Global Daily – Can Draghi revitalise Italy’s economic prospects?

Indeed, Italian assets have performed spectacularly since it became clear that he would be asked to form a government. Having said that, there is still uncertainty about whether the former ECB President will succeed in gaining the necessary parliamentary support. The largest party in the Chamber of Deputies – Five Star – seems reluctant to support a Draghi-led government, though some of the deputies might. Meanwhile, the centre-left parties, the centre-right Forza Italia and even the right wing Lega party could potentially be supportive. Against this background, Mr Draghi may just get the support he needs to form a government.

If he does succeed, the new Prime Minister’s immediate order of business will of course be the health crisis. However, Italy’s long-running problem, which is often cited as being its sovereign debt burden, is actually economic growth. On many estimates, Italy’s trend level of economic growth is around zero. That partly reflects demographics, but more importantly is down to chronic weak productivity growth. A combination of well-focused public investment and structural reforms could start to change this narrative. Can Mr Draghi deliver? He has a lot going for him, but also some significant political hurdles to overcome.

Mario Draghi’s CV and achievements in the past are encouraging. Mr Draghi is of course well known as a central banker with a background as a trained economist, but he also had a long stint as the top civil servant at Italy’s Ministry of Finance. As such he had a high level view of Italy’s fiscal and economic policy issues and the functioning of government and politics in the country. Although he has never been a professional politician, he has experience as a political operator within the Governing Council of the ECB but also more broadly in the European context.

Crucially, this would not be an austerity government. Italy is eligible for around 12% GDP of loans and grants from the European Recovery Fund in 2021-2023. In addition, relatively low debt service costs combined with good will due to the pandemic and a paradigm shift in the way Europe is thinking about fiscal policy gives governments room for manoeuvre. As part of the Recovery Fund programme, governments need to submit reform and investment plans. From this perspective, the conditions for Italy to redefine its future economic prospects have never been better.

There are some pretty important caveats however. One is politics, the other is time. Although Mr Draghi is a skilled political operator, he will face an extremely challenging political environment. Obviously he does not have his own political base and may need to navigate various and likely often opposing political interests. For instance, he may need to find a path that is agreed by the centre left (which often disagree with each other), the centre-right (which often disagree with each other) and either elements of the populist left and populist right. This will be far from easy. Furthermore, time is short. Italy is scheduled to have elections in just over two years, even if a new government manages to survive that long.

Bringing these elements together, a new government could make a good start in putting in place a significant investment programme. Economic growth is likely to be rapid over coming quarters, but the political and time constraints mean that the type of far-reaching reforms that could be a game changer for the long-term growth outlook may not materialise. Still, we remain positive on the outlook for Italian government bonds given the institutional support from the ECB and the European Recovery Fund and the potential – albeit with limits – of a Draghi-led government. In addition, despite the spread tightening of the last few days, the 10y Italian government bond spread still looks high relative to its credit rating, which will likely remain stable.