Analysis: Italy’s vote and Israel’s economy

Voters in Italy, Europe’s fourth-largest economy, elected a government in deadlock on Sunday and Monday, a setback that will have repercussions for all of Europe and Israel.

Pier Luigi Bersani led the Center-Left bloc to a victory in the Chamber of Deputies, the lower house, but failed to win a majority in the Senate. The Center-Right bloc of former prime minister Silvio Berlusconi – whom The Economist in 2011 dubbed “the man who screwed an entire country” for his corruption, economic mismanagement and a playboy lifestyle that landed him on trial for sleeping with an underage prostitute – turned in a surprising showing in the Senate.

One factor that blocked a decisive win was the resounding success of a new protest “non-party” called the Five Star Movement (M5S), founded by former comedian Beppe Grillo. It won fully a quarter of all the votes, in part for promising not to aid and abet the old political class.

Between Berlusconi and Grillo, it seems that Italian politics are content to blithely careen from one clown to another, while sidelining the “responsible adults” in the room; despite the nascent reforms that technocratic prime minister Mario Monti managed to implement during his short time in office, he received only 10 percent of the vote – a reminder that voters are seldom partial to austerity.

Because control of both houses is necessary to pass laws in Italy, Bersani and Berlusconi will either have to team up or eventually face new elections, leaving heaps of uncertainty in Europe’s largest overall debt-holder, which is second only to Greece in its debt-to-GDP ratio.

Markets reacted sharply to the election results. Italy’s own Milan stock fell over 4%, while the Dow Jones, London Stock exchange and other European stocks fell between 1.5-2% each. In Asian trading, the euro’s value dropped to a seven-week low against the dollar, while the Italian government’s borrowing costs spiked over two-thirds from last month, reaching their highest levels since October.

What does all that mean for Israel? For one, Italy’s deadlock could prolong economic stagnation there and in Europe in general, which affects Israel through trade by lowering demand for Israeli goods. On the other hand, it also weakens the euro, which has implications for Israel’s interest rate.

“In our opinion, the meaning of fear returning over a euro zone debt crisis is mixed, from Israel’s point of view,” says Ofer Klein, head of the Economics and Research Department at Harel Insurance and Finance. “The descent of Europe into recession weakens European demand for Israeli products. On the other hand, the strengthening of the dollar in the short run as a result of the crisis produces a positive effect that will help to mitigate the impact on exports.”

Yet when it comes to setting Israel’s interest rate, even a relatively stronger dollar might not balance the effect of a weakened euro.

“The effect on Israel is not a direct one,” explains Amir Kahanovich, chief economist at Clal Insurance.

“We know that at the end of the day, the Bank of Israel is worried about the shekel strengthening and slowing the Israeli economy,” Kahanovich continues, predicting that the bank will eventually intervene if the shekel gets too strong.

Yet in regard to the larger concern of the euro eventually collapsing, Kahanovich is sanguine.

“There is almost no chance of that,” he says. “Nobody wants to go back to their old currency. The meaning of it would be catastrophic for the county.” Any responsible leader, he says, would not risk the inflation, balance of payments crises, loss of investment, and debt challenges that parting from the euro would entail.

“Leaving the euro zone is economic suicide,” he says. “Even in Greece we saw that when it got to a really tough situation, it didn’t fold.”

Far from breaking the Euro apart, Kahanovich says the trials and tribulations will ultimately lead to stronger European interconnectedness, as politicians built institutions to overcome their economic challenges.

“We can be optimistic, not because the situation is good, but because the market reacts swiftly to bad decisions,” he says. “The path is pretty clear, and whatever the politicians don’t do correctly, they’ll pay for it.

In other words, despite short-term difficulties, the long-run prospects are good.

On Tuesday, German Foreign Minister Guido Westerwelle said that “what is now decisive for Italy – but, because Italy is such an important country for Europe, also for the whole of Europe – is that a stable government that is capable of acting can be formed as quickly as possible.”

The question, then, remains as to how big of an obstacle Italian politics will present in overcoming those challenges in the short- and medium-term.