If Brussels to play hardball with Italy, it will be shooting itself in the foot

Italy is heading towards new elections. This weekend, the nationalist League and the populist Five Star Movement seemed on the verge forming a government – when Italy’s President exercised his constitutional power to veto their choice of a controversial Eurosceptic economist, Paolo Savona, as finance minister on the grounds that his appointment "could provoke Italy’s exit from the Euro".

The President suggested the appointment of a prominent and less controversial senior politician from the League as minister. But Matteo Salvini, leader of the League, refused – sensing fresh elections as an opportunity consolidate his leadership over the Right and make large gains.

The President acted within his constitutional rights by vetoing Savona’s appointment as minister. But his move will only strengthen those arguing that Italy is no longer fully sovereign, and that financial markets rather than the electorate now decide who governs the country.

Further compounding this impression, the President has nominated a former IMF official, Carlo Cottarelli, as caretaker PM, to ferry the country to new elections. These moves have enraged the Five Star Movement, which has demanded his impeachment, although the League is taking a more conciliatory line.

New elections will probably take place later this autumn. The coming months will reveal whether the League will run in alliance with Berlusconi’s Forza Italia, or whether it will align with the Five Star. However, it is already clear that the campaign will be very different from the one earlier this year.

The League and Five Star will try to capitalise on the President’s alleged interference in the political process. The euro, which the parties hardly mentioned in the previous campaign, will be one of the key issues. Polls suggest the League is likely to make large gains, although Five Star may have peaked. Meanwhile, the pro-European side, the Democratic Party and Forza Italia, are to be in a weak position as apparent defenders of the status quo.  

The events of the past few days have also raised the risk of an Italian exit from the euro. It seems unlikely that either Five Star or the League will campaign on leaving the single currency outright. But they are both likely to call for transformational reforms of the eurozone that other European capitals will see as fantasy. Indeed, even Macron’s proposed reforms of the Eurozone seem unlikely to see light.

Germany simply will not trust Italy to clean up its banks– a necessary precondition for common deposit insurance or a larger fiscal backstop. This means that, even if Italy treads water for the near future, the risks of a crisis will increase over the coming years.

If Five Star and the League manage to form a government, Italy will take an increasingly assertive stance towards Brussels from migration to economic governance and foreign policy. Their demands will put them on a collision course with the EU. Rome is likely to get increasingly more confrontational if this fails to get its way and try to implement controversial ideas such as a domestic credit system to be used for settling tax payments. These moves would increase the risk of Italy crashing out of the Euro.

Of course, fresh elections could also lead to other outcomes. The League could form a coalition with Berlusconi’s Forza Italia, which may take the edge of some of its more extreme policies. And an alliance between the Democratic Party and the Five Star Movement is also possible: many in the Five Star were unhappy about the alliance with the League, and the party is still torn about its positions on the Euro and the EU.

Whatever happens, the EU will be scoring an own goal if it refuses to give Italy further fiscal leeway to boost growth and provide it with aid in dealing with migration flows. While Italians are not yet set on leaving the euro and most want to remain in the EU, Italy appears set on a Eurosceptic trajectory.

Italians are disillusioned with Brussels, and think that it did not show Italy solidarity in the eurozone and migration crises; the latest Eurobarometer survey shows only 44 per cent now think EU membership has benefited Italy. If Rome is rebuffed, Italians will become more Eurosceptic, and when the next economic crisis hits, the possibility of Italy leaving the Eurozone, or even the EU, would seem less remote than as it does today.

Luigi Scazzieri is research fellow at the Centre for European Reform.