A devotee is smeared with a vermillion powder while celebrating the "Sindoor Jatra" vermillion powder festival at Thimi, in Bhaktapur, Nepal. Reuters/Navesh Chitrakar Italy is in the middle of a period of amazing political and financial turmoil.

The country faces a constitutional referendum that could lead to the fall of its government. Its banking system is experiencing unprecedented problems thanks to a huge surfeit of non-performing loans, despite a rescue package for its weakest lenders.

All this turmoil adds up to make Italy the "biggest headache" for the rest of Europe, according to research from staff at Citi.

"While Italy needs Europe to get out of the woods, Europe might struggle to survive with a key partner lost in the woods. Five years into the crisis which led to the ousting of Silvio Berlusconi, Italy is still Europe’s biggest headache. And the headache might intensify in the coming months should Renzi’s government collapse."

In their latest analysis of the situation: "Talking About Italy Flirting with the Past: Is Italy Europe’s Sleeping Risk?" — Citi analysts led by Mauro Baragiola, Tina Fordham, Jonathan Stubbs, and Giada Giani, discuss Italy in depth, covering everything from the luxury goods sector in the country, all the way to the massive problem the country has with debt. Within the note, Citi staff discuss the five big issues that make Italy Europe's main "headache."

Italy's enormous debt problem

"Whatever it takes." Reuters/Francois Lenoir First, the country's problems with debt are enormous, and are described by Citi as "A €2.2 trn 'Whatever it Takes' Headache." Essentially, the European Central Bank is bound by president Mario Draghi's famous statement that he will do "whatever it takes" to save the euro in 2012, Citi argues.

Italy has a public debt of more than 131% of GDP, and if that starts to go sour, things could get real ugly, real quick. As Citi notes: "The euro might come under renewed pressure on Italian public debt. And European partners might not want to have Italy run by parties targeting debt restructuring."

Second, and equally important, is the rising swell of populist, anti-EU sentiment in the country, which Citi fears, could help spread this ill-feeling across the continent, especially if Matteo Renzi's government collapses and the Five Star Movement finds its way to power. As Citi notes, this is a big switch, given that the country's citizens have traditional been big Europhiles.

Here is the extract (emphasis ours):

"Whereas Italy is a founding member of the European Community and Italians used to be among the biggest supporters of European integration, the degree of EU/euro scepticism in Italian politics and voters is on the rise and relatively high."

"After Brexit, Vox Populi is spreading across the Continent, European institutions might not shrug off Italians’ criticism (also considering that Italy’s experience in the Eurozone has been somewhat disappointing – with 2015 real GDP per person lower than in 1999) – providing an efficient populist message across Europe for the many anti-establishment parties."

Another issue that Europe faces when it comes to Italy is the fact that many big institutions have substantial operations in the country, and should its stagnant economy get even worse, big companies could start to feel the pinch.

"Italy is a poor state but a rich country: whereas public debt might provide a headache for the European institutions, a further collapse in the Italian economy might be a big blow for the income statements of the many global companies that still have large B2B and B2C operations in Italy," Citi argues.

Matteo Renzi, Italy's prime minister. AP Photo/Khalil Senosi

One of the issues we have highlighted the most about the Italian crisis in recent months is the country's ongoing banking crisis, which centres around the huge number of bad loans granted by banks in the country, particularly its third largest lender, Monte dei Paschi di Siena.

Some of the country's issues have been addressed through the creation of the Atalante fund, and a private rescue package for MPS, but issues still remain. Those issues could turn out to be systemic, Citi notes, potentially having serious knock-on effects

Here is the full extract (emphasis ours):

"Although a banking crisis in Italy should be theoretically ringfenced and have little impact on banks outside Italy, collateral damage cannot be ruled out given the systemic risk of the Italian banks as well as large Italian operations of European banks. EBA tests and the IMF recently highlighted some weaknesses in other European banks which might struggle to remain immune from a confidence crisis in Italy."

Finally, not only is Italy a political and an economic worry for Europe, it also has the potential to turn into a geopolitical headache, given its location on the fringes of Europe, and in a key region in turns of mass immigration from the Middle East.

"Given the situation in Libya, Italy might increasingly become the soft belly of Europe in fighting illegal immigration," Citi argues, adding that "Italy might have somewhat recovered the strategic geopolitical status it enjoyed during the Cold War as a crossroad between West and East."