Q&A relating to the Referendum in Italy

What is Italy voting on?
Some 47 million Italians are being called upon to vote within the scope of a referendum on whether the competence of the Senate (one of two houses of the Italian Parliament that have equal powers) that is governed by the country’s constitution, should be modified and its powers largely reduced to a regional level.

Why is the decision being made by means of a Referendum?
Although both houses of Parliament have already approved the reform, the constitutional amendment fell short of the two-thirds majority required. The Italian constitution is therefore calling on the country’s citizens to have the last word in determining the reform within the scope of the referendum. The constitution does not require a minimum turnout for the vote to be valid.

Who supports and who rejects the Reform?
This undertaking is supported by the Italian government, the vast majority of the government parties, as well as by some more moderate unions and the country’s business-friendly newspapers. On the other hand, it is rejected by large parts of the opposition, left-wing unions and numerous conservative as well as left-wing media.

What is the aim of the Reform?
Italy’s perfect form of bicameralism is a decisive hurdle to implementing structural reforms. At present, both houses of Parliament have to approve all laws. However, because of different electoral laws, the government rarely gains a sufficient majority of seats in the two houses, so that planned reforms also require the approval of the opposition, which frequently blocks or waters down laws. Those opposing the reform argue that reducing the Senate’s competence would weaken Italian democracy, even though Italy’s legislation would then resemble that of some other European states, if change was implemented.

What outcome is expected?
A large majority of the opinion polls predict the failure of the project, even though the „no“ camp’s lead is still comparatively small, despite having risen in recent weeks. Roughly one quarter of Italians have yet to decide. Uncertainty is also heightened by the fact that no new polls have been published in the last few days ahead of the election.

When will the result be known?
The polling stations will be open from 7.00 am to 11.00 pm on Sunday, so that the result can be expected late Sunday night at the earliest. In case of a close result, it cannot be ruled out that a result will still not be available early on Monday morning.

What does a „no“ vote mean for prime minister Renzi’s government?
Prime minister Renzi has always pushed the reform and his political future is tied in with the outcome of the referendum. The government is therefore expected to step down, even though Renzi never wanted to commit to his resignation in the event of a vote against the reform.

Will Renzi’s resignation lead to new elections?
A government’s resignation does not automatically lead to new elections. The prime minister’s centre-left party, PD, would probably try to form a new government, to prevent new elections. Although the PD is ahead of the opposition party, the left-wing populist Five Star Movement, in the opinion polls, the lead is too small to guarantee the PD a win. Given that the Five Star Movement and other opposition forces will demand new elections, public pressure and unity within the PD and the coalition should ultimately decide whether a centre-left government can remain in power until the regular elections are held in 2018.

Who could replace Renzi as prime minister?
If Renzi has to resign, finance minister Padoan, president of the Senate Grasso and Franceschini, minister of Cultural Heritage and Activities and Tourism could be seen as potential successors. Renzi’s opponent D’Alema of the political left has been given an outside chance only.

Could a „no“ vote lead to a referendum on Italy’s exit from the EU?
The hurdles to Italy’s exit from the EU (Italexit) are very high. For this to happen, the government would have to resign and new elections would have to be called. The Five Star Movement would have to win the elections (which would be uncertain as things stand at present) and gain a large majority in the entire parliament, for it to form a government and schedule a referendum on an EU exit. Italy’s constitutional court would have to decide on whether such a referendum could be conducted and if the result would have legal validity. Surveys show that a large majority of Italians (currently 67%) are in favour of remaining in the EU/EMU.

Will a „no“ vote block reform?
It is feared that the pace of reform in Italy could slow down again if the opposition to the Senate reform is victorious. The government will likely make every effort to secure its survival or avert new elections at least. Far-reaching reforms that are difficult to enforce publicly would probably be shelved. The chances in particular of finding a lasting solution to the crisis in parts of the Italian banking sector would scarcely improve.
What would the consequences be if the Five Star Movement came to power?
For the Five Star Movement to rise to power, the populists would have to gain a majority in both houses of Parliament in new elections or one established party at least would have to be prepared to form a coalition with it. Given the heterogeneous nature of the party and its united front above all in its resistance to the political establishment, it will likely concern itself for now with drawing up a government agenda that does not not yet exist at present. Resistance against the austerity policy that has been watered down already by Renzi could be at the centre of this agenda. Besides lower taxes for low earners, public expenditure on social affairs and infrastructure would probably be raised. Some of the previous reforms, such as the „jobs act“ would more than likely be revoked or at least toned down. However, the lack of political experience among many party members bears the risk that administrative errors would be committed, like those already experienced in cities such as Rome that are already governed by the Five Star Movement.

What consequences would the outcome have for the country’s credit Rating?
The rating agencies cannot agree on the importance they attach to the outcome of the referendum. While Fitch recently lowered the outlook to „negative“ and DBRS threatened to respond to a „no“ vote with a downgrade, S&P recently affirmed its rating. However, S&P’s BBB- rating is already at the lower edge of the peer group, while DBRS still rates Italy with a much better AL. Even though there is no consensus on the direct consequences of the outcome, all the rating agencies are likely to respond critically if the government in Rome reacts to the decision with further tax cuts or spending programmes, therefore driving up new borrowing.
Will the election outcome impact on the collateral requirements of BTPs?
If DBRS decides to downgrade Italy after the referendum, the country would lose its last A rating, which would drive up the haircuts required by the ECB for loan collateral. Because more BTPs would have to be pledged for the same credit volume, Italian government bonds would become less attractive. As the government’s main creditor, Italian banks in particular would likely be disadvantaged as a result.

How will the markets react to the outcome of the referendum?

The markets have already factored in the failure of the reform to some extent, which is why BTP spreads had already widened vis-à-vis Bunds in recent weeks and bonds of other periphery states too. Italian government bonds are likely to post strong gains if the Italians vote in favour of the reform, as many of the aforementioned risks would not materialise. A „no“ vote on the other hand would probably drive up yields to even new heights, at least in the short term. A rating downgrade by DBRS in particular would have further negative consequences.

Is the ECB expected to intervene on the market?
According to unconfirmed reports, the ECB is considering buying more Italian debt within the framework of the PSPP, if yields overshoot as a result of the referendum. This intervention could help to prevent a spiral of overshooting yields.

Will Italy face a refinancing bottleneck in case of overshooting BTP yields?
Around 12% of Italy’s bonds are due to be refinanced next year. If yields were to continue rising sharply, the government would therefore be expected to refinance itself more at the short end than it has this year, so as to contain additional costs. However, yields would have to rise significantly until these exceed the coupons of the bonds that were issued in an environment of generally higher EMU yields and are maturing now. The situation would then become critical from Italy’s perspective, if uncertainty prompted a decline in demand for BTPs on the primary market and Italy would face the threat of a liquidity squeeze. In this case, the ECB would have to make it clear that it will continue to buy BTPs on the secondary market and that a sustained demand gap would therefore not materialise.

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