With the Italian parliamentary election only one week away, polls continue to point to a hung parliament with no clear majority in sight. However, irrespective of the governing coalition formed after the election, we do not expect the new government to undertake the necessary structural reforms to kick-start the Italian economy. Instead, most parties have called for higher public spending and such policies would be likely to bring Italy onto a confrontational course with the European Commission over fiscal consolidation and deficit reduction targets at some point.
Fiscal profligacy and rising tension with the EU could further heighten market concerns over Italy's debt sustainability, also in light of the possibility of ECB QE purchases ending in 2018, of which Italy has been a large benefactor. We look at the medium-term Italian debt dynamics under three different political scenarios: the good, the bad and the ugly. In light of a rise in global yields, weak growth prospects and a fragile banking system, it would not take a lot for Italian debt dynamics to worsen.
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