Italy’s Prime Minister Giorgia Meloni faced a strong market backlash on Wednesday, after she announced a plan to impose a windfall tax on banks and other financial institutions. The plan, which was part of a broader budget proposal for 2023, sparked a sell-off in Italian bank stocks and bonds, and raised doubts about the country’s fiscal credibility and stability.
What Is the Windfall Tax Plan?
The windfall tax plan was a surprise move by Meloni’s government, which aimed to raise about €2 billion ($2.3 billion) in additional revenue for 2023. The plan would levy a one-off tax of 15% on the profits that banks and other financial institutions made from holding Italian government bonds in 2022.
The plan was justified by the government as a way to share the benefits of the ultra-low interest rates that the European Central Bank (ECB) has provided to support the Italian economy during the pandemic. The government argued that banks and other financial institutions have enjoyed windfall gains from holding Italian government bonds, which have seen their yields drop to record lows thanks to the ECB’s bond-buying program.
The plan was also seen as a political gesture by Meloni, who leads the right-wing Brothers of Italy party, to appeal to her populist and nationalist base. Meloni has been critical of the ECB’s policies and the European Union’s fiscal rules, and has advocated for more fiscal sovereignty and spending for Italy.
How Did the Markets React?
The markets reacted negatively to the windfall tax plan, as they saw it as a sign of fiscal irresponsibility and unpredictability by Meloni’s government. The plan was also seen as a breach of trust and cooperation between the government and the financial sector, which have been working together to support the Italian economy and debt sustainability.
The Italian bank stocks plunged on Wednesday, with the FTSE Italia All-Share Banks Index dropping 7.6%, its biggest daily decline since March 2020. Some of the biggest losers were UniCredit, Italy’s largest bank by assets, which fell 9.4%; Intesa Sanpaolo, Italy’s largest bank by market value, which fell 8.1%; and Banco BPM, Italy’s third-largest bank, which fell 10.4%.
The Italian bond yields also rose on Wednesday, as investors demanded higher returns to hold Italian debt. The yield on the 10-year Italian government bond rose to 1.07%, its highest level since June. The yield spread between the 10-year Italian bond and its German counterpart, a measure of risk premium, widened to 113 basis points, its highest level since July.
What Are the Implications and Outlook?
The windfall tax plan has raised concerns about Italy’s fiscal credibility and stability, as well as its relationship with the ECB and the EU. The plan could undermine Italy’s efforts to reduce its public debt, which is expected to reach 160% of GDP by the end of 2023, the highest in the euro zone. The plan could also jeopardize Italy’s access to cheap funding from the ECB and the EU’s recovery fund, which are conditional on sound fiscal policies and reforms.
The windfall tax plan has also damaged Meloni’s reputation as a pragmatic and reliable leader, who had been praised for her handling of the pandemic and her economic policies. Meloni had been enjoying high popularity ratings and had been seen as a potential contender for the next general election in 2024.
However, after facing strong criticism and opposition from her coalition partners, business groups, unions, and regulators, Meloni backtracked on Thursday and announced that she would cap the windfall tax at €1 billion ($1.2 billion) and exclude smaller banks from it. She also said that she would consult with the ECB and the EU before implementing the tax.
The market reaction to Meloni’s U-turn was mixed, as some investors welcomed her willingness to compromise and revise her plan, while others remained skeptical about her fiscal credibility and stability. The Italian bank stocks recovered some of their losses on Thursday, with the FTSE Italia All-Share Banks Index rising 2.6%. The Italian bond yields also eased slightly on Thursday, with the 10-year yield falling to 1.04% and the spread narrowing to 110 basis points.
