Three months after its general elections, Italy is still without a Government as a result of a prolonged political stalemate. This has already quietly happened in other large European countries like Spain, the Netherlands and Germany in the recent past. This time, however, the spread between Italy's Government bonds and the German bund has gone up to levels not seen since 2014 and Italy's stock market collapsed as well. This also started causing spillover effects in the financial markets in the rest of the world.
Why does political stalemate in Italy worry financial markets while the stalemate in other Eurozone countries does not?
Most other EU countries have fully recouped the GDP losses suffered during the Great Recession, Italy has not. This leaves Italy with a heavy legacy in terms of higher unemployment, a bigger number of companies in distress and a larger ratio of non-performing loans over total credits in the banking sector. Fiscal policy cannot help much for Italy's public debt is the fourth largest in the world, with the potential of heading towards unsustainability in case recovery were to stop or interest rates to skyrocket as in 2011.
Why is Italy's political crisis causing stock market fluctuations both in Europe and in the USA?
Italy's political crisis is seen as a sign of the fragility of the institutional architecture of the euro area in which there is no consensus on the completion of the banking union and on the preparation of a more substantial permanent fiscal backstop fund. This fragility is particularly worrisome at this time because the time of a turnover of the ECB presidency is coming. The current president Mario Draghi has placed himself as a last-resort guarantor of the Eurozone - interpreting the current treaties as extensively as possible. The new President may entertain different, milder views about the irreversibility of the euro.
Is there a possibility that Italy will fail because it can no longer finance its public debt?
The theoretical possibility is there. But so far Italy has always honored its commitments to repay its public debt obligations, even during the financial crisis of 2011-12, when the spread rose to 575 points and the economy fell in a deep and prolonged recession.
Italy's voluntary exit from the euro is very unlikely but not impossible. Unlikely because the most dynamic part of the country - that is, Northern Italy - is strongly integrated with Europe and I do not believe it would support a decision to exit the single currency that would jeopardise the recovery and entail strongly destabilizing effects. A forced exit on the part of other Eurozone members is even less likely given that it has not occurred in the even more problematic case of Greece.