What Does the Italian Referendum Mean for Investors?

Getty Images / Guillaume CHANSON.

Italians voted strongly against a controversial constitutional change designed to create a stronger government in a move that dealt a fresh blow to the European Union. After Britain’s surprise exit from the E.U. and Donald Trump’s equally surprising election in the U.S., investors have become increasingly wary about the growing tide of nationalism and protectionism sweeping the world and its potential impact on global economies and financial markets.

What Happened?

Italy’s constitutional referendum would have amended the Italian Constitution to reform the composition and powers of the Italian Parliament along with the divisions of power between the state, regions, and certain administrative entities. Supporters argued that these changes would enable the government to move forward with much-needed changes, but critics argued the bill was poorly written and gave the government too much power.

The most significant changes would have reduced the Senate’s legislative power and eliminated its ability to pass a motion of ‘no confidence’ against the government. The Chamber of Deputies would instead be the primary legislative power that would be able to overrule the Senate in certain matters with a second vote. The move was aimed at preventing the Senate from ousting Prime Ministers and make it easier to pass unpopular legislation.

Opinion polls showed 63.2 percent support for the referendum in March, but that support eroded to just 46.9 percent supporting the measure by November.

Nearly 65 percent of Italian citizens turned out to vote on Sunday, December 4, 2016 and rejected the referendum by 59.11 percent of the votes. Rome and Tuscany were two of three regions that supported the measure by a majority, along with Italians abroad, while every other region of the country opposed the measure.

What Happens to Italy?

Italy’s banking sector has been struggling with over 350 billion euros of non-performing loans that could derail its economy. In January, Prime Minister Renzi reached an agreement with the European Commission whereby Italy would guarantee the loans to make them more appealing to private investors that might purchase them. The Italian referendum was intended to make these kinds of politically difficult measures easier to implement moving forward.

With Renzi resigning, many investors fear that a populist Prime Minister may replace him and veto the agreement with the European Commission. This would deter investors from recapitalizing Italy’s troubled banks and potentially lead to a failure in its banking system. For example, Monte dei Paschi di Siena would potentially go under if the agreement isn’t enforced and lead to a loss of confidence across the banking sector.

What Happens to the E.U.?

The European Union has been struggling to maintain political unity since the 2011 sovereign debt crisis that pitted North against South. As Europe’s third largest economy, Italy plays an important role in ensuring the compliance of southern economies that have experienced the brunt of the financial crises.

Italy’s non-compliance or departure from the European Union could trigger a collapse in the political and economic union.

With Prime Minister Renzi resigning, the populist Five Star Movement could take over as one of Italy’s most popular parties since its founding in 2009. The FSM recently launch a campaign to hold a referendum on the euro — like Britain — in a move that could eventually lead to an exit from the European Union. Of course, Italian law doesn’t permit referendums to repeal international treaties and there is a long legal process associated with the move.

The Bottom Line

The market’s reaction to Italy’s ‘no’ vote on the referendum has been like Britain’s reaction to the ‘Brexit’ and the U.S.’s reaction to Trump’s election — markets fell sharply and then recovered much of their losses.

While the populist movements may be negative over the long-term, investors are realizing that short-term gains may be possible and the negative effects could take years to materialize — especially when it comes to exiting the European Union.

International investors should tread carefully when it comes to investing in Italy and the European Union’s financial sector. If the European Commission agreement falls through, the country’s financial sector could experience a crisis that spreads throughout the E.U. Investors should also keep an eye on the Five Star Movement and whether it’s successful in installing new politicians to replace Renzi and other leaders.