New Governments in Greece and Italy Could Contain Damage

Darren Williams

As political casualties of the European sovereign-debt crisis mounted this week, it’s easy to understand why financial markets panicked. But all hope is not yet lost.

The resignation of Georges Papandreou as Greek prime minister followed by Silvio Berlusconi’s promise to step down in Italy have added confusion rather than clarity to the European disarray. We’re clearly entering a dangerous new phase in the crisis, as indicated by Italian 10-year bond yields soaring above 7% yesterday and widening their spread over German bond yields to 550 basis points.

But I think the incoming interim administrations in both countries are capable of helping to contain the damage if they put their minds to it.

In Greece, Lucas Papademos, former vice president of the European Central Bank (ECB) was just named prime minister. The new government’s main task will be to negotiate the measures needed to secure a second Greek rescue package and then push them through parliament. After that, the government will resign and fresh elections will take place—probably in the first quarter of 2012.

The two largest parties—PASOK and New Democracy—have reached an agreement on forming a coalition government with a limited time frame and mandate, setting the basis for a broad-based agreement between Greece and its official creditors.

Time is of the essence. According to the finance ministry, the government has enough money to get it through to December 15. But it must receive the next tranche of funding from the European Union and International Monetary Fund by then because €8 billion of bonds are due to mature in the second half of December.

While the Greek challenges are huge, Italy is now in the eye of the storm. The Senate is due to vote on an austerity package today. The Chamber of Deputies will begin discussions on Saturday with a vote due to follow by Sunday at the latest. In theory, this should be followed by Prime Minister Berlusconi’s resignation.

At this point in time, the role of the President is very important in Italian politics. The significance was highlighted by President Giorgio Napolitano’s decision last night to make Mario Monti—a former European Commissioner—a lifetime Senator.

This looks like a signal that Monti may head up a new technocratic government as soon as next week. Alternatively, there is speculation that Monti could become finance minister in a government led by Giuliano Amato. That would resonate well with investors: Amato served as prime minister in 1992 and pushed through radical austerity measures after the lira was forced out of the European exchange rate mechanism.

The coming weeks are likely to be very messy in Italian politics and the outlook is still uncertain. But the often dysfunctional Italian political system has pulled together before when the pressure was really on. I expect it to do the same this time.

In fact, the type of “technocratic” government by non-political figures now being considered in Greece is very much an Italian concept. It was used extensively during the 1990s to help Italy avoid a financial meltdown and guide it into the single currency.

I think that Italy will eventually end up with the technocratic government it needs. I hope it gets there sooner, rather than later, because that would give a significant boost to Italy’s credibility. While this alone is unlikely to be sufficient to stabilize markets, it is clearly a necessary condition for any meaningful increase in support for Italy from the ECB or its euro area partners.

Darren Williams is Senior European Economist at AllianceBernstein.

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