Letta's Italy?

The first left-right coalition in Italy since 1946 has survived its first confidence motion in both chambers. As difficult as it may have been to break the political logjam, the hard work lies ahead for Prime Minister Letta.  

A new government often has a honeymoon period.  There are two tells that Letta's honeymoon will be short-lived.  First, initial polls show support for him is soft near 40%.  In contrast, when Monti took office his public support rating was a lofty 70%--now that was a honeymoon.  Second, Letta want a smaller cabinet, but was forced to accept 21 ministers rather than 12.  Neither the center-left nor the center-right seemed willing to accept anything that would dilute its numbers.    

This plays on concerns that although the cabinet lacks the heavy hitters and king makers in Italian politics, they still are pulling the strings from the sidelines.  The relative youthfulness of the cabinet (average age 53 years, a decade younger on average than Monti's cabinet) and the record representation by women, does not necessarily mean the old political elite have been pushed out as Renzi suggested.  

Letta identified three issues that will be the initial priority of his government: halting the June payment of the unpopular IMU tax on primary residence, delay the implementation of the VAT hike planned for mid-year (22% from 21%) and end the government financing of political campaigns. 

Getting rid of the IMU was one Berlusconi's campaign promises, but Letta stopped short of fulfilling the promise.  It appears that he has halted the June payment, but has not abolished the tax nor has he endorsed the refunding the sums previously paid.   The tax may have greater symbolic value of the austerity than substance as according to a Wall Street Journal report, half of Italian households pay less than 150 euros in the IMU tax.  

There were a couple of other ways that Letta quickly has made it clear that despite his uncle being one of Belusconi's key advisor, he would not capitulate to all of the center-rights demands.  Berlusconi wanted his ally Alfano to be the deputy prime minister and have the portfolio of the justice Ministry.  Letta granted the former but denied the latter and instead gave Alfano the interior Ministry.  

Berlusconi has opposed Saccomanni's advancement.  Draghi had wanted Saccomanni to replace him at the helm of the Bank of Italy, but Berlucsconi blocked this and instead the position was given to Visco, who, in unorthodox fashion leapfrogged ahead of Saccomanni in the pecking order of a hierarchy that is said to rival the Catholic Church.  Again Berlusconi tried to block Saccomanni's appointment in the new government, but Letta gave him the critical finance ministry. 

In some ways, with a younger cabinet, which includes some specialists with weak party affiliation, and the move away from Monti's austerity, Letta also appears to be stealing some of Grillo's thunder.   Yet Letta realizes that the government's stakeholders are not just the domestic forces.  Shortly after he survived the vote of confidence in the Senate today, Letta went to Berlin.  Later this week he will visit Paris and Brussels.  

Letta will not have to push very hard to get some concessions from the EU, where the EC President recently acknowledged that austerity has gone as far as it can.   Italy has reduced its government debt for three consecutive years.  It is one of the few countries in the euro area to run a primary budget surplus (budget position excluding debt servicing costs).  It could be as high as 2.5% of GDP.   The economy is in poor shape to say the least.  In fact, the severity of the economic contraction means that the Italian economy is smaller than it was a decade ago.  

The roughly 6 bln euros of revenue lost between the property tax and the VAT hike are relatively minor for the 1.2 trillion euro economy.   We would not push this point too far given the large stock of Italian debt and average maturity of around, but the decline in Italian yields this month (83 bp on the 2-year note to a record low) and 88 bp on the 10-year bond to 2 1/2 year lows), if sustained will help lower the government's borrowing costs and debt servicing costs). 

Electoral reform may be the most significant political issue for the Letta government.  Ironically, delivering this could jeopardize the longevity of Letta's government.  Berlusoni's center-right is running ahead in the polls and an early election would seem to benefit it.  On the other hand, Renzi, who is tipped to be the next head of the center-left, is polling better than Berlusoni.  However, the left is Italy is in disarray.   Yet, unlike the center-right and Grillo who want Italy out of EMU, Letta knows that the future of Italy is inextricably tied to Europe.

.