Italy's populists reportedly drew up a plan to drop the euro — here's what you need to know

italy Giuseppe Conte

  • Italy’s 5-Star Movement and League have been accused of making a plan to abandon the euro.
  • That could pose major risks to Italy’s economy in the short run.
  • Some Italians don’t like the euro, but doubt dropping the currency is plausible.

Italy’s antiestablishment 5-Star Movement and the far-right Northern League, populist parties that came out on top in an inconclusive election earlier this year, have been accused of making a plan to abandon the euro. Here’s what you need to know. 

Is it legal?

The eurozone was designed to be a “one-way street,” according to a recent report from German think-tank Bertelsmann Stiftung. And the treaty laying out ground rules of the eurozone doesn’t include any provisions for an exit from the currency system, which has been labeled “irreversible” and “iirrevocable.”

But a eurozone exit is still possible, and the idea isn’t new. Even back in 2015, economists thought Greece could be forced out of the currency union during the country’s government-debt crisis. 

What are the main risks for Italy?

A new currency would likely see rapid devaluation. Stephen Brown and Jessica Hinds, economists at Capital Economics who specialize in Europe, estimate that a new Italian currency would depreciate by about 30% versus the euro.

This would trigger inflationary pressure, canceling out any positive effects on competitiveness that devaluation might offer. Since foreign goods are used as inputs in the production process, higher import prices can feed through to faster domestic inflation. And because financial markets tend to react to economic circumstances more quickly than labor and product markets, initial changes in the nominal exchange rate could easily overshoot. 

On top of that, yields could move even higher to price in redenomination risks. Italian government bonds, which move opposite of yields, have already been selling off amid uncertainty. Italy’s benchmark 10-year BTP yield shot up more than 50 basis points early Tuesday to the highest level in more than four years.

This could cause Italy’s economy to contract sharply in the near-term for a multitude of reasons, including a reduction in real income and trade disruptions caused by exchange rate volatility. 

Are there any possible benefits?

A team of Capital Economics analysts led by Jonathan Loynes suggested in a note to clients last year that Italy’s medium-term prospects would be better outside the eurozone.

“Experience from past devaluations suggests that a few years down the line, the Italian economy might grow fairly quickly,” they wrote. 

They argue that an economy with less-than-potential output, including Italy’s, can sometimes perform better awhile after devaluation. But this would depend heavily on actions of the central bank and could be hindered by unorthodox fiscal policies. 

What do Italians think about it?

A majority of Italians seem to support European Union membership, which analysts say typically goes hand-in-hand with eurozone approval. A recent opinion poll found that 49% of Italians under 45 and 68% over 45 supported European Union membership, according to Capital Economics, implying a majority in favor of about 60%. 

For some Italians, the prospect of a eurozone exit is a sour reminder of the country’s last currency change in 1999. When the euro replaced the Italian lira, according to analysts, it lowered Italy’s competitiveness by nearly 25% relative to the rest of the currency union. 

“When we joined the euro, our country paid more than anybody else,” Francesca Belluardo Giovatto, who lives in the Sicilian town of Ragusa, told Business Insider. “[The price of] everything doubled, except the salaries.” 

“We will never get back to our Italian lira,” she said. “We want to leave the euro now, but it’s too late. We should have done this earlier … We have to keep going. That’s the only way we can do it.”

Cathy Fleming contributed to this report. 

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Read the full article from it’s original source: http://uk.businessinsider.com/italy-eurozone-exit-heres-what-you-need-to-know-2018-5

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