Why is the Italian referendum important?

When you think Italy, chances are you think pizza, gelato, spaghetti, risotto, olive oil, mozarella, freshly ground coffee, creamy cappucinos and I could go on. But while it has always excelled in the food department, sadly Italy has been rather less successful in politics. Its prime minister is trying to change that; this could be make or break for the European Union.

Matteo Renzi, Italy’s youngest ever prime minister at just 39 years of age, has called a referendum for 4 December this year. He wants Italians to approve a raft of changes to their constitution that will essentially make it easier for him to ‘get stuff done’.

Italy is facing perhaps the biggest political and economic challenges in its history, including a banking crisis, a government weighed down by debt and slow economic growth. Renzi has already made headway on reform, overhauling the Italian senate, relaxing employment and labour laws, and simplifying the legal system.

However he needs to do more and he believes the solution is to reduce the power of the Italian senate, which is currently a major source of political gridlock. The current 315 senators would be replaced by 100 regional councillors and mayors who would no longer be able to call a vote of no confidence in the current government. The reforms would tip the balance of power towards the chamber of deputies – Italy’s equivalent of the House of Commons¹.

Renzi hopes these reforms will help rid Italy of its crippling instability. Critics argue the proposals are undemocratic and will hand too much power to Renzi and future prime ministers.

A popularity contest

Renzi is leader of the centre-left, Democratic party and notably pro-EU. He has yet to face the electorate at a national election, having become prime minister after winning an internal power struggle in 2014. Although he is widely liked by financial markets, who believe his reforms will be good for the Italian economy over the longer term, he has inevitably upset a lot of people in his home country in his quest for reform, including the trade unions.

Much like David Cameron did with the EU referendum in the UK, Renzi has staked his political career on the vote by promising to resign if he loses. By personalising the referendum, Renzi has united the opposition against him. As with Brexit, the vote is being seen by many Italians as a way to air their discontent with the EU and the political establishment. So while notionally the vote is about constitutional reform, in practice it has become about many other issues, such as the economy, the EU, the Italian banking crisis, and Renzi’s general performance and popularity.

The rise of the anti-EU?

When the referendum was first called the ‘yes’ side had a huge lead, but this has rapidly deteriorated. As late as February many polls were showing the ‘yes’ side with a more than 30 point lead. This might be one reason why the vote is still off most people’s radar. However since July, 13 out of the last 20 polls have shown the ‘no’ side with a lead2. Essentially the polls are now too close to call and the outcome is highly uncertain.

Renzi has promised to resign if he loses the vote. He has started to backtrack on this recently but it would be unlikely that he could survive the fallout. If there is a ‘no’ vote, there will be a huge amount of uncertainty which is likely to trigger volatility in financial markets. Renzi is widely seen as the best chance that Italy has had at reform in years and his fall could potentially lead to a crisis.

It is possible new elections would be called, which could pave the way for the populist anti-EU Five Star Movement to take power, as well as a potential referendum on Italy’s membership of the EU. That’s why some commentators are saying this vote is even more important for the future of EU than the Brexit vote. A ‘No’ vote could spell the beginning of the end for the EU.

What does it mean for your investments?

Stock markets can struggle to deal with too many ideas at one time. At the moment the focus is on the US: who will win the election and when the US Federal Reserve will raise interest rates. As such, the Italian referendum has flown completely under the radar but this is likely to change in the coming weeks, particularly if the polls continue to stay so close.

A ‘no’ vote would likely be bad for risk assets, particularly European equities. The euro would likely also fall against all major currencies. The cost of Italian government debt would likely spike, which might ripple through to other southern European countries such as Spain and Portugal. Gold should do well on any fears the EU might break up.

I like the Elite Rated Blackrock Gold & General fund, which invests primarily in gold mining equities. It has a very long track record going back more than 25 years and it invests in high quality gold miners with strong cash flows.

If there is a ‘yes’ vote, it could be a boost not just to Italian equities but also to the wider European market as it breathes a sigh of relief. Newly Elite Rated Mirabaud Equities Europe Ex UK Small and Mid fund has around 11% invested in Italian companies. Another two my favourites in this sector are the Elite Rated Henderson European Focus (currently with 5.8% exposure to the Italian market) and Jupiter European (with 3.3% Italian exposure).

^1,2https://en.wikipedia.org/wiki/Italian_constitutional_referendum_2016