Italy’s Supreme Court last night upheld Silvio Berlusconi’s conviction for tax fraud and a four-year jail term, to the fury of the man who has dominated Italian politics for 20 years and throwing a fragile coalition government into peril.
The markets have been sanguine about Italy, maybe with good reason, since its reform and debt-cutting programme is well in train and no one seems to want fresh elections. But that could change for a country that has always been viewed as “too big to bail” by the euro zone.
Italian bond futures have even risen a little, taking a wait-and-see view. There is of course the little matter of the U.S. non-farm payrolls report looming later, with markets still fixated on the chances of the Federal Reserve slowing its bond-buying programme this year.
For investors, the equation that the bonds of countries like Italy offer a decent return and the European Central Bank has taken default risk off the table has held good for nearly a year. And to give some perspective, Italy can borrow for 10 years at about 4.4 percent having been forced to pay seven percent and more at the height of its crisis in late 2011.
Given his age, Berlusconi is unlikely to serve any jail time and the court ordered a review of the ban on him holding political office.
Afterwards, the media tycoon conspicuously did not repeat his previous expressions of support for the coalition government comprising his centre-right PDL and Prime Minister Enrico Letta’s centre-left PD, but neither did he threaten to pull it down. Instead, he pledged to relaunch his party under its original “Forza Italia” (Go Italy) banner and seek a majority to modernize the country and judiciary.
President Giorgio Napolitano, the man who would have to decide whether to call new elections if the coalition fell apart, urged calm, as did Letta, and given the August holiday lull, we shouldn’t overstate the threat.
But there is a scenario – albeit a minority one – which looks pretty nasty. If Berlusconi’s PDL threatens to pull out of the coalition or a chunk of the PD refuses to work with him any more then it won’t be easy to cobble together an alternative coalition. So new elections are not impossible at some point and February’s vote showed how unpredictable those could be.
There is also the scope for more modest troubles. Berlusconi’s camp has lobbied hard for a housing tax to be scrapped along with a planned increase in sales tax – at a cost of about 8 billion euros.
That argument is likely to go up a notch and if it comes to pass, compensating spending cuts or tax rises will have to be found or Rome will bust its budget constraints. There has been some talk of share sales in state-owned giants such as oil group Eni and aerospace group Finmeccanica but nothing definitive on that either.
So is there any alarm in the capitals of the euro zone? Europe’s leadership forced the issue when Berlusconi was last prime minister and it’s not hard to imagine Berlin being keen to impress upon Rome the need to keep things steady until October at least, when German elections are out of the way.
Moving further down the hypothetical highway, if Italy ended up with a government that refused to play the debt-cutting game, it’s possible borrowing costs would start climbing quite sharply.
Italy is well funded for this year so there’s no immediate pressure but if yields did spiral out of control, could the European Central Bank use its bond-buying scheme to shore things up? It looks doubtful under that scenario since the ECB requires a country to seek help from the euro zone bailout fund first and sign up to reform and budget conditions.
Yet Draghi said a year ago he would remove euro zone break-up risk so the central bank would have to do something, whatever the hardliners in his camp felt. There is no muttering about a Plan B but it’s interesting to note that the ECB has never published the legalese underpinning its still-unused bond-buying scheme.
The summer lull may keep a lid on all this for a while – and there is clearly determination in Rome to hold things together. Elsewhere in the euro zone everything looks on hold until Angela Merkel seeks re-election on Sept. 22. Thereafter, big decisions still loom; on Greece, Portugal and banking union to name but a few.
IMF chief Christine Lagarde served up a reminder last night, saying she had no doubt the euro zone would give further debt relief to Greece if needed. The Fund thinks there is a hole of up to 11 billion euros in Athens’ finances over the next two years, although Greek finance minister Stournaras told us this week that he was hoping there will be no gap in 2015/16 if growth picks up.