Italy has been on a political rollercoaster over the last 12 months with the resignation of Prime Minister Matteo Renzi and steady rise of populist party Five Star Movement. These events combined with weaker fundamentals have led many investors to avoid Italy, in favour of core European bonds such as France.
We take a different view. Italy is the largest holding in our Franklin European Total Return fund1 while we have a benchmark underweight to France. While a number of risks prevail in Italy, we think they are manageable and investors are well compensated at current yields.2
Political volatility contained
While the political situation is still uncertain, we are now not as concerned about a populist uprising. Early in 2016 the anti-EU Five Star Movement gained significant momentum. However, in recent local elections they lost in key cities, so it does appear some support is waning.
Though not our base case, it is not completely unfathomable they could win majority support in the next elections. But, even if they did, thanks to Italy’s current constitutional structure, they would face similar challenges to Renzi in pushing through reform.
On their anti-EU stance specifically, Italy’s constitution prevents a political party calling a referendum on an international treaty such as the EU Treaty. While it is still possible that they could achieve this, it would be a difficult process.
Primary surplus
Italy’s weak fundamentals have long been a turn-off for debt investors. Growth in the country has been slow, while the budget deficit needs to be reduced.
However, we are seeing a turnaround. If interest payments are discounted, the government is currently running a budget surplus. As such, in our opinion growth should go up, so we may see Italy’s debt to GDP (Gross Domestic Product) plateau this year rather than keep rising.
