10/12/2012 07:42 GMT | Updated 06/02/2013 05:12 GMT

Italy: A Step Into the Unknown

When the technocratic government led by Prime Minister Mario Monti took over from Silvio Berlusconi's discredited right-of-centre administration in November 2011, Italy was on the brink of economic and financial collapse. Investor concerns about Italy's huge sovereign debt burden (equivalent to 120% of Italian GDP at the time) and the country's dismal economic growth performance had pushed secondary market ten-year government bond yields up to unsustainable levels of 6-7%. Incredibly, just before Mr Berlusconi withdrew his party's support from the Monti government this week, the former prime minister declared that his successor's management of the Italian economy had been "disastrous", leaving Italy "on the edge of a precipice". The Monti government's economic reform programme is far from complete, but it has done more in the last 12 months to tackle Italy's structural economic deficiencies than was achieved under Mr Berlusconi in 2008-11. At the beginning of December Italian ten-year government bond yields stood at 4.4%, the lowest level in two years.

The political turmoil caused by Mr Berlusconi's last-minute decision to return to lead the centre-right and the uncertainty of the outcome of the general election, which is likely to be held in January or February next year (only a few months earlier than it was due), will put renewed pressure on Italian government bond yields. Investors would clearly prefer another Monti-led grand coalition government. That may well happen, if no clear winner emerges from the election. Preferring to remain above the political fray, Mr Monti is not running, but he has expressed a willingness to continue beyond the election, if necessary. He has considerable support from business circles and centrist political parties, who fear what might happen if Italy return to the politics of fractious coalition government.

However, based on standings in recent opinion polls, the next government may be formed by a broad centre-left coalition led by Pier Luigi Bersani, the 62-year old, left-leaning leader of the Partito Democratico (PD), the largest party on the centre-left. On December 2nd centre-left voters chose Mr Bersani to lead them in the next general election ahead of the 37-year old PD mayor of Florence, Matteo Renzi. The main challenge facing Mr Bersani ahead of the general election and after it, if he succeeds in becoming the next prime minister, is to hold together a broad coalition of political parties and factions that range from the far left to the centre. After months of bitter rivalry with Mr Renzi, he must also try to harness the young mayor's energy and ideas, which were supported by 40% of centre-left supporters who voted. Until his defeat in the centre-left primaries Mr Renzi promised to tear down the old leftist guard and renew his party's ideas and personnel.

By contrast, Mr Bersani's leftist ally, Nichi Vendola, who is president of the region of Apulia and leader of the Sinistra Ecologia e Libertà (SEL) party, called on the newly-elected leader to shift the alliance clearly to the left. Mr Vendola wants to eliminate from the outset the possibility that, if the centre-left fails to win a clear majority at the general election, the PD will back another government led by Mr Monti. Anticipating that the centre-right's election campaign will seek to exploit Mr Bersani's leftist tendencies and his alliance with Mr Vendola to scare off potential centrist voters, Mr Bersani promised to continue the line of fiscal discipline followed by Mr Monti. That may help to win over some centrist votes, but many will remember how infighting and horse trading brought down the centre-left governments of 1996-2001 and 2006-08. A repeat of that would have disastrous consequences for Italy. Because of the size of the Italian economy and government debt, it could also threaten the survival of the single European currency.