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World Italian Prime Minister's defeat plunges EU into uncertainty

Italian Prime Minister Matteo Renzi gives a speech after the results of the referendum on constitutional reforms at Palazzo Chigi on December 5, 2016 in Rome, Italy.

Franco Origlia/Getty Images

The stalling European integration project took another blow Sunday night when Italian Prime Minister Matteo Renzi's effort to overhaul the constitution and stop the populist march in the euro zone's third largest economy suffered a resounding defeat.

Addressing the country shortly after midnight local time from his official residence at Palazzo Chigi in Rome, Mr. Renzi said he "takes full responsibility" for the stinging defeat and will submit his resignation to President Sergio Mattarella on Monday. "I have lost and I will say it out loud," he said.

The referendum's No outcome means that Mr. Renzi's bold plan to overhaul the constitution, secure his tenure as a reformist leader and trip up the country's – and by extension Europe's – rising populist parties has died a premature death. At 2 a.m., the Italian interior ministry put the No side at almost 60 per cent per cent and Yes at 40 per cent.

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In a tweet, Marine Le Pen, leader of France's anti-EU, xenophobic National Front party said "The Italians have disavowed the EU and Renzi. We must listen to this thirst for freedom of nations and protection!" She congratulated Matteo Salvini, leader of Italy's anti-immigrant, separatist and eurosceptic Northern League party for pushing for a No vote.

Mr. Renzi's resignation will plunge Italy back into political uncertainty, and perhaps outright chaos, at a time when it cannot afford to alienate the domestic and international investors who fund its burgeoning debt load as growth remains stalled.

It will also inflict further damage on the ailing Italian banks, whose efforts to raise billions of euros in new capital will come under pressure as Italy steps into the political unknown. In early Asian trading, the euro sank almost 1 per cent, to $1.06 (U.S.), hitting a 12-year low against the dollar.

Italy's three main opposition parties, including the surging anti-establishment, eurosceptic Five Star Movement (M5S), had all campaigned against Mr. Renzi. It celebrated the No vote as a victory for democracy and voter damnation of Mr. Renzi's apparent effort to use the constitution's overhaul as a blatant power grab.

Sensing momentum, Beppe Grillo, the firebrand former comedian who leads M5S, used his blog on Sunday night to call for a snap election. "We need to vote as soon as possible," he said.

Mr. Grillo has pledged to hold a referendum on the euro if M5S wins the next election but insists he wants to keep Italy in the European Union. Many European economists believe both the EU and the euro would collapse if Italy, whose economy is bigger than Canada's, were to ditch the euro. The EU is already reeling from Brexit – Britain's decision to exit the 28-country union, the world's biggest trading bloc.

But the No vote does not necessarily mean Italy has fully succumbed to the wave of populism, and drift to the far right, that helped to propel Donald Trump into the White House and secure Brexit.

Many Italian voters seem to have used the referendum simply as a plebiscite on Mr. Renzi's popularity, which sank as the Italian economy failed to revive under his tenure, not necessarily an endorsement of the anti-establishment parties that have gained momentum as European youth unemployment remains stuck at high levels and refugee resentment builds.

Political pundits also noted that the endorsement of a No vote by M5S, which draws its support from both the left and right sides of the political spectrum, was, ironically, a vote for the status quo, not for sweeping political change. It was Mr. Renzi who wanted to use a new constitution to streamline government by eliminating most of the lawmaking powers of the Senate, the upper house of parliament. If the referendum had succeeded, the lower house, the Chamber of Deputies (similar to the U.S. House of Representatives), would have dominated the legislative process.

Still, Italian and European populist parties will promote the No victory to argue that they are unstoppable. "The No vote adds another dimension to the populist sentiment that has been expressed in the EU referendum in the U.K. and the presidential elections in the U.S. earlier this year," said Michael Menhart, chief economist of Munich Re, one of the world's biggest reinsurers.

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Austrians earlier Sunday bucked the populist trend in Europe by electing Alexander Van der Bellen, a candidate backed by the Green party, as president. But in the spring presidential election in France, Ms. Le Pen's victory is not out of the question. She is expected to make it into the second round of voting.

Mr. Renzi, 41, has been Prime Minister and leader of the centre-left Democratic Party for less than two years. It will now fall upon Mr. Mattarella, who is head of state, to form a caretaker government. In the interests of stability until the scheduled elections in mid-2018, he is unlikely to endorse a snap election that could be won by M5S, the leading opposition party and the biggest elected populist party among the top EU countries. At 30 per cent, M5S is polling roughly equally with the ruling Democrats.

He could ask Mr. Renzi to form a caretaker government, appoint an interim prime minister from Mr. Renzi's cabinet or seek a non-partisan technocrat for the post.

Ahead of the referendum, economists and market strategists warned that Italian banks would suffer more damage if a No vote were to come out on top.

The banks are stuffed with the highest percentage of non-performing loans – loans that are unlikely to be repaid in full – on the continent. At least one of Italy's biggest banks, Monte dei Paschi di Siena (MPS), is in danger of collapse. Its failure would trigger contagion that would send shockwaves across the banking industry in Europe, including Germany, where market-leading Deutsche bank is in terrible shape.

MPS is in the middle of a €5-billion capital-raising effort that it wants to complete by the end of the month.

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"If Italy is plunged into a period of political uncertainty following a No vote in the referendum, investors may well steer clear of participating in MPS's capital-raising efforts," Manulife chief economist Megan Greene said Sunday night. "MPS would then need to be rescued. From the day after the referendum, this most likely turns into a banking story."

If the No vote rattles markets on Monday, which is expected, the European Central Bank might buy vast quantities of Italian sovereign bonds to support their price, preventing their yields – their interest rate – from climbing drastically. The ECB has already been buying Italian bonds, and those of most other euro-zone countries, through its €80-billion a month quantitative-easing program.

Since the No vote was certainly evidence of M5S's greater popularity, the government, which will retain its majority in parliament even when Mr. Renzi resigns, will make every effort to impede M5S's chances of victory in the next election.

Doing so would require rewriting Italy's new electoral law – known as the Italicum – which automatically gives the party that wins the second round of an election enough bonus seats to guarantee it a majority. If the rewritten Italicum reverts back to proportional representation, M5S's chances of forming a government would fall because, unlike other parties, it refuses to form coalitions.

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