World Economy

Italy Poised to Tear Up Eurozone

Italy Poised to Tear Up Eurozone
Italy Poised to Tear Up Eurozone

Two weeks after Britain voted to leave the European Union, Italy is now the latest European nation to come under the spotlight. The country's financial sector is on the brink of collapse, and a referendum on constitutional reforms in October has the potential to topple Prime Minister Matteo Renzi's government and cause an unprecedented political crisis.

All eyes have turned to Britain's vote to leave the European Union as having the most drastic political and economic impact on the 28-nation state but if you look at the country's economic data, bank issues, and the impending constitutional referendum coming up, Italy is like a bomb waiting to explode, Business Insider reported.

The Italian financial system, which to put it gently, is in a major state of flux right now. While Britain's EU referendum in June was seismic in terms of having economic and political repercussions across the bloc, the October referendum is of equal importance and the result could fundamentally alter the state of the already delicate Italian economy.

Italians will have a say on reforms to its senate, the upper house of parliament. The proposed reforms are widespread, and if approved could improve the stability of Italy’s political set up and allow Renzi to push through laws aimed at improving the country’s economic competitiveness.

If denied, Renzi’s government will most likely fall, plunging Italy back into the type of political chaos last seen after the ousting of former prime minister Silvio Berlusconi, according to Deutsche Bank.

“If the referendum is rejected, we would expect the fall of Renzi’s government. Forming a stable government majority either before or after a new election could become extremely challenging even by Italian standards,” Deutsche Bank analysts led by Marco Stringa said in a note to clients in May. Fears that the reforms will be rejected have intensified since the eurosceptic vote won in Britain.

Poor Productivity, Bad Loans

A political mess can quickly turn into a cornucopia of financial and economic disarray. According to estimates from business lobby Confindustria, if Renzi's reforms do not pass, it would further widen spreads on Italian debt. Italy simply cannot afford any of those things at the moment.

Not only is the country in a state of economic and political turmoil—it has crushingly low productivity, a history of missing growth targets, and has generally underperformed the rest of Europe in recent years—but the country's banking system is also in the midst of very serious problems.

The country's financial sector is plagued by an enormous surfeit of bad loans so great that the government was, in April, forced into rallying bank executives, insurers and investors to put €5 billion ($5.57 billion) behind a rescue fund for its weakest banks. The Atalante fund is designed to buy so-called bad loans from lenders and invest in their shares in the hope that the re-energized banks will lend more to businesses and spur growth.

However, Monte dei Paschi di Siena—the oldest bank in the world and weakest bank in Italy—is in possession of a bad loan book of around €47 billion right now, and that has got the European Central Bank very worried.

On Monday, the ECB's banking supervisor insisted that Monte dei Paschi must cut that book by €8 billion by the end of 2017, and by another €6 billion by the end of 2018.

“The bank has immediately initiated discussions with the European Central Bank in order to understand all the indications included in this draft letter, and to present its reasoning before the final decision, expected by the end of July 2016,” Monte Paschi said in response to the ECB's demands.

The news sent shares in all of Italy's banks substantially lower, with Monte dei Paschi understandably bearing the brunt of the falls. Shares dropped more than 8% on Monday to just 0.3 cents, valuing the bank at €1 billion, according to the Financial Times.