zero seats to holding the balance of power in parliament, overtaking the People of Liberty and very nearly the Democrats as Italy’s most popular party.

“The real dynamic now is not between left and right but between politics and anti-politics, between demagoguery and political realism,” says Deborah Bergamini, a member of parliament on the liberal wing of Mr Berlusconi’s party.

Italy was not a “particularly sick country” but its politics reflect “a more profound movement crossing Europe” she says in the week that the UK Independence Party made large gains in local elections campaigning on an anti-EU and anti-immigration platform.

Playing a weak hand well, Mr Berlusconi understood this profound shift better than Pier Luigi Bersani, who resigned as leader of the Democrats after the party shattered along ideological and personal faultlines over the issue of coalition-building.

At 46, Mr Letta, former deputy to Mr Bersani, is among Italy’s youngest premiers. His deputy is 42-year-old Angelino Alfano, secretary of People of Liberty. Despite talk of a generational handover, the reality is that influence will be wielded by the 76-year-old Mr Berlusconi and Giorgio Napolitano, the 87-year-old head of state who forced the Democrats to share power with their old enemies.

But unlike Mr Napolitano, a pillar of European unity, Mr Berlusconi is still on his anti-austerity and anti-German tack, believing that populism in power will take the sting out of the protest vote that led to the surge for the Five Star Movement.

Mr Letta has bowed to Mr Berlusconi’s campaign demand and cancelled the first payment, due in June, of an unpopular property tax imposed by Mario Monti’s technocrat government. With opinion polls showing the centre-right in the ascendancy, Mr Berlusconi is threatening to force early elections if Mr Letta does not agree to cancel the next housing tax instalment in December.

This leaves Brussels wondering how Italy plans to finance an estimated €10bn in proposed tax cuts and increases in social welfare spending without derailing its fiscal commitments.

In depth

Italy politics

News and commentary on the latest political manoeuvring after Italy’s inconclusive general election

The latest OECD survey of Italy, released last week, warns that “Italy remains exposed to sudden changes in financial market sentiment”. It urges the new government to make its priority “large and sustained reductions” in public debt and to consolidate “gains” from structural reforms initiated by Mr Monti.

Europe’s worry is that Italy, the third largest eurozone economy with €2tn in debt, might fail on both scores as anger at austerity meets reform fatigue.

Dissident Democrats opposed to sharing power with Mr Berlusconi are mobilising amid talk of forming a “new left”. Mr Letta is aware that further labour reforms, which Mr Monti left half-finished, would risk cementing the party’s schism.

Meanwhile, reforms needed to liberalise sectors guarded by powerful vested interests are unlikely to find a champion in Mr Berlusconi. The OECD notes that from 2000 to 2011, when Mr Berlusconi was prime minister for more than eight years, Italy was alone among its 34-member countries where average annual gross domestic product per capita declined because of its poor competitiveness.

Many commentators give the new government a one-year shelf life. Verdicts in Mr Berlusconi’s trials for corporate tax fraud and paying an underage prostitute are due in weeks, adding a further unpredictable element. As Mr Letta says, Italy is entering unknown territory. The same could be said of Europe.