With the assistance of Ransquawk

Curious "What Happens Next in Italy" after this weekend's elections which resulted in a surge for anti-establishment parties, doomed Matteo Renzi after a disastrous showing by the PD, and resulted in a hung parliament, or perhaps even a goverment of Euroskeptic parties (Five-Star and Northern League)? Then the following primer courtesy of Ransquawk should answer most of the pressing questions.

5-Star founder Beppe Grillo with current leader Luigi Di Maio

Italy exit polls pointed to a hung parliament with anti-establishment 5-Star Movement as the largest single party and the Centre-Right seen as the leading coalition, with far-right junior coalition partner Northern League having possibly outperformed Berlusconi’s Forza Italia.

Timeline

23rd March : Parliament will gather for the first time

: Parliament will gather for the first time 23rd – 30th March : Both the upper and lower houses will elect their respective Presidents and then begin consultations with President Mattarella

: Both the upper and lower houses will elect their respective Presidents and then begin consultations with President Mattarella 30th March – 6th April : President Mattarella will name his chosen candidate to form a government. Note, Mattarella will choose the candidate which he deems to have the best chance of forming a government, not necessarily the candidate whose party gained the largest share of the vote.

: President Mattarella will name his chosen candidate to form a government. Note, Mattarella will choose the candidate which he deems to have the best chance of forming a government, not necessarily the candidate whose party gained the largest share of the vote. **In the week that follows this, the candidate will either accept the mandate and both houses will hold a vote on the appointment. Alternatively, if no deal can be agreed, Italy will then move on to a fresh round of consultations.**

Potential outcomes

Centre-right coalition (Forza Italia/Northern League): This had been touted as a likely option heading into the election. However, that’d been under the assumption that Forza Italia would outperform the Northern League. Since this has not been the case, serious questions have been raised over the possibility of this partnership being formed as Berlusconi (Forza Italia) is unlikely to want to play junior to the Northern League or back its leader Matteo Salvini as a candidate for PM. Therefore, some serious compromises would need to be made in order for this option to go-ahead.

This had been touted as a likely option heading into the election. However, that’d been under the assumption that Forza Italia would outperform the Northern League. Since this has not been the case, serious questions have been raised over the possibility of this partnership being formed as Berlusconi (Forza Italia) is unlikely to want to play junior to the Northern League or back its leader Matteo Salvini as a candidate for PM. Therefore, some serious compromises would need to be made in order for this option to go-ahead. Grand coalition (Forza Italia/Democratic Party): Heading into the election, this had been touted as the most likely outcome. However, the below-par performance by the Democratic Party makes this option mathematically difficult without involving the support of one of the more radical parties; an unlikely outcome. Furthermore, the poor performance of the Democratic Party makes the prospect of a centre-left coalition unviable.

Heading into the election, this had been touted as the most likely outcome. However, the below-par performance by the Democratic Party makes this option mathematically difficult without involving the support of one of the more radical parties; an unlikely outcome. Furthermore, the poor performance of the Democratic Party makes the prospect of a centre-left coalition unviable. Populist Government (Five Star/Northern League/Brothers of Italy): Such a coalition would depend on the willingness of the Five Star Movement which at this stage appears to be unlikely (despite a recent softening of their opposition to coalitions) given their anti-establishment views. Furthermore, despite being of the populist mould, the coalition would hold fairly wide-ranging views.

Such a coalition would depend on the willingness of the Five Star Movement which at this stage appears to be unlikely (despite a recent softening of their opposition to coalitions) given their anti-establishment views. Furthermore, despite being of the populist mould, the coalition would hold fairly wide-ranging views. Repeat elections: Should all of the above options fail, Italian voters would be sent back to the voting booths in an attempt to break the deadlock. During this period, the current Gentiloni government would operate on a caretaker basis but the ongoing political uncertainty would likely act as a negative to Italian assets.

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Finally, here is Goldman explaining why Italy is now "more vulnerable than before the general election", and why the vote has "negative medium-term implications for stability in the Euro Area and markets."

Italy more vulnerable than before the general election

The official result of the Italian general election is yet to be announced. Electoral projections based on the votes counted so far (from roughly two thirds of the polling stations) suggest that no major party or electoral coalition will win an absolute majority of seats in the Lower House and Senate. These projections indicate that the centre-right coalition will win most seats in both the Lower House and Senate (about 37.1% and 37.5% of seats respectively, according to the latest numbers), with Lega (the anti-immigration, anti-European party led by Mr. Salvini) the leading party of the centre-right, ahead of Mr. Berlusconi’s Forza Italia. The Five Star Movement (the anti-establishment party led by Mr. De Maio) is projected to win the highest share of seats for an individual party in Parliament (about 32.1% and 31.9% of Lower House and Senate seats respectively).

If these projections are confirmed, the Italian elections will result in a hung parliament. We expect a bumpy and potentially long period before a new government is in place. In the meantime, the current government will remain as a caretaker. The formation of a new government will come only after a period of negotiations all among political forces.

Centre-left and centre-right parties are unlikely to have enough seats between them in the Parliament to create the weak centrist coalition government that we were expecting. Both the Partito Democratico (centre-left party led by Mr. Renzi) and Forza Italia are projected to win fewer seats than opinion polls suggested.

Given the strong showing of the Five Star Movement, the President of the Republic could grant them first the exploratory mandate to form a government. Based on current projections, an absolute majority of seats could be held, for example, by (i) the Five Star Movement in coalition with the Partito Democratico and its spin-off Free and Equal; (ii) the right-wing coalition with the support of PD; or (iii) by an anti-establishment coalition of Five Star Movement, Lega, and the right-wing party Brothers of Italy. These post-electoral alliances will not be easy to pursue and none of them would be a "friendly" outcome for markets.

A failure for any of these alliances to materialize will likely lead to a technocratic/caretaker government operating under a narrow mandate, most likely limited to a revision of the (recently approved) electoral law. It is conceivable that the Five Star Movement and the centre-right coalition parties will support an electoral law that will include a majority premium to increase their chances of winning an absolute majority in Parliament at the next election. Hence, new elections could occur quite soon, perhaps in a year's time.

Even if a technocratic/caretaker government takes office and pursues continuity in economic policy over the near term, the Italian economy – with its longstanding weaknesses on the growth, fiscal, structural and institutional fronts – remains vulnerable, probably more so than before the election. As we discussed in a recent note (A tale of three macro fundamentals and three catalysts), the outcome of the election is unlikely to lead to a government able or willing to address the fundamental economic frailties in Italy, but rather – were some electoral promises implemented – to exacerbate them.

In our view, the inconclusive Italian vote has negative "medium-term" implications for stability in the Euro area and thus for markets. Even though the prospect of a caretaker government could diffuse tensions for now, the Italian vote suggests little appetite for economic policies that would keep Italian fiscal deficit under the 3 percent Maastricht limit, for example. This will create tension between Italy and its European partners. More generally, the composition of the new Parliament will not be seen as favourable by those partners, especially in northern Europe. We expect the northern Europeans to demand more risk reduction at the national level before further steps towards integration and risk sharing can be made across the EU. The Italian Parliament will likely oppose the former.