No simple Senate agreement, expect weeks of negotiations
The centre left coalition led by Pierluigi Bersani secured a majority in the lower house, but needs a coalition partner in the Senate in order to govern. A coalition with Monti's list would be 20 seats short and a grand coalition with Monti and Berlusconi is de facto unviable as Berlusconi has ruled out cooperation with Monti. The remaining options are: a Bersani-Berlusconi (BB) cooperation, a Bersani-Grillo cooperation or elections again.

BB government: Not stable, not likely
As we noted before, Bersani-Berlusconi may only be able to agree on a very narrow set of reforms possibly in the area of spending cuts and modest tax reshuffling. However, the two parties have profound divergences and neither would gain electoral support from such a cooperation. As a result, we think initial discussions between the two are possible, a temporary arrangement cannot be excluded, but we do not think it would last long and would not deliver the reforms the country needs.

Bersani-Grillo: Not easy, but positive for reforms: Likely
This cooperation would take several weeks to negotiate, but if it materialises it could prove very positive for reform momentum since Five Stars in our view will only agree on an agenda that closely reflects their priorities: institutional reforms, liberalisations, greater social support for vulnerable groups.

Early elections require a new President: Meaningful risk
Early elections cannot be called until a new president is elected sometime in May. The first session of parliament will take place on the 15th of March, whether a new round of elections will materialise in our view will not become clear before May.

Strong downside risks to growth
Our forecast for a 1.1% GDP contraction this year, following -2.2% in 2012, is subject to strong downside risks due to a lukewarm global recovery, strong fiscal constraints and the high propensity to save by the private sector given the strong external and domestic uncertainty. This implies that the incoming government will have limited scope for manoeuvre on the fiscal front and therefore any increase in social spending will have to be financed via spending cuts

Credit rating downward pressure
The three main rating agencies have Italy on negative outlook and S&P also has Italy on negative watch. We believe that the combination of downside risks to GDP prospects and uncertain political backdrop will trigger another wave of downgrades in coming quarters and the trend is unlikely to reverse until the new government proves significant ability and willingness to implement bold reforms
2013 Merrill Lynch, Pierce, Fenner & Smith Incorporated

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