Italians are poised to cast on Sunday the most important ballots of their history in a referendum that could echo through the global economy.
They are being asked to vote on whether they approve of amending the Italian Constitution. The changes would mean a third of their constitution would be rewritten – 47 articles out of a total 139.
Only a simple majority of voters need to vote ‘yes’ to usher in what would be the biggest reforms in Italy since the abolition of the monarch after World War II.
Many analysts see a ‘yes’ vote as crucial for economic reform and fear that ‘no’ would doom Italy to further stagnation.
Watch a quick summary here:
Politically, the referendum threatens the survival of the European Union. Prime Minister Matteo Renzi, who called the vote, promised many months ago to resign if it is defeated.
If he does so, Italian president Sergio Mattarella would likely call an early election. This could sweep one of three anti-EU parties to power: the Five Star Movement, founded by comedian Beppe Grillo; Forza Italia, led by former PM Silvio Berlusconi; or the anti-establishment Northern League.
In reality though, it’s quite difficult to leave the EU, as shown in Britain. It is the economic consequences that may be the most dire.
The need for economic reform
Mr Renzi says a yes vote is vital to modernising Italy’s economy.
“To the financial markets, we say that we have always received the message that structural reforms are the prime asset of Italy’s future,” he told reporters on Monday.
The referendum proposes to weaken the country’s powerful senate, making it easier for Rome to push through its reform agenda.
For example, the Prime Minister wants to make it easier for businesses to fire employees and declare bankruptcy, and easier for workers to enter protected professions like law, medicine and pharmacy.
Italy suffers from parliamentary gridlock because the upper house is just as powerful as the lower house.
The Senate can unseat the government with a vote of no confidence, and indefinitely block its bills. It is a relic from World War II: its founders wanted to prevent the rise of another Benito Mussolini.
The referendum proposes cutting the size of the upper house from 315 to 100 senators, reducing their generous benefits, appointing rather than electing them, and limiting their ability to block legislation.
It would also further federalise Italy by taking some power away from regional governments and centralising it in Rome.
Bank crisis looms
Many fear a ‘no’ vote could trigger a bank crisis and spell doom for the European Union — outcomes that would spook world markets and hinder the global recovery.
Because the Italian economy is struggling, its banks are also struggling. Their balance sheets are choked with ‘bad debt’ (loans with little prospect of being repaid), and they’ve collectively lost about half their value on the share market this year.
The country’s biggest bank, Banca Monte dei Paschi di Siena, which agreed to a rescue package in July, is the worst affected. Seven others are thought to be at risk.
The bad debts of Italian banks exceed the money these banks have set aside to cover defaults (‘loan loss provisions’), and also exceed the total value of their core capital (‘CET1’), the Bank of England warned this week.
They are expected to need billions of dollars of fresh capital in coming months to cover losses. But a ‘no’ vote could frighten away investors and savers, also prevent the government from bailing them out.
But the good news is that Italy’s banks owe most of their debt to Italians, so the risks of global contagion are relatively low.
The confounding factor
On the face of it, most financial experts would probably back a yes vote. The confounding factor is that Italy’s membership in the EU is arguably strangling its economy.
Public debt is 130 per cent of GDP, and unemployment is at 11.6 per cent.
Italy, the third biggest economy in the monetary union, does not have its own currency nor its own central bank, which makes it very difficult for it to respond to Italy-specific problems.
Normally, when a country faces economic challenges, its central bank will adjust monetary policy (buy or sell bonds; lift or lower rates), and its government will tinker with fiscal policy (spend less or more).
But Italy has no central bank. Its monetary policy is set Europe-wide by the European Central Bank.
Italy’s EU membership also limits how much the Italian government can engage in deficit spending to prop up struggling parts of the country. It also isn’t allowed to impose controls on outflows of capital, to prevent investors fleeing after the referendum.
Given the unreliability of the Brexit and Trump polls, the verdict is anyone’s guess.