Investors are mistaken to be relaxed about the possible revival of Berlusconi

Two ailing European entities have come back to life. One is the Italian economy; that's the good news. The other is Silvio Berlusconi; that's the bad news. His centre-right coalition could form the next government after the March 4 election, and its economic track record is dreadful.

The Italian economy is hardly on fire and remains the standout laggard among the large European economies, but at least it's growing after nearly a decade of recession or stagnation. Gross domestic product was up 1.4 per cent in 2017, and unemployment is falling, though, at 11.8 per cent, it's still atrociously high.

Any growth is to be welcomed. Italy is the euro zone's third-largest economy, after Germany and France, and is saddled with €2.3-trillion ($3.5-trillion) of debt, for a crushing debt-to-GDP ratio of 132 per cent (Germany's is half that). When Italy was circling the drain during the crisis years, the fear was that every other European economy would get sucked down with it. Mr. Berlusconi was prime minister at the time. In 2011, at the peak of the Italian crisis, he was, in effect, ousted before he could do more damage. The country was saved by the fire-fighting campaign launched by a more respectable Italian, Mario Draghi, president of the European Central Bank.

If Italy's revival has been slow. Mr. Berlusconi's has been quick. Two years after he left the premiership, he was sentenced to seven years in prison for paying an underage prostitute for sex. The conviction was overturned on appeal. He was later convicted for tax fraud, a ruling which prevents him from holding public office until 2019.

Still, at 81 and in declining health, he's a player and a formidable campaigner. He and his family remain in control of Mediaset, Italy's biggest private broadcaster. While he cannot step into parliament, his party, Forza Italia (Go Italy), leads the centre-right, three-party coalition that is topping the polls, at about 35 per cent. The populist, anti-establishment Five Star Movement (M5S) is the single-most-popular party, at about 27 per cent, but has refused to form coalitions and is unlikely to win a majority. Meanwhile, the ruling centre-left Democratic Party (PD), led by former whiz kid prime minister Matteo Renzi, is going nowhere, reflecting the downfall of centre-left parties across Europe.

As it stands, the coalition, led by Forza Italia, has the best chance of coming out on top were that to happen, Mr. Berlusconi, as head of the party, would be kingmaker, giving him enormous power to pick the next prime minister. A Forza Italia-led coalition scenario sits well with many European Union countries and investors. Why? Because, in their view, any government is better than a M5S government. They fear that M5S is skeptical of the European integration project and the common currency (even though it has backed off on demands for a referendum on the euro), lacks experience and is full of whackos, including its founder, Beppe Grillo, the firebrand comedian who espouses a mish-mash of economic policies.

Investors seem entirely relaxed about the election, maybe because they expect a centre-right victory. Italy can sell 10-year debt at 2.2 per cent, cheaper than U.S. debt, and the spread over benchmark German bonds has not widened as the election approaches, signalling confidence in the Italian economy. The Milan stock exchange has been powering ahead as the Italian banking crisis fades, exports pick up and economic growth returns. In the past year, it's up more than 20 per cent – the best performer in Europe.

The optimism may be misplaced. Mr. Berlusconi's centre-right coalition, should it form a government, might be as scary as an M5S government and not just because he presided over Italy's deepest downturn since the Second World War (In spite of the recent growth, Italian GDP remains below its precrisis peak).

While Mr. Berlusconi and his Forza Italia party are broadly pro-European, he has been inconsistent. At one point not long ago, he was saying the euro has done Italy no favours (he was right about that). More recently, he has talked up the idea of a parallel currency, which would see the euro stay in use for international trade and the old lira reprinted for domestic use. Forza Italia's pro-European stance might suffer a blow if the centre-right does form a government. That's because Mr. Berlusconi's main coalition partner is the decidedly euroskeptic (and xenophobic) League party, formerly the Northern League, led by Matteo Salvini. He has called the euro a "German currency" which is entirely unsuited to the Italian economy, and is predicting the currency's collapse, a scenario that he says he would welcome. Investors face a nasty surprise if Mr. Salvini pushes a centre-right coalition to drop its pro-Europe stance. A hung parliament, the other highly possible scenario, would also make investors nervous because it might easily lead to an unstable coalition government, cluttered with parties from the centre-right and centre-left, that would be incapable of launching any significant economic reforms.

Meanwhile, rising energy prices and the wind-down of the quantitative easing program, which has seen the ECB buy vast amounts of Italian sovereign bonds, pushing their yields down, are bound to put pressure on the Italian economy in the not-too-distant future. Over all, investors seem to be underpricing Italian risk. Italy under Mr. Berlusconi's centre-right coalition or any other coalition could throw the tentative economic revival into reverse. Italy is a big economy. Europe cannot be healthy unless Italy is healthy.