To deal with this situation, Draghi’s leverage will mainly be on the fiscal side. So far, the Italian government has been generous on guarantees but more cautious on stimulus measures (6.5% of GDP), especially when it comes to public spending. According to our (preliminary) growth forecast of +3.3% this year and +3.8% next year, Italy will be one of the last Eurozone countries to reach pre-crisis GDP levels in mid 2023, one year after the Eurozone as a whole. To catch up with its European peers, a fiscal package similar in size to that of 2020 would be necessary to boost GDP growth by at least 2pp this year. No rumors of a new package have leaked out yet, but Draghi will have to position himself here soon (upcoming end of redundancy ban and support for most exposed sectors). In the case of a new package, we expect more weight on the demand side (the previous was equally weighted). This is easier to achieve in a heterogeneous coalition, especially as the supply side should be covered by the national recovery plan.
Given the tight schedule, we don’t expect major changes in the size and orientation of the national recovery plan. Italy is one the largest beneficiaries of the “Next Generation EU” package, with grants of EUR82bn (5% of GDP). The implementation of the national recovery plan will be essential in getting the economy back on track. However, the last government broke apart over the design of the plan. The current draft includes expenses of EUR310bn over six years (EUR210bn from the EU recovery fund, EUR20bn from other EU programs and EUR80bn from national funds), of which 70% should be allocated to investments.
The weakness of the current draft plan is not its thematic focus (green transition, transport and digitalization), but rather its fragmented structure into numerous small- and mid-sized projects that are prone to operational frictions. Given the tight schedule (target date 30 April), major changes in size and general orientation are unlikely, but Draghi and Finance Minister Franco could provide more strategic guidance and specify governance here. In the negotiation with the Commission, we expect a cooperative approach. However, given Draghi’s heterogeneous coalition, tough negotiations might occur with regard to the reform counterparts. But we are also convinced that the communication will be handled with care. Draghi knows far too well that the biggest risk to the Italian spread lies in political uncertainty and open conflict with Europe. In advance of his appointment, the 10y spread vs
Germany had already contracted by 20bp, bringing 10y yields to a record low of 0.50%. Concerns about Italy's remaining in the Eurozone have largely disappeared from markets: hardly any break-up premium is currently priced in (see Figure 2). Draghi in office is an additional, but not the only reason why we remain positive on the Italian spread until the year’s end.
Figure 2 – Italian spread pricing hardly any break-up risk
(decomposition of spread 10y Italy vs 10y
Germany, in bp)