Italy Populist Proposals Face Difficult Road Ahead, Analysts Say

(Bloomberg) -- While Italy’s populist duo nears the completion of a governing plan that includes a flat tax and guaranteed income for the poor, markets are taking the news in their stride as investors and analysts say some of the parties’ proposed policies will likely encounter roadblocks.

The FTSE MIB Index was down 0.4 percent on Monday, underperforming the rest of Europe, while the spread between Italy’s 10-year bond yields and German bunds was little changed at 132 basis points, after the anti-establishment Five Star Movement’s leader Luigi Di Maio and his anti-immigrant League counterpart Matteo Salvini refined the last details of their program before meeting President Sergio Mattarella later Monday.

The prospect of a tie-up between the two factions -- widely considered among the worst-case scenarios for markets before the March vote -- has in recent weeks fueled investor concerns that it could jeopardize state finances and slow the pace of growth in the euro area’s third-biggest economy. Yet, banks including Natixis SA and Barclays Plc on Monday said there are no guarantees that measures like the tax reform and universal income will be implemented. That echoed calls made last week that a populist government will likely eventually water down plans for greater spending and any anti-euro rhetoric.

Appetite for higher-yielding debt and buying by the European Central Bank for its quantitative-easing program should continue to support Italian bonds, while stocks look cheap compared to earnings, some analysts said. Provisional orders for an inflation-linked BTP Italia bond, mainly aimed at retail investors, surpassed 1 billion euros ($1.2 billion) at midday local time on Monday, compared to 2.2 billion euros at the end of the first day in the previous auction.

Below is a round-up of investor and analyst views of the impact of the potential tie-up.

SOCIETE GENERALE

• While Five Star/League government was worst-case scenario three months ago, ability to deliver large fiscal stimulus seems limited given small majority in parliament and divergences on economic issues
• Increase in fiscal deficit and tensions with the rest of the EU likely
• 2019 budget the first real test; SocGen remains positive on Italian economic outlook
• “Surprisingly, the market is taking the news rather well for now”
• Notes Italy is up for review with rating agencies in coming months: “the big risk is Moody’s,” the only agency with a negative outlook on Italy, at Baa2; downgrade to Baa3 not in itself enough to lead to large sell-off, though brokerage’s fear is downgrade with negative outlook would “raise the specter of BTPs going sub-investment grade”

NATIXIS

• There are no guarantees that measures like the flat tax and universal citizen income would be eventually adopted; the costliest one, the flat tax, will likely face significant legal challenges
• The negotiations may still fail; no certainty that the two parties will find an agreement on a “neutral” prime minister
• Probability that the two parties form a government has increased from 30% to 60%
• While there is room for continued repricing in the coming days and weeks in the case that a government between the Five Star and the League materializes, doesn’t expect Italian yields to skyrocket

BARCLAYS

• Unless properly backed by credible financial and economic measures, the proposed economic program would likely bring about “substantial fiscal slippage”
• The likely quality and expected size of the offsetting measures mentioned do not look sufficient to counterbalance the estimated cost of the program
• Some of the proposed changes may not be easy to implement; parliament support is unlikely to be strong enough to fully support such a potentially contentious government program

KEPLER CHEUVREUX

• Broad agreement on program -- though there are still significant differences -- and on the prime minister, which “was not an easy issue to sort out;” seems that neither leader will be prime minister
• First reactions to program point to significant impact on accounts (an impact on the deficit of up to 5% of GDP), which would make it difficult to implement
• Details “so poor” it’s impossible to provide a proper forecast; notes such an aggressive plan will certainly be backed by measures to compensate the negative impact on the deficit

MEDIOBANCA

• Notes President Sergio Mattarella indicated over the weekend that “he could not approve whatever Five Star/League may have approved”
• While short-term it is positive that Italy avoids new elections that may arguably lead nowhere, proposals from new government will have to face the reality check of public finances and sustainability of the proposed measures
• Maintains selective approach to the Italian market
• NOTE Feb. 27: Favor Pro-Cyclical Sector Allocation Into Italy Vote: Mediobanca

MIZUHO

• Growth is the more significant determinant than the change in the deficit, within reasonable bounds, suggesting that the market could reward fiscal spending, even with a multiplier some way below 1, with tighter spreads in the near term
• The structural risk for Italian government bonds BTPs remains a lack of economic reform and a relative inability to cope with tighter ECB monetary policy

RABOBANK

• There may be optimism that the soon-to-be revealed nominee for the premiership will be seen as a “civilizing force” that may curb the worst excesses of a Five Star/League
• There is the reassuring thought that President Mattarella will, himself, keep the populists in check
• Sees a sizable question mark over the longevity of just such an administration (meaning they may not have the chance to roil out much of their policy platform)
• Retail inflation-linked BTP Italia sale from Monday, if strongly subscribed by retail investors, may well provide another string-to-the-bow for investors wishing to rationalize a long BTP position

MPPM EK

• If the new prime minister is a newcomer without political experience, there is a risk Italy will not succeed in finding a path for necessary reforms, which might weigh both on the euro and equity markets
• Expect volume to remain muted for the time being

RELATED

• NOTE: Italy Populists Go All In on Pricey Vows Preparing for Power
• NOTE: Italy Bond Blowout Hurdle Is High Unless Populists Blow Budget
• NOTE: Italian Populists Bring Promises With Hefty Price Tags
• NOTE: Italy Stock Hedges Grow Pricey as Populist Risk Looms: Chart
• See: Get Used to U.S. Stock Volatility Gauge Trumping Europe’s: Chart

--With assistance from Paul Dobson Stephen Spratt and Lorenzo Totaro

To contact the reporters on this story: Chiara Remondini in Milan at cremondini@bloomberg.net, Aleksandra Gjorgievska in London at agjorgievska@bloomberg.net, Marco Bertacche in Milan at mbertacche@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Celeste Perri

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