The eurozone, also called the euro area, is a union of 19 European Union member states that have officially adopted the euro as their primary currency and sole legal tender. These member states exist under one monetary authority, the Eurosystem. At the beginning of 2018, Italy was the third-largest economy in the currency bloc. When Italy entered into a deep political and economic crisis, it was a concern for the European Union (EU) as well as for the global markets. At the time, Italy accounted for 11% of the EU's gross domestic product (GDP).

At the end of September 2018, the ruling coalition comprising the Five Star Movement (M5S)—a political party that espoused a populist, antiestablishment view (and was critical of the EU)—and the Lega Nord—also a political party in Italy—submitted their 2019 budget to the European Commission.

The proposed spending plan called for a deficit equal to 2.4% of the gross domestic product (GDP). At the same time, Italy's total government debt was equal to 131% of the GDP (more than double the eurozone limit); the eurozone contingent had been pressuring Italy to decrease its debt. As a result, this move upset Italy's eurozone partners.

Key Takeaways

  • The euro zone's third-largest nation has plunged into deep political and economic crisis, which has become a concern for the European Union (EU) as well as for the global markets.
  • Italy has been a problematic state for many years. In a nutshell, a weak economy and a failure to form a workable political coalition have caused the problems in Italy.
  • Italy ranks among the countries with the most significant sovereign debt—around 2.8 trillion euros and counting—and has been facing a double-digit unemployment rate since 2012.

Failure to Form a Stable Government

Political chaos and the failure to form a stable coalition government were at the root of the problems in Italy. Despite several weeks of prolonged discussions and negotiation, an agreement failed to materialize between the EU-skeptic populist group, M5S, and the pro-EU establishment lawmakers. This left the country in a deep political and economic crisis.

After the March 2018 vote produced a hung parliament, Italy was without a proper government. At this time, the populist M5S party emerged as the largest contender; they attempted to join the far-right Lega Nord party to form a coalition government. While the two groups agreed on Giuseppe Conte, a law professor, to be their prime ministerial candidate, his surprise resignation shortly thereafter caused a stir.

This development was attributed to President Sergio Mattarella’s refusal to accept a euro-skeptic candidate Paolo Savona as economy minister. Savona has been an opponent of the single currency in the past, calling it a “German Cage.” He has also advocated for a “Plan B” alternative to EU membership.

Under the law, the Italian president has the authority to block individual cabinet appointments. As M5S and Lega Nord refused to offer a different choice for finance minister, the coalition went for a toss. Instead, President Mattarella appointed former International Monetary Fund (IMF) official Carlo Cottarelli as interim prime minister; this paved the way for another round of elections. Cottarelli thus became responsible for planning the new elections, as well as for introducing the new budget. (Cottarelli has a reputation of significantly cutting down on public spending, which has earned him the title "Mr. Scissors.")

Unfortunately, this decision by the president did not bode well with the M5S and Lega Nord parties. Mattarella, who was instituted by the earlier pro-EU government, faced calls for impeachment from the leaders of M5S, as a result of Mattarella’s refusal to accept Savona as economy minister, appointing Cottarelli as interim prime minister, and mandating fresh elections. At the time, Lega Nord's leaders did not support the impeachment that the leaders of M5S were calling for. When these political developments hit the Italian economy, it caused further turmoil.

Weak Fundamentals in the Italian Economy

Many of Italy's economic problems were longstanding, including a high number of problem loans on its central banks’ balance sheets, combined with decades of slow growth. It ranks among the countries with the most significant government debt—around 2.8 trillion euros in 2018—and the country has moreover been facing high unemployment since even before the 2007-2009 financial crisis made things worse.

In fact, after the 2008 financial crises, Italy never made any significant strides towards a recovery. Greece and Italy were the two of the advanced economies carrying the highest debt burden at the beginning of the crisis; in subsequent years, only Greece has suffered a more severe and more protracted economic depression. 

2.3 trillion euros

The amount of Italy's debt.

However, the bigger challenge faced by Italy is surrounding the snap elections, meant to take place in early 2019. Experts opine that it will be fought over the country's role in the EU and eurozone. The voting, as well as the results, will put a big question mark over the EU's future. The elections are seen as a quasi-referendum about Italy's role in the EU. The economic impact of Italian developments is also a cause of concern as the nation appears set to join other ailing economies, like Spain and Portugal, leading to larger problems for the EU.

If the anti-Brussels, anti-euro coalition comes to power with a decisive majority, the fate of the EU and the euro common currency will be at risk.

The Bottom Line

Though the current Italian crisis is worse than that of Greece in 2015, the situation is not a death-knell. The EU survived a crisis in 2012 when several smaller EU members were perceived to be potential defaulters and fears were looming large that the euro would collapse. Mario Draghi, head of the European Central Bank (ECB), unveiled the emergency program of bond buying, which ended the risk of a destructive debt spiral and boosted investors’ confidence.

Going forward, it will be a volatile situation in Italy and in the eurozone until the election sorts things out. A clear mandate to pro-EU groups is expected to soothe the situation, but a victory for anti-EU parties may deepen the crisis, while hung results may see fresh attempts at coalitions.