The eurozone’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. At the end of Sept. 2018, the ruling coalition comprising the Five Star Movement and the Lega Nord announced their 2019 budget, which increases deficit spending to 2.4 percent of the GDP. The move has upset Italy's euro zone partners, who had been pressuring Italy to decrease its debt. This article looks at what Italy’s political and economic problems are all about and why it matters so much to the world economy.

Its Politics That Hurts

In a nutshell, political chaos and failure to form a stable coalition government has caused the problems in Italy. Despite several weeks of prolonged discussions and negotiation, an agreement between a euro-skeptic populist group and pro-EU establishment lawmakers have failed to materialize, leaving the country in a deep political and economic crisis.

Italy has been without a proper government since the March polls resulted in a hung assembly. The populist Five Star Movement (M5S) emerged as the largest party; they attempted to join the far-right Lega Nord group 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 over the weekend caused a stir. The 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,” and 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, and paved the way for another round of elections. Cottarelli is now responsible for planning the new elections as well for introducing the new budget. However, 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 go down well with M5S and Lega Nord. Mattarella, who was instituted by the earlier pro-EU government, now faces calls for impeachment, which comes from M5S’s top brass owing to the president’s refusal to accept Savona as economy minister, appointing Cottarelli as interim prime minister, and mandating fresh elections. However, the impeachment move is not supported by Lega Nord’s leaders. These political developments hit the Italian economy, causing the recent turmoil.

Weak Fundamentals in the Italian Economy

Italy has been a problematic state for many years. It ranks among the countries with the largest debt—around 2.3 trillion euros—and has a been facing a double-digit unemployment rate since 2012. Its Gross Domestic Product (GDP) stands at a level lower than in 2005. 

However, the bigger challenge faced by Italy is about 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 EU.

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

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. (See also: The Origins of Greece's Debt Crisis and What Caused the European / Eurozone Debt Crisis?)

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. (See also: Global Economics: Is Italy the Next Greece?)