Graphic of Italy with the Italian floag colours with the EU ring of stars hovering over top.The Italian elections of March 4 marked an unprecedented turning point both for Italy and for the European Union. Two populist parties, the Five Stars Movement and the League, interrupted the historical alternation between the center-left, represented by the Democratic Party, and the center-right, which over the last twenty years was represented by Silvio Berlusconi’s Forza Italia. The victory of the so-called “yellow-green” government represents an absolute novelty also for the European Union, which has never dealt with the election of an anti-establishment government in one of its founding states. From this perspective, the League and the Five Stars Movement succeeded where Marie Le Pen’s Front National failed in France.

The League and Movement Five Stars won their battle against the establishment by launching vehement slogans against the European Union, in particular Germany, which were deemed guilty of having increased the poverty level in Italy as a result of the austerity measures imposed in the last years by the German-led European Commission, with the objective of reducing the Italian public deficit and the huge mountain of public debt, currently equal to 2.3 trillion euros ($2.7 trillion). They also attacked Brussels on the migrant issue, accusing the European institutions of leaving Italy alone in activities such as the rescue at sea, first aid and management of migratory flows, also underlining the scarcity of European funds allocated by the European Union to cover the costs of migration policies.

The resulting increase in the fiscal pressure, which has led Italy to be the European country with the highest tax burden, especially on businesses, and the discontent that has ensued, has created a fertile ground for the proliferation of populist messages. Another keyword used by the two parties during the electoral campaign was “sovereignism,” which was exploited as a synonym for reducing the EU meddling in Italy, a communication strategy already used successfully in Hungary by Viktor Orban, by whom the League was inspired.

Since the draconian economic policies imposed by the European Union have been presented by the two parties as the direct consequence of the liberal and capitalist vision of the globalized economy, the proposed recipe has been the total break with the spirit of rigor and control of public finance. This break was expressed in a clear socialist economic program, all stuffed with welfare measures and statism. The proposal for the introduction of a citizenship income and pension for all taxpayers is the best example.

But winning the election in one thing, another is keeping the promises made during the electoral campaign. The yellow-green government led by Giuseppe Conte, an academic and a lawyer without previous political experience, realized it very soon. The government program signed by the two coalition leaders, Luigi Di Maio and Matteo Salvini, contains an economic plan worth more than 100 billion euros, with very expensive measures, such as a flat tax with a 15 percent tax rate, a citizenship income, a loosening of the previous pension reform, measures to reduce poverty and the reduction of taxes. Such an expensive program is evidently incompatible with respect to European rules for public finances. Previous Italian governments had made commitments to the European Commission to eliminate structural deficits by 2020, and to bring down the debt-to-GDP ratio, which is currently above the 130 percent threshold. The leaders of the League and Five Star Movement have repeatedly declared that they are ready to disregard European rules and want to use a deficit spending strategy to cover their ambitious program. Some members of Conte’s government, such as the Minister for European Affairs, professor Paolo Savona and two influential League economists, Claudio Borghi and Alberto Bagnai, declared their willingness to exit from the single currency in some of their academic publications. The response from European economic institutions and from financial markets was obviously negative. Yield on Italian sovereign bonds jumped when investors realized the danger of having anti-euro economists at top seats.

The risk of observing an unprecedented clash between Italy and EU institutions is high, and Italy has much to lose from it. The rating agencies have already warned Italian policy-makers that, in case of abandonment of the deficit and debt reduction strategy, the sovereign rating of Italy would be revised downwards. If so, borrowing on markets would become much more difficult and expensive by the Treasury, which would pay a higher yield on the issued bonds.

Another very important issue on which Conte’s government will have to demonstrate its ability is the reform of European economic governance, which is being discussed in the Economic Council. Germany and France have been working on it for a long time and they agreed to propose the creation of a European Monetary Fund (EMF), based on the International Monetary Fund (IMF) model, which should replace the current European Stability Mechanism (ESM), the fund created in 2012 to help member states in financial distress.

The aim of German Chancellor Angela Merkel and French President Emmanuel Macron is to create a concessional mechanism, which would grant financial aids to heavily indebted countries, in exchange for structural reforms, such as those on labor markets, productivity and spending review of public administration. Since the decisional mechanism will be based on a majority which will depend on the share of underwritten capital, instead of unanimity, Germany and France would have a de facto veto power, as their quotas would be worth around 47 percent. Furthermore, France and Germany agreed upon the creation of an EU economic minister and broader European fiscal powers. These proposals are evidently not in the Italian interest, as Italy could indeed be the first victim of the EMF, running the risk to lose its freedom to decide economic policies. Secondly, we must bear in mind that in 2019 Italy will lose three top seats in the European institutions: the presidency of European Parliament (Antonio Tajani), the presidency of the European Central Bank (Mario Draghi) and the High Representative of the EU for Foreign Affairs and Security Policy (Federica Mogherini). Other member states will remind that Italy has had too many top seats over the last years and they will claim them. Germany and France are serious candidates to win the ECB top seat, with Bundesbank’s governor Jans Weidmann sponsored by Berlin, and the new minister of economy, a seat which could be taken by France. If this scenario should occur, Italy would be subject to the German-French axis, with their dreaded mix of restrictive fiscal and monetary policies. For all these reasons, premier Giuseppe Conte will have to negotiate with his EU colleagues, to prevent the German-French position, without forgetting he is not in a position to ask without giving something in return. Especially after his ministry of economy, professor Giovanni Tria has already asked European institutions to allow a higher deficit to postpone the balanced structural budget goal beyond 2020. From this perspective, France and Germany could grant Italy some leeway for deficit spending in exchange for the Italian assent to their economic governance proposals.

The other big trap that the Franco-German axis is preparing for Italy concerns the completion of the European Banking Union, to be implemented through a maximum clearing of the banks’ balance sheets, especially on the part related to the non-performing loans (NPL). The Franco-German agreement was given birth at a recent meeting held in Mesemberg, Germany, where Paris and Berlin agreed on the need to introduce the goal of reducing gross impaired loans to 5 percent and net impaired loans to 2.5 percent of total loans held. Should this proposal pass, the Italian financial institutes, which currently hold gross NPLs share of 11 percent and net share of 6 percent, would have to make a huge effort to respect the parameters. It is almost certain that, to achieve the goal, they will be forced to reduce their lending activity to households and businesses. This choice that would be punished by financial markets through a selloff in shares, making the institutions themselves prey to foreign acquisitions. It is a widely held belief in Italian society that it is France’s goal to continue in its campaign to conquer Italian savings, which started with the acquisitions of Pioneer, taken over by Amundi, and Banca Leonardo, taken over by Credite Agricole.

The next goal is the conquest of Unicredit through a merger into Société Générale. From this point of view, France had the ability to name Daniel Nouy at the helm of the supervision arm of the European Central Bank. Nouy, the most strenuous proponent of the NPL reform, will clash with ECB’s governor Mario Draghi and the President of the European Parliament Antonio Tajani, who claimed responsibility for legislative power on this topic. The proposal was also backed by another prominent French representative, Christine Lagarde, director general of the International Monetary Fund. For the moment, the Italian front has won its battle, but things will change inexorably starting next year, when the mandates of Tajani and Draghi will expire. At that point, France, which currently does not hold important roles within the Union, is ready to launch the assault on these two seats. At that point, it would find very few obstacles to get through the reform of bank overdrafts, from a profitable perspective. For the Italian banking system, this would be a catastrophe. Strangely, in the Franco-German proposals there is no mention of the question of illiquid securities, of which 75 percent are held by French and German banks. Italy has never put forward a proposal on this subject, and it would have good reasons to do it. In short, if the model of banking union proposed by Macron and Merkel were to pass, risk sharing would exist only for France and Germany. The weaker ones would not be guaranteed at all, on the contrary, the saving of their citizens would easily fall prey to the Franco-German colossus.

Defending Italian interests in Europe will be the first goal of Conte’s government. It is perfectly in line with the anti-establishment slogans launched during the electoral campaign. Nevertheless, the new government will need more than slogans to convince the other European superpowers that it is time to reform European Union according to what people, and not bureaucrats, desire.