A Busy Electoral Calendar Could Throw Up Policy Risks

The crowded European electoral schedule (general elections in March in the Netherlands and in Italy by May next year, general and presidential elections in April-May in France, and a German federal election in September), and the possibility of unexpected political outcomes, could lead to sharp policy shifts in eurozone member states with implications for sovereign ratings.

However, our core view remains that, while any meaningful fiscal and political convergence of eurozone sovereigns is decidedly off the table, commitment to ensuring that all current members remain in the zone remains firm. As stated previously, we expect that any impending member state withdrawal from the Economic and Monetary Union (EMU) would focus minds on the negative implications for the financial and economic stability for that member state. As we observed during the summer of 2015 in Greece, depositors are unlikely to wait patiently for political outcomes before hedging themselves against policy shifts. This is a key difference from Brexit: the cost of openly contemplating radical policy shifts is higher in a monetary union. The Greek Prime Minister Syriza’s 2015 election victory and subsequent volte-face on budgetary and other measures, is a case in point; the outflow of household deposits before and after Tsipras’ election contributed to a capital shortfall in Greece’s banking system with a cost of around 9% of GDP, alongside a shift of the economy back into recession.
With exports of goods and services at around 28% of GDP, the eurozone is the world’s most export-driven trading block–more than twice so than the U.S., and almost 10% of GDP more than Japan. This, in our view, could make Europe more susceptible to a global rise in protectionism than other advanced economies. An external shock would likely result in rapid fiscal pressure on the EU, once again raising questions about the compatibility of the monetary union with fiscal and political federalism. In the past, the eurozone has presented a common front in the face of external shocks, most recently ahead of the Brexit negotiations. We think eurozone solidarity will deepen should the external environment become more unpredictable. This alone is not total insurance against possible event risk, however, not least from the numerous elections during 2016.

Netherlands
The Dutch general election takes place on March 15, with Gert Wilder’s Freedom Party (PVV) leading in the polls (with anywhere between 20% and 25% of the vote) and promising to hold a referendum on the Netherlands’ EU membership. Our baseline expectation is that smaller parties will be able to cobble together a multi-party coalition, preventing the PVV from governing. We would flag the defeat of far right Austrian presidential candidate Norbert Hofer (Freedom Party of Austria) as a precedent in this regard. Even so, the alternative to PVV victory would likely be a weak and fragmented Dutch coalition government that might not remain in power until the end of its term; such a government would most likely be on the defensive domestically. This would cause the Netherlands, one of the original six founders of the EU, to be even more reluctant than it is at present to support European efforts to adopt common policies, especially those that require financial outlays.

France
The first round of France’s presidential election is scheduled to take place on April 23, 2017. If no candidate wins an outright majority, which is highly likely, a run-off will follow a fortnight later. Our baseline expectation is that the next president of France is likely to continue or even accelerate the current moderate pace of reform, with a focus on unblocking the labor market, and hence generating better growth outcomes. This expectation is also reflected in our change of the outlook to stable from negative in October. Given the surge of support for populism–reflected in the Brexit vote and the Trump victory in the U.S. elections–as well as the failure of opinion polls to detect those trends, a victory by Marine Le Pen of the National Front (FN) cannot be ruled out, although this is not our baseline assumption.
A victory by Le Pen, who is on record as favoring both the breakup of the EU and a referendum to reintroduce the franc (though she has recently partially backtracked on this position), would likely be a blow to financial and economic stability, not only in France but across the monetary union. While the FN has yet to publish its full manifesto, it is expected to include measures that could be incompatible with EU obligations, including retaking control of national borders.
Alternatively, a victory by the republican candidate Francois Fillon, the socialist candidate Manuel Valls, or independent candidate Emmanuel Macron would, in our view, likely build on ongoing reform efforts. Mr. Fillon has laid out a comprehensive economic reform platform that could ease bottlenecks in France’s labor and product market and also reduce the size of the state in the economy (with general government currently spending 56% of French GDP). Macron, meanwhile, is advocating further labor reform but less radical fiscal adjustments. To the extent that the implementation of either program lastingly enhances France’s economic and fiscal performance, the sovereign rating could experience upward pressure.

Germany
The German general election scheduled for autumn will, in our view, return another multi-party coalition into government, likely ensuring policy continuity. While eurosceptic party Alternative for Germany has seen its approval rating rise, at 15% it lacks sufficient numbers to take on incumbent parties, in our opinion. We therefore see a policy shift in Germany as a low probability event.

Italy
In Italy we expect that, following the resignation of Prime Minister Renzi, the next government is likely to reduce legislative activity on economic and medium-term budgetary policies, especially given the fragmented political landscape. We think reform delivery will therefore decelerate before the next parliamentary elections. Downward pressure on the ratings could emerge were there to be an overt reversal of past reforms, or if Italy’s external or fiscal performance were to deviate materially and negatively from our current projections. At present, it is difficult to determine whether elections are likely to take place this summer or in 2018. This week’s ruling by the Constitutional Court on whether or not a referendum on Renzi’s benchmark labor reform can be held is likely to tip the balance toward an early election, should the decision permit that referendum to take place.

Spain
We expect that 2017 should be a relatively calm year in Spain at the national level, with early elections only posing a risk in 2018 or 2019. In Spain’s case, the current minority government (Partido Popular) can only legislate with the support of opposition parties (largely socialist and regional party MPs), however this did not prevent them from delivering a 2017 national budget. Opposition parties are, moreover, wary of pushing for early elections, given lower approval ratings and election fatigue. The more immediate political risk in Spain, in our view, is the tense legal and political relationship between Madrid and the region of Catalonia, where leaders have promised to move ahead with a  legally contested independence referendum this autumn. Even on this issue some fatigue has set in, with the central government likely to explore the possibility of offering face-saving financial incentives to the Generalitat of Catalonia to reconsider its position.

Frank Gill – Credit Analyst – Standard & Poor’s