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With fresh elections ahead, Italian fiscal challenges will persist, says DBRS

With a snap election on the horizon, fiscal policy challenges will continue for Italy, along with the likelihood of further tension with the European Union, according to DBRS.

On Aug. 9, Deputy Prime Minister Matteo Salvini and his League party called for fresh elections amid ongoing disagreements with its coalition partner, the Five Star Movement. Prime Minister Giuseppe Conte is expected to go to the Upper House of Parliament to face a no-confidence motion brought by the League in the coming days. If the vote is successful, or he concedes that there is no longer a working majority, he will resign. After this, heads of delegations and speakers of the Houses will assess whether an alternative majority can be formed. If this fails, Italian President Sergio Mattarella will dissolve both houses of Parliament, "maybe by Aug. 24," an Aug. 13 note from DBRS said.

Elections are then likely to be held by late October or early November, in the middle of Italy's presentation of its draft budget plan 2020 to the European Commission, DBRS noted.

Italy's budget deficit has been a recurring flash point with Brussels, with Italy narrowly avoiding a €3 billion fine earlier this year for failing to curb rising levels of structural debt.

Ratings agency DBRS believes that fiscal challenges could persist if Italy ends up with a center-right government led by the League following a snap elections. Policies are likely to include a personal income tax cut and proposals for a major infrastructure investment plan, according to DBRS.

A win by the League would mean "a more coherent and pro-business" agenda that might be more conducive to Italian GDP growth, the note said. But it could also mean that anti-EU sentiment could resurface and that the controversial topic of government spending and tax cuts could be on the table again.

However, EU frameworks and "financial market discipline" will mitigate the risk of a prolonged deterioration in Italy's fiscal position, Carlo Capuano, vice president, Global Sovereign Ratings at DBRS said in a statement.

A less likely scenario is that Italy will end up with a caretaker government supported by the Five Star Movement, the Democratic Party and other smaller parties, the note said.

Shares in Italy's largest banks took a hit on the news of the snap election Aug. 9 as the market digested the likelihood of higher funding costs for lenders and a more volatile economic environment. UniCredit SpA shares fell by 5.13%. Intesa Sanpaolo SpA was down 3.63%, while Unione di Banche Italiane SpA and Banca Monte dei Paschi di Siena SpA were both down over 8%.

DBRS' comments come shortly after Fitch Ratings held Italy's sovereign rating at BBB with a negative outlook on Aug. 9. The ratings agency cited high levels of government debt and heightened political uncertainty due to the snap election as the reason for the decision.

Fitch Ratings also said that tensions between Rome and the EU could reemerge, but added that a future government would be "wary" of disregarding EU processes.