Comic: Mario Draghi Saved the Euro. Can He Save Italy?

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Comic: Mario Draghi Saved the Euro. Can He Save Italy?
Credit: © Reuters.

By Geoffrey Smith -- After saving the euro from speculative attack eight years ago, Mario Draghi has accepted arguably an even bigger challenge – saving Italy from itself.

Italian assets have been on a tear since his name was first mentioned as the likeliest candidate to replace Giuseppe Conte as Prime Minister at the head of a government of national unity. The FTSE MIB has risen some 9.5% since the start of the month, compared to 5.7% for the Stoxx 600 (the outperformance is even greater if you strip out the Italian components of the latter).

Italian bank stocks have done even better, rising by between 10% and 20% as investors previously wary of Italian country risk have embraced some of the highest-yielding sovereign bonds in Europe.

Yields on 10-year Italian government debt have fallen sharply, and the infamous spread over their German equivalent, a rough proxy for systemic stress in the euro zone, has collapsed to its lowest ever.

Faith in ‘Super Mario’ is obviously undimmed. But is it warranted?

The challenges ahead are daunting: first, there is the pandemic, which has claimed more lives in Italy than anywhere else in the European Union (94,000, according to Johns Hopkins) and which has almost certainly pushed the country into a double-digit recession: gross domestic product contracted 2% in the final quarter and lockdowns seem likely to keep it in negative territory in the current three months. Health minister Roberto Speranza was conspicuously one of very few ministers to keep his job when Draghi announced his cabinet at the weekend.

Then there is the business of structural reforms, which Draghi used to urge every month from his press conferences in Frankfurt. Without them, analysts say, it is only a matter of time before Italy’s chronically weak growth and its staggering debt mountain of some 2.5 trillion euros puts the single currency's viability in question again. Italy is the third-largest economy in the Eurozone and a founder member of the EU. For it to leave the euro would be a disaster far bigger than the loss of Greece would have been.

“As Italy has always been the elephant in the room during discussions of the viability of the euro project, this administration’s performance will echo well beyond its borders,” JPMorgan analysts led by Bruce Kasman said in a note to clients this week.

Draghi’s to-do list is a long one: the tax and judicial systems both remain ripe for simplification, as do local planning rules; the financial system remains clogged with bad assets due to bureaucracy. The authorities have shown remarkable ingenuity in trying to clean up bank balance sheets over the last few years, but the problem will remain as long as the average bankruptcy takes seven years to process.

The measure of Draghi’s success in that area may well be the sale of Banca Monte dei Paschi di Siena (MI: BMPS ), the Eurozone’s most notorious ‘zombie bank’, which is under threat of being wound up by the ECB if the government can’t find a buyer for it within weeks.

The trouble, as Draghi and everyone else who has tried to rule Italy knows, is that reform creates more losers than winners in the short term, and that potential losers are adept at using a system with multiple checks and balances to frustrate any attempt to change the status quo.

For Draghi to succeed, he needs the factions in his government to collectively abandon some of the constituencies that have put them in office. That is perhaps the biggest challenge of all. In giving cabinet positions to all the parties supporting his government, he has at least made it harder for the parties to escape responsibility – and popular displeasure – for what must follow. The key question, and one unanswerable for now, is how long Draghi can maintain discipline and unity as he pushes reform through.

Markets won’t have to wait long to see how much Draghi is willing to risk: the country has to present a “Recovery and Resilience” plan to the European Commission by April to unlock over 200 billion euros in funding from the EU’s Recovery Fund. That will need to show that Italy can ultimately grow its way out of its current troubles. For that, Draghi will need to mobilize all the goodwill that he has not only within Italy, but also in financial markets and in European capitals. The outcome is far from guaranteed.

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