Will Italy's political drama spawn a new eurozone crisis?

AP News
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Posted: Dec 05, 2016 12:32 PM
Will Italy's political drama spawn a new eurozone crisis?

LONDON (AP) — Italy's political upheaval has raised questions of whether the eurozone is headed for a new financial crisis that could once again put in doubt the future of the euro and roil global markets.

Some observers think there's a chance that the uncertainty generated by the announced resignation of Premier Matteo Renzi could exacerbate concerns about Italy's economy, banks and state finances. In a worst case, they say, that could see the country falling out of the 19-country eurozone.

One consultancy, the London-based Centre for Economics and Business Research, thinks the chances of Italy still using the euro in five years' time have fallen below 30 percent following the rejection of Renzi's constitutional reform plan in a referendum Sunday.

Others see the turmoil as business as usual for a country where political instability is the norm. At worst, they say, Italy's shaky banks could need some extra rescue money.

Here's a look at the potential economic implications of Italy's political drama.

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Q: What is the biggest immediate risk?

A: That's Italy's banks, which need to raise billions in new capital to remain healthy. The main problem bank is Monte dei Paschi di Siena, the country's third-biggest lender, which failed a stress test this year and has been in negotiations with investors to raise 5 billion euros ($5.4 billion). Those talks were reportedly being reviewed Monday, when the bank's shares fell 4.2 percent, as it could be harder to attract capital amid political uncertainty. Several other banks may need financial help, too — Italian banks have some 360 billion euros ($400 billion) in loans that won't be paid back in full.

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Q: What about the longer-term?

A: There is the possibility that Italy's populist parties will be energized by their win in the referendum and could come to power. The 5-Star Movement in particular has made gains in the polls and wants to hold a non-binding referendum on whether to leave the euro. Experts say the party could be more lax about government spending, which could increase investor concerns about Italy's finances. The country has public debt worth 130 percent of GDP, a huge sum. If investors get jittery and ask for higher returns to buy Italy's debt, the country's borrowing costs could rise, in turn putting more pressure on the public finances and the economic outlook. That could cause a repeat of the crisis of 2012, when Italy's borrowing costs jumped up to unsustainable levels.

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Q: How bad would it be if Italy left the euro?

A: Nobody knows for sure, as no country has left the currency union, but most experts say it would be a big blow to markets and the world economy. Italy is the eurozone's third-largest economy and leaving would require it to print a new currency and redenominate its debt into the new money. The country would probably have to default on a lot of its debt, a move that could see the banks face possible collapse, leading to a deep recession. Uncertainty over the eurozone would heighten and that, economists say, would hit global growth. Any fears of Italy leaving would dwarf those experienced in 2015, when Greece last teetered on the euro exit edge.

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Q: Why are markets not nose-diving, then?

A: In part, investors had already been expecting this result in Italy. Also, any danger of financial instability is not immediate, as it was with Greece, which last year was potentially just hours away from leaving the eurozone.

Meanwhile, the European Central Bank is acting as a big backstop in bond markets, indirectly protecting Italy's borrowing rates from rising too much. The ECB buys 80 billion euros ($86 billion) in bonds every month in the eurozone. That has the effect of weighing on bond yields such as Italy's. The country's 10-year bond yield is at 2 percent, still very low by historical standards and far below the 7 percent that Italy experienced in 2012.

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Q: What happens now?

A: Whether Italy's jitters become an economic crisis depends on the upcoming political decisions. The president could call for early elections, a scenario that would roil markets as the 5-Star Movement would likely do well or even win. Analysts say it's more likely that Italy's president will appoint a transition government that will help ease the uncertainty, see through the rescue of the banks and eventually call for early elections, possibly for early 2018.