New Italian Government: Will Promises Pay Off for Investors?

When Matteo Renzi succeeded his own party’s Enrico Letta as prime minister of Italy, he became the youngest Italian leader in modern times at 39. He’s counting on that youth, as well as on an extraordinarily ambitious program of reforms, to haul Italy out of its doldrums and set the country’s economy humming again, and has made promises that many feel are so unrealistic they can’t possibly succeed.

But Renzi isn’t standing still. Once he got a vote of confidence from the Italian parliament, he began to take steps to shake up the status quo. His new government is young, like him, and if they are as ambitious as he is, investors may see some results—though it’s too soon to tell whether they’ll be positive or negative.

Italy’s economy grew in Q4 of 2013, albeit by a paltry 0.1%—the first quarter-on-quarter increase since 2011. While the European Commission only projects growth of 0.6% for the country this year, Renzi is determined to boost the economy and create jobs. To that end, he has promised action on the “tax wedge,” the difference between what it costs an employer to have an employee and that employee’s take-home pay. The intent is to reduce the cost to employers so that they will hire more employees.

Particulars on his plan have not yet been announced, but La Repubblica said that he will announce a 10-billion-euro ($13.9 billion) income tax cut as the first move in an accelerated schedule that also encompasses action on education, youth unemployment and spending cuts. Other planned actions include changes to Italy’s electoral law—intended to end political roadblocks to change—and reforms to the public administration system. Renzi has promised to act on all of these within his first 100 days, at a rate of one major reform per month.

Certainly there was optimism in February, with Moody’s Investors Service raising the outlook on Italy’s credit rating from negative to stable. But perhaps the most positive indications came from investors at the end of the month after Renzi took office, with a large bond sale seeing 10-year borrowing costs hitting their lowest level in 8 years.

Investors latched onto 9 billion euros with enthusiasm. The new bonds offered a yield of 3.42%, 5 basis points lower than on secondary markets. In fact, Italy had also raised up to 12 billion euros earlier in the week under Renzi, indicating that markets at least looked for some positive action from the new prime minister.

The country has been focused on measures that were aimed at cutting public debt, which is so high that the European Commission has just placed Italy on its watch list. While Italy’s economy ministry pointed out that two years of concentration on stabilizing public finances have brought lower borrowing costs, thus far the emphasis has been more on raising taxes than cutting spending. Should Renzi not succeed in bringing down debt levels and boosting competitiveness, the EC could impose fines.

Renzi also intends to ask for easier terms for Italy from Europe. While it’s doubtful that he’ll succeed unless he exhibits real progress in the rest of his agenda, he certainly isn’t hesitating to shake up the status quo. One area that will be under close watch is whether he exceeds the 3% budget deficit limit in his drive to institute reforms that require additional spending—such as the education and youth unemployment actions.