|M5 and NL have reached an agreement on the policy plan and government formation. The next government has committed to simplifying the tax rates and code for households and corporates, as well as supporting the incomes of those less well-off, as widely discussed during the campaign. In addition, the “contract” written by the two parties confirms a more active role within the EU to push for some procedural and institutional changes, commits to boosting investment in infrastructure and to supporting tourism, and pledges support for education and public healthcare, as well as maternity support. Last but not least, it promises potentially profound changes to the judicial system, to change the relationship between the state and the tax payer dramatically, and to also modify critical aspects of the labour market.
The content of the agreement matches our expectations and, as a result, at this stage, does not trigger any changes in forecasts. We maintain the view that the economy is in a favourable cyclical position and the incoming leadership is unlikely to affect this trend in the coming year; if anything, it may have a small positive effect in 2019E via fiscal policy.
We reiterate that the budget outlook is likely to deviate from the current strict budget deficit goals agreed with the EU: 1.6% of GDP expected by the MOF this year, 0.8% in 2019E and 0% in 2020E; we expect the deficit to stay at 2-2.5% of GDP instead. The critical elements will be the coherence of implementation between policies and the quality (rather than the speed) of the changes. The biggest test will be whether the new government will make Italians more willing to stay and invest in their country, or not.
We do not believe that the government will be able to implement all the proposed changes quickly. We expect the corporate tax reform and the pension reform to be discussed and introduced first in 2019E, with the phasing in of the minimum income and simplified tax structure for households for implementation in 2020-21E. Proposed procedural changes surrounding the way taxes are paid, in our view, could prove the most important aspect of the tax reform and, equally, the most dangerous for fiscal execution; as a result, slower implementation would be desirable and prudent, in our view.
According to what has been reported by the local press, the split of the critical ministers among the coalition parties gives the Prime Minister and Economic Development positions to the 5 Star Movement, while the Northern League (NL) has secured the Finance Ministry and the Internal Ministry. Notwithstanding the large gap in electoral performance back in March, this split suggests to us that the two parties are negotiating an equal weight, which is an important barometer of how the relationship between the two may unfold going forward.
The approval rating of the Northern League has risen further recently, touching 25% in some polls, while M5 is stable at 32%. The rise of NL lately is due largely to a switch from Forza Italia and, as such, the centre-right coalition overall would still not secure an outright mandate convincingly if elections were held again today, in our view. We suspect that NL is aiming to trigger early elections as soon as possible, but this may not prove easy to achieve. We suspect the party has already reached its maximum support base, while M5 could leap further ahead over time. All-in-all, in our view, the political risk for markets in the coming 18 months will come largely from noise surrounding the policy implementation and the stability of the coalition.