It’s long been argued that, if there was a major blow-up in the Italian economy, the country would – unlike Greece, Portugal and Ireland, which received bail-outs after the financial crisis from the European Commission, the International Monetary Fund and the European Central Bank – be “too big to save”.
During the last week or so, as the anti-establishment Five Star Movement and the far-right League have fumbled their way towards forming a coalition government, bond markets have been fretting that the two parties plan to test that theory to destruction.
A list of the proposed policies the new government planned to implement, which leaked on Tuesday, prompted alarm.
They included demands that the ECB write off some €250bn of Italian government debt that it has bought under its asset purchase scheme – Quantitative Easing in the jargon – and that new rules be put in place allowing member states to leave the eurozone if they so wish.
It has sparked fears of another eurozone sovereign debt crisis.
Italian 10-year government bonds, a good indication of the country’s borrowing costs, have surged from 1.913% on Monday night to 2.2% on Friday morning – the highest level since early October.
As the respected economist and commentator Lorenzo Codogno, a former official at the Italian treasury and now visiting professor at the London School of Economics, noted, the leaked document revived the risk of ‘Italexit’.
He said: “While both parties have moderated their tones over the past few months, the issue of Italexit and the relationship with Europe comes back in the document in a way very much in line with their original programmes.”
The two parties later insisted the leaked policy programme was old – although the question remains who leaked it.
Some in Rome think it was leaked by Sergio Matarella, the Italian president, in a bid to highlight that the incoming government’s proposals were unconstitutional and that therefore he would be justified in blocking its formation.
On Friday, however, the two parties agreed a deal to form a coalition in which none of these policies appear.
Gone are any mentions of asking the ECB to cancel Italian debt or of a referendum on either Italian membership of the EU or the eurozone.
However, there is a proposal to introduce a “universal basic income” of €780 per month for every Italian citizen, funded by the EU.
This is an idea that has won support elsewhere on both sides of the political divide.
Some on the left think it would reduce poverty while some on the right believe it is a straightforward alternative to often complex benefit schemes.
But Finland last month abandoned an experiment it had been running with such a scheme and it is extremely unlikely the EU will put up any money for Italy to introduce one.
The cost of introducing such a policy has been put at €17bn annually.
The League, meanwhile, wants to cut taxes with the introduction of a “flat tax” of 15% for businesses and two rates of 15% and 20% for individuals.
The cost of this latter policy is estimated to be at least €50bn.
Other plans include a roiling back of reforms to pensions, aimed at cutting government spending, which would cost a further €5bn.
Even though these policies represent a watering-down of the original leaked proposals, they are likely to provoke a row with the EU, since they would break the rules of the Maastricht Treaty governing how much member states may spend or borrow.
To an extent, this is slightly irrelevant, since the treaty capped the amount of total debt a country may have outstanding at 60% of GDP.
Most EU countries broke that rule long ago and few more spectacularly than Italy, which apart from Greece, has a higher debt-to-GDP ratio (132%) than any other country in the eurozone.
But most EU members have been trying in recent years to stick to the other main fiscal rule under Maastricht, which is that member states may only run a budget deficit of 3% of the previous year’s GDP, with only Spain and Malta in breach last year.
So, if these proposals were implemented, it would spark a showdown with the European Commission and the European Central Bank.
Accordingly, the main Italian stock index, the MIB, has fallen by nearly 3% since its close on Monday night while the euro has fallen against the US dollar by more than 1% this week – quite a dramatic move by the standards of the foreign exchange market – and currently stands at a five-month low against the greenback.
Investors in Italian assets are hoping that, once the government is formed, Five Star and the League will rapidly become aware of the limits of what they can do in power and that the financial markets will keep them in check.
But that is likely to provoke further turbulence in the eurozone and particularly once, as is expected in the next year to 18 months, the ECB starts looking at raising interest rates.