While the market overcame its initial scare following yesterday’s counter-establishment Italian referendum vote, and European stocks proceeded to not only make up all losses, but soar in the overnight session by the most since Trump’s presidential victory, what happens next in Italy is largely unknown. What follows are Goldman’s snap thoughts on the Italian next steps.
First, a quick recap of what has happened in yesterday’s referendum in which many more Italians than expected turned up to reject the proposed reforms, leading PM Renzi to announce his resignation later today. The odds of a general election have risen from one-in-five to one-in four, according to Goldman. Despite yesterday’s outcome, Renzi remains the most popular politician on the centre-left. More importantly, the outcome of the vote lowers the chances of a market-driven solution for the ailing Italian banks, and in turn increases the likelihood of a State-led restructuring Goldman notes.
Here are the details:
In a national confirmative referendum held yesterday, Italian voters rejected a Constitutional reform bill sponsored by the coalition government of Mr Renzi and passed by Parliament in April. The referendum was called because the bill had failed to receive the quorum of 2/3 of MPs in its final reading.
The outcome of the referendum was in line with opinion polls in the run-up to the vote. These had been suggesting that the ‘Vote No’ side would win by some distance. Two elements are new, however (all numbers based on quasi-final vote count):
- At 59.1%, the percentage of voters rejecting the reform bill was 5 percentage points higher than projected by opinion polls going into the referendum (55%). This outcome represents a much starker victory for the ‘Vote No’ camp than generally envisaged. Goldman assumed that the odds favoured a ‘Vote No’ win only marginally (55%), and that the gap between the two sides would be small, within 10 percentage points rather than the realised 20.
- The voter turnout was 10 percentage points higher than projected by pollsters (65.5% vs. 55%), with close to 33 million people casting their vote (19.4 million voted ‘No’ and 13.4 million ‘Yes’). By comparison, the turnout in the UK Brexit vote was 72.2% (corresponding to 33.6 million people) while in the Italian 2006 referendum on Constitutional reforms, which also saw the amendments being rejected, the turnout was 52.3%.
A first analysis of the vote breakdown suggests that the electorate largely acted on political priors. Specifically:
- In polling districts where opposition right-wing parties and the 5 Star Movement gathered higher consensus back in 2013 (Southern Italy, alongside some areas in the North), the ‘Vote No’ camp has achieved its best results, reaching as much as 70% of the vote share.
- In the South, the ‘No’ vote outnumbered the ‘Yes’ by a remarkably ample margin (more than 40%) in Sicily and Sardinia, where the 5 Star Movement managed to outperform the Democratic Party in the 2013 general election.
- The constitutional reform has been largely rejected also in the North-East of the country, a stronghold of the Euro-sceptical Northern League. The ‘Vote No’ camp, for instance, obtained 62% of the vote in Veneto, where Lega won roughly one-third of opposition votes in the 2013 general election.
- Conversely, the regions where the Democratic Party performed better at the 2013 elections – such as Emilia Romagna and Tuscany, where it won more than 40% of votes – were those experiencing a victory of the ‘Vote Yes’ camp.
- The relationship between the share of youth unemployment by polling region and No share of the vote is strikingly positive (see Exhibit 2). This is a result that will carry a large weight in the next general elections, as well as those in other European countries. The general impression here is that the youth and the disadvantaged are rebelling against the establishment, even when its policies bring economic benefits, albeit unequally distributed (incidentally, the protests against the ECB policies of low rates and QE go in the same direction).
Exhibit 1: The percentage of voters rejecting the reform bill was 5% higher than projected by opinion polls
Monthly average of opinion polls weighted by survey sample size, and final results
Exhibit 2: The reform has been more largely rejected in disadvantaged regions
Regional Youth (18-29) Unemployment Rate in 2015 and ‘Vote No’ Percentage By Region
What Happens Next
The rejection of the Constitutional amendments does not represent an institutional trauma. Indeed, the architecture of the Italian State will remain as it has been since 1948. What are more relevant for market participants are the political scenarios that open up from here. Indeed, the vote was seen as a test of the popular support still enjoyed by the moderate, reformist and pro-European government of Mr Renzi and the larger-than-expected defeat will not be without consequences. Goldman’s base case remains that a transition government will be in seat until a general election in early 2018.
This is how Goldman see the political situation evolving:
- This afternoon, PM Renzi will formally tender his resignations to the President of the Republic, Mr Mattarella. The latter will likely ask Mr Renzi to stay on to preside over the approval of the 2017 Budget Law – the deadline is 31 December. Meanwhile, the President will officially start consultations with leaders of all political forces represented in Parliament to explore the formation of a new government.
- Mr Renzi’s Democratic Party (PD) enjoys a relative majority in Parliament. Together with its centrist allies, it holds an absolute majority in both Houses (393 seats out of 630 in the Lower House and 186 out of 320 in the Senate). Since the ‘old guard’ of PD’s leadership did not support the constitutional reforms, the political fallout is likely to be mostly within the party, rather than altering broader political balances. Goldman’s base case is that the current ruling coalition will stick together and back a new government.
- Relative to Goldman’s prior expectations, the bank would elevate its subjective probability from 45% to 60% of a caretaker government being appointed. GS expects the Cabinet to be led by a political figure drawn from the ranks of the ruling coalition (one possibility is the Minister of the Economy, Mr Padoan). An outsider technocrat is unlikely to be appointed as this would be highly unpopular choice with the electorate. The new government would likely have a narrow policy agenda consisting mainly of: (i) Overseeing the recapitalisation of the partly state-owned Monte dei Paschi di Siena and potentially other smaller banks. If the referendum outcome stalls the current recap plans, a precautionary injection of public funds into these institutions could be required. In such a case, the application of the ‘bail-in’ rule book would be contentious, and the market instability exemption could be invoked; and (ii) re-drafting the electoral laws for the two Chambers of Parliament ahead of a general election in the spring of 2018.
- As expected, the opposition 5 Star Movement and Lega Nord are calling for the dissolution of Parliament and early general elections. Goldman has raised its subjective odds of elections in 2017 from 20% to 25%, but not higher. The Constitutional Court is expected to rule on whether the electoral law for the Lower House (nick-named Italicum in the Italian media) is fit for purpose. The central case is that the Court will ask Parliament to redraft the law to enhance social representation. The same fate already occurred to the electoral law for the Senate and voting with the current set of electoral rules would most likely result in a ‘hung’ Parliament. A redrafting of the electoral laws would also serve the purpose of reducing the risk that anti-establishment forces take control of Parliament. Arguing for an increase in the odds of an early election is the fact that Mr Renzi, whilst defeated, was able to get around 13 million voters behind him, around 30% higher than in the European parliament elections of 2013, and he remains the most popular politician on the centre-left of the political spectrum.
Exhibit 3: Updated probability scenarios after the vote
What Are the Market Implications
In relation to markets, Goldman thinks that some pressure on Italian BTP spreads to their core counterpart will be seen over coming days, especially following the tightening seen in the latter part of last week (the 10-year spread to Germany closed at around 160bp last Friday and is currently trading just under 170bp).
That said, with the Bank of Italy active in the secondary market and the ECB expected to announce an extension of QE on Thursday (Goldman’s forecast is EUR 80bn pace through most of 2017), the bank doubts that the widening can take the 10-year differential with Germany much above the highs of 190-200bp even on turbulent days.
Most of the focus will be on banks. Today, official news on the (conditional) subordinated debt-to-equity conversion of Monte dei Paschi is expected and discussions with ‘anchor investors’ will follow. Goldman views the likelihood of successful market-driven recapitalisations of the weaker Italian retail banks as relatively low. The outcome of the vote increases the chance of a State-led restructuring. In such cases, the application of ‘bail-in’ rules under the BBRD remains a key point of contention. The government could invoke an exemption from burden sharing on the grounds that financial stability could be endangered. Goldman would separate the fate of Monte dei Paschi (and that of smaller ailing lenders) from sovereign risk more broadly, and is of the view that a resolution of the banking capital shortfalls, even if it involves public funds, would ultimately be positive for the sovereign risk outlook.
Exhibit 4: Around 40-50bp of BTPs current yields are driven by Italian idiosyncratic factors
Italy 10-year yields idiosyncratic factor estimate based on G4-PCA
Exhibit 5: Italian banks have underperformed their European peers
Italian banks and European banks indexes (set to 100 in Jan 2016) and 10-Year Bunds 
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