The polls announce that the right-wing coalition, bringing together Giorgia Meloni’s Les Frères d’Italie, Matteo Salvini’s Northern League and Silvio Berlusconi’s Forza Italia, could win the elections on 25th September.
At this stage, it is difficult to predict the risks of such a coalition for the country, because everything depends on Giorgia Meloni’s ability to form a majority with two or three parties. Lately, she was at odds with the League of Salvini, which advocates more public spending to counter the rising cost of living. However, Meloni adopted a more constructive tone vis-à-vis Europe and a more cautious approach to spending and fiscal rules. A majority, including only Forza Italia would be simpler from the point of view of Italy’s economic prospects.
A grand coalition would reassure the markets
The nature of the Italian electoral system makes the results uncertain, so it would not be surprising if a grand coalition emerged. In this case, the markets would react positively to it, since it would be seen as a continuation of Draghi’s fiscal policies. The new government will not have time to complete a new budget for 2023 anyway, which will be presented by Draghi on the basis of an unchanged deficit target for next year. The many aids granted this year have been financed by additional taxes on energy companies. The trend is expected to continue and as such Italian government bond yields are unlikely to weaken further.
Default on government bonds unlikely
If the right-wing coalition were to win, Giorgia Meloni would have to try to respect the European Commission’s tax rules and, in fact, only make budgetary changes gradually. For example, the Flat Tax could cost only 13 billion euros in the first year if it is adopted, thus respecting the tax rules which aim to improve the budget balance by around 0.5%.
The current economic situation and indebtedness of the country pose a challenge for the new government. However, regardless of the outcome, the ECB’s new anti-fragmentation tool, designed to reduce fiscal risks when rates rise, appears to limit sovereign risk. Thus, the risk of default on sovereign bonds in Italy or any other peripheral country is rather very low.