To be clear, if a referendum was to be held, we doubt that the Five Star Movement would actively seek a euro-exit, the Italian public preferring to remain within the euro. That said that, should economic conditions remain very weak and other economic policies fail to achieve any improvement in economic conditions, the Five Star Movement will most likely be more willing than other political forces to seriously consider the option of an exit, and as a consequence the movement poses a serious risk from a market perspective. Currently, however, it does not hold a parliamentary majority.
Possible items on the Five Star Movement's economic agenda
In an interview with the newspaper Il Corriere over the weekend, Mauro Gallegati, who works closely with Nobel Prize winning economist Josef Stiglitz – and who says he knows Beppe Grillo very well, and has apparently contributed to the Five Star Movement's economic agenda – pointed out that the programme is still not well defined, though he believes a shared economic programme may be developed soon. He also commented that Grillo likes to listen to ideas from many contributors and economists before forming his own opinions.
Importantly, Gallegati said that he has never heard Grillo saying that he wants to leave the euro, but that his position is that the population should be more involved in the decision-making process in Europe, and that a referendum would be one way to ensure that those voices are heard.
Hence, it looks as if a well-framed economic view within the Movement still proves elusive, although Gallegati did say that he will propose to Grillo, amongst other things, a tax on the richest citizens to help counter inequality; that fiscal reform is required to fight the black market; significant labour market reform based on employee sharing of profits; and the need for better, more transparent corporate governance.
We expect the development of an economic agenda with specific objectives over the coming months to remain a cause of concern for the market as these objectives could be misaligned with the economic agenda being pursued at the European level.
Coalition talks still inconclusive
Meanwhile, there still appears to be little clarity over the likely shape of the next government. The president has made clear that Italy needs a government and that he prefers the formation of a coalition over new elections, albeit one with a limited mandate in terms of time and possible reforms to pursue.
La Stampa reports that ahead of the official consultations that are due to start on 21 March, to follow the first reunion of the two new Houses on 15 March (there is a possibility that the latter will be brought forward to 12 March, thus providing room to expect consultations), the president is in the process of starting informal consultations among political parties to attempt to build a consensus between possibly the Five Star Movement and the centre-left. So far the Five Star Movement has rejected vehemently any invitation from Bersani, but negotiations are likely to continue in the coming days and there are expectations that the president may ultimately persuade the Five Start Movement to provide support to a government "of scope", that would deal with a very select number of items, in particular a reform of the electoral law and the cost of politics.
La Stampa also reports that the president is against attributing an explorative mandate to form a government without a clear picture of the political situation, since if such a mandate would fail then immediate elections would follow (a situation Italy can ill-afford). As such, we believe he will be looking into all options, including a technocratic government led by central bank Governor Visco, or within the central bank by Saccomanni, or even a short-term government run by Monti (according to La Stampa).
Conclusion
The situation remains very fluid and we expect markets to remain quite volatile as uncertainty around the political outlook remains and negative headlines around political maneuvering continue to hit the wires. As we noted recently (see Risk of ungovernability to be priced by the market, 26 February 2013) we are likely to face a period of high uncertainty with no new government, likely up until the end of March. In this context, markets will have to price in the risk of ungovernability. The absence of government in the short term makes OMT eligibility more complicated as shown in previous cases where there was a lack of political leadership in other euro area countries.
However, should market pressure build rapidly, we do not expect bond yields to test the highs of the crisis given that the OMT optionality remains. Needless to say, Europe would likely make the formation of a government a precondition to OMT eligibility. This unfortunately might increase investor anxiety about the ability of the OMT to provide an efficient cap to yields given that it is not at all clear at this stage how a new government can be established promptly. The ECB may be required to step up its rhetoric and hint at the availability of support to prevent markets from falling back into a bad equilibrium.

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