Submitted by Chiara Zangarelli and George Buckely, European Economists at Nomura

Pulling the plug: Crisis in the Italian government – the roadmap

Lega’s Matteo Salvini has effectively called time on the current Italian government. While it is still formally in place, from here it seems highly likely that parliament will be dissolved or a confidence vote on Prime Minister Conte will be called. What is still uncertain is the timing, though in the event of an early election it will most likely be between mid-October and mid-November. The outcome of such an election, if called, could have far-reaching consequences for both Italy’s fiscal position and its interaction with the EU.

First of all, amid this government crisis there are a series of deadlines to be met that could make the whole process of calling an election in coming months more complicated:

26 August: Italy must present its candidate for European Commissioner. Mr Salvini had already provided a list of names to PM Conte.

27 September: The government must present in parliament an update of the document of economy and finance (NaDef).

15 October: The government must present its Draft Budgetary Plan to the EC.

27 October: Regional vote in Umbria, followed by Calabria and Emilia Romagna.

30 November: Brussels to express its opinion on Italy’s Draft Budgetary Plan.

There are several ways in which the current government crisis can be transformed into elections. It is not up to Mr Salvini to call new elections – his role of internal affairs minister does not allow it. Of course, if the party no longer wishes to cooperate with 5SM Prime Minister Conte will be required to submit his resignation to President Mattarella. From here the President of the Republic can either choose to accept the resignation immediately or ask for a no confidence vote on the current government. The latter could lengthen the process towards new elections by a number of weeks|. First of all, parliament will need to be recalled from summer recess to vote on the confidence motion against Mr Conte and that in itself would require few additional days – parliament is not due to return from recess until 9 September.

Once President Mattarella has officially accepted the resignation of Mr Conte – either immediately or after a vote of no confidence – Mr Mattarella will consider whether the current parliament will allow the formation of another majority government (it seems very unlikely in this case) before opting for another election. If a new majority government cannot be found then the President of the Republic can officially dissolve parliament and call new elections. New elections should be held within 40 to 70 days from when parliament is dissolved.

The date of the elections depends on how long this whole process will take. If Mr Conte resigns without a vote of no confidence, Mr Mattarella accepts his resignation and parliament is dissolved next week then this is about the shortest possible timeline for new elections – which could be held by mid-October. However, if the government is removed via a vote of no confidence, then this will take longer and elections might not be expected to happen until mid-November at the earliest.

An important question is who, in this situation, would prepare the budget bill before year-end, in order that the planned VAT hike scheduled for early 2020 can be avoided? Both governing parties, 5SM and the League, agree on the fact that the VAT hike (worth €23bn) should be avoided. However, a newly formed government may not have enough time to act upon this.

The VAT hike clause is an instrument used by the Italian government enshrined in the budget law that intends to safeguard European deficit rules. It has been in place in Italy since 2011 (introduced by Mr Berlusconi’s government), but since then every government has either postponed or offset it with other measures to be compliant with European rules. This time should be no different. However, finding a way to plug the €23bn fiscal hole that postponing the VAT hike implies may not be easy, particularly if a government is not formed until the very end of the year.

Another key question is what government will result from new elections? While it is uncertain how the ‘alliances’ game plays out, it seems reasonable to conclude based on the opinion polls that it would be a League-led coalition. An alternative government could result from coalition talks between 5SM and PD, though we see this as less likely as we do not expect the two parties to run together as a coalition at the next elections. Our base case remains a right-wing coalition taking power after an election. Figure 1 shows that the League might only require the support of a smaller party such as Fratelli d’Italia (Brothers of Italy), thereby not requiring the support of Mr Berlusconi’s Forza Italia in the coalition. That would lead to a far-right government, the consequences of which may be increased concerns about Euroscepticism or even, in the extreme, fears of a euro exit (see Figure 2).

We had expected new elections not to take place until the spring of 2020. However, following this week’s news the likelihood of earlier elections has increased significantly. We now think that fresh elections will most likely take place between mid-October and mid-November 2019.

Our base case is of a far-right government headed by Mr Salvini’s Lega. However, much uncertainty remains on the exact date of these elections, which will depend crucially on PM Conte’s intentions and President Mattarella’s willingness to dissolve parliament. The results of the election could have far-reaching consequences for both Italy’s fiscal position and its interaction with the EU.