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Giorgia Meloni, leader of the far-right Brothers of Italy party, speaks throughout a rally in Duomo square prior to the Sept. 25 snap election, in Milan, Italy, September 11, 2022. REUTERS/Flavio Lo Scalzo

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LONDON, Sept 19 (Reuters Breakingviews) – The following month it’ll be 100 years since Benito Mussolini launched his fascist coup in Italy when his supporters marched on Rome. Later this month the united states is nearly certain to elect Giorgia Meloni, a former post-fascist and eurosceptic, as its new prime minister. Up to now, investors havent blinked.

Meloni may be the favourite to displace Mario Draghi, the highly respected technocrat who helped save the euro about ten years ago. The gap between yields on Italian and German 10-year government bonds is 2.3 percentage points, exactly the same level as when Super Marios government began to collapse in July.

Italy will most likely muddle through under Meloni, the first choice of the Brothers of Italy, which opinion polls suggest would be the largest party following this Sundays election. But theres also a medium-term risk that the countrys massive debt will spin uncontrollable. This may happen under her watch or, given the short life of all Italian governments, under another prime minister.

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Melonis right-wing alliance is promising lower taxes and early retirement. Yet investors are calm because she’s abandoned her euroscepticism and says tax cuts be determined by hawaii of the countrys finances, which she promises will undoubtedly be safe in her hands.

Italys next prime minister would want to steer clear of the fate of previous governments which picked fights with europe over fiscal policy. Silvio Berlusconi was ejected from power in 2011 after yields on 10-year government bonds raised to 4.9 percentage points above Germanys. The anti-austerity coalition led by Giuseppe Conte, which collapsed in 2019, faced an identical experience.

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EU SOLIDARITY

Investors may also be relaxed as the EU is showing more solidarity than through the euro crisis about ten years ago. In reaction to the Covid-19 pandemic, it launched a Recovery and Resilience Facility comprised of cheap loans and grants. Italy will have the biggest chunk: 192 billion euros, equal to nearly 10% of national income.

The EU in addition has suspended fiscal rules which require member countries to help keep budget deficits below 3% of GDP a suspension which may be extended due to the existing energy crisis. Consequently, Meloni won’t have to cut spending or raise taxes immediately.

Russias invasion of Ukraine in addition has strengthened EU solidarity. Melonis consistent criticism of Vladimir Putin has won her brownie points in elements of the EU, despite the fact that many disagree with her views on LGBTQ rights and immigration.

The European Central Bank also offers a fresh tool to avoid the euro zone fragmenting. It’ll choose the bonds of governments which come under speculative attack as long as their debt is sustainable. Nobody wants Italy to get into a tailspin and drag down countries such as for example France and Spain, which likewise have high degrees of sovereign debt.

VIRTUALLY UNSUSTAINABLE

The snag is that Italian government debt, that your International Monetary Fund expects to get rid of the entire year at 148% of national income, is near being unsustainable. It has risen from 104% in 2007 following shocks like the global financial meltdown, the euro zone meltdown, and the pandemic. Furthermore, the united states has found it hard to cultivate out of its debt. In real terms, the countrys national income is nearly exactly where it had been 20 years back.

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Optimists explain that inflation and the bounce-back from the pandemic-induced recession have helped to create your debt down from 155% of GDP in 2020. But they are temporary factors. The ECB is set to create inflation back again to its 2% target and soaring energy costs may push Italy into another recession.

Whats more, the era of near-zero interest levels has ended. Italian 10-year government bonds are actually yielding 4.1% greater than when alarm bells last rang in 2018 and early 2019. Rome is paying typically 2.5% on its debt since it borrowed lots of money when interest levels were low, however the average cost is currently rising.

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Consider how things can look after the energy crisis has ended and the post-pandemic recovery funds are exhausted. Imagine charitably that Italys average debt costs are then only 3% and its own trend growth rate is 1%. If inflation was back off to 2%, Rome would need to run a primary budget surplus before interest payments every year to be able to lower its debt ratio.

HOW THINGS COULD BREAKDOWN

Draghis plans envisaged Italy owning a primary deficit until 2025. So obtaining a grip on the countrys debt might not seem probably the most urgent problem. But Meloni lacks Draghis credibility. She actually is an inexperienced leader whose only previous job in government was as youth minister.

Whats more, her decision to abandon euroscepticism appears like among convenience. Therefore, she could embrace it again if she thinks it really is in her interest to take action. In the end, the Italian electorate is fickle. Within the last election in 2018, the Brothers of Italy had just 4.3% of the vote as the League, Melonis main ally, had 17.4%. Now opinion polls show Melonis party at 25%, weighed against about 50 % that for the League.

Despite the fact that the right-wing alliance looks set to win a large majority, it’ll be unstable, says Roberto DAlimonte, a political scientist. The League has very different policies to Meloni: its leader Matteo Salvini is sympathetic to Putin and wishes to jack up spending.

Salvini wont necessarily throw Meloni off course: his party may replace him with a far more moderate leader. Theres also a slim chance that Meloni could get together with some centrist parties should they prosper in the election. In extremis, Draghi may go back to government.

But theres also a scenario where Meloni shifts back again to more extreme policies in order to avoid being outflanked. She might think the EU would still keep financial support flowing to Italy since it wouldnt have the guts for a confrontation. If the ECB then refused to get Italian debt, and when neither side blinked, there will be a blow-up.

This isnt the central scenario in financial markets. It really is more likely that Italy will hobble along. But if growth remains low and interest levels rise, investors will once more get jittery.

Follow @Hugodixon on Twitter

(The writer is really a Reuters Breakingviews columnist. The opinions expressed are their own.)

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Editing by Peter Thal Larsen and Oliver Taslic

Our Standards: The Thomson Reuters Trust Principles.

Opinions expressed are those of the writer. They don’t reflect the views of Reuters News, which, beneath the Trust Principles, is focused on integrity, independence, and freedom from bias.

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