After an historically unusual stretch of stability, the latest crisis in Italian politics was triggered by nothing less than a scrum over money between former premier Matteo Renzi, now head of the tiny Italia Viva party, and outgoing Prime Minister and coalition head Giuseppe Conte – specifically the 200 billion or so euros in European Union funds that is to be disbursed to Italy over the next three years.
That political crisis now appears to be heading towards a hugely market friendly resolution – at least for now — as the highly respected former European Central Bank President, Mario Draghi, is reported to have been tapped by President Sergio Mattarella to start the process tomorrow of exploring the formation of a technocratic government.
But market reaction, most specifically the spread between Italian government BTP bonds and the benchmark German bund, has truth be told been somewhat muted to date, tamped down in no small part by massive ECB sovereign bond purchases for as far as the eye can see.
Sources in Brussels, however, point to another reason to take this, and even potentially future, political volatility in stride — and that is the tight control the European Commission will exert over any significant fiscal policy deviations from Rome.
Italy’s national recovery and resilience plan is being put together in very close cooperation with the European Commission, which guides all national governments on the construction of such plans. And Italy, as the biggest recipient of these funds, will be the country under tightest scrutiny at every stage of the budget process from hawkish member states like the Netherlands, Finland, and Germany.
So whoever is in charge – even perhaps, as most feared by markets, a government at some point led by Matteo Salvini and his Northern League – will for all practical purposes have to adhere to European Commission demands such as that 37% of EU funds be spent on a green transition of the economy, 20% on increased digitalization, and so on. The Commission will also in its demands include Country Specific Recommendations, although these, in all fairness, have been flouted for years by member states.
Most to the point, for Italy, the Commission wields an enforcement mechanism that trumps all, and that is the threat of withholding future tranches in the case of non-compliance. Italy is slated to get just 13% of the total amount promised in a pre-payment around the middle of this year, with subsequent tranches to be released only after verification by the European Commission of agreed to milestones.
The threat of withholding subsequent tranches of money in cases of non-compliance may seem extreme, especially as Europe grapples with the ongoing effects of the Covid crisis, but as veterans of the Greek bailout and financial crisis will recall, it can be, and has been, wielded with considerable effect.
If Draghi does end up in charge, all such considerations will, of course, be moot – at least for now.