There is no respite for Matteo Renzi, Italy’s prime minister. Having just dodged a bullet by orchestrating a private capital injection, instead of a politically toxic public intervention, to save Monte dei Paschi di Siena, Italy’s third-largest bank, Mr Renzi is faced with a sharp slowdown in the country’s economy.
According to data released on Friday, Italy’s gross domestic product was flat in the second quarter of this year as growth ground to a halt after five consecutive quarters of gains. The country’s economic performance dragged down the eurozone as a whole and was unflattering compared with most of its peers in the 19-member currency bloc.
Such a dispiriting lack of growth will be gnawing at Mr Renzi for several reasons. It will make it much harder for Italy’s banks to work through their large stocks of non-performing loans, which — despite the recent MPS deal — are still lurking in the background as a big source of financial vulnerability.
In addition, flat output — in combination with deflation — makes it even more difficult for Italy to meet EU-mandated fiscal targets and pare down its high debt-to-GDP ratio.
The third reason is political. Mr Renzi has staked his tenure in office on a referendum on constitutional reform to be held in the autumn, by threatening to resign if he loses. The prime minister has since acknowledged that it was a “mistake” to personalise it in such a way — to the detriment of a debate on the actual merits of reform. But the damage may be done.
Opposition parties have pounced on the opportunity to make the referendum an up-or-down vote on Mr Renzi’s increasingly unpopular government. Many Italians will see it the same way. So any weakness between now and the November poll will only hurt Mr Renzi’s odds of survival.
Against this gloomy background, Mr Renzi is considering ways to deliver a jolt of stimulus to the faltering economy. Of course, he has an incentive to do so because of the threat the referendum now poses to him. The needs of the Italian economy should, however, be paramount to avoid the risk of a new Italian recession, with ripples spreading across the eurozone.
Despite the fact that his space for fiscal manoeuvre has only become tighter with the economy flatlining, Mr Renzi should push to get as much leeway as he can out of Brussels. So far, Italy’s recovery has been fuelled largely by monetary stimulus, on the back of the European Central Bank’s bond-buying programme. There is, though, a strong case for fiscal expansion to step in at this point.
To be sure, any stimulus would need to be well crafted. Mr Renzi has shown a tendency towards politically motivated gimmicks and Italy generally has a poor record when it comes to spending money efficiently. An acceleration in broad-based income tax cuts, planned for 2018, would be one option.
The EU’s reaction will be key. But having shown leniency to Spain, Portugal and France for their fiscal sins in recent months, Brussels cannot in good conscience turn around and take a tough stance against Italy, particularly with the 10-year Italian government bond yield grazing 1 per cent — far from alarming levels.
One condition, however, must be that Mr Renzi continues his push for structural reforms. After a flurry of activity in 2014 and 2015, his drive for change has slowed this year as his political troubles have mounted. Once the referendum is behind him, Mr Renzi must stop dawdling and stay true to the promises he has made to reform the economy.
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