The risks of austerity

Why Italy's election results are bad news for India

Plummeting global markets and surging bond yields have underlined the unambiguous message that Italian voters have sent to the rest of the European Union. Raising taxes and cutting wages and expenditure look like the only possible response to a crisis; but, in practice, these policies put the brakes on growth - and are politically extremely difficult to sustain. In Italy, the cutbacks are not as severe as they are in Greece or Spain, but they are still deeply unpopular. Thus, the uncharismatic technocrat Mario Monti's centrist Civic Choice party went down to a fairly comprehensive defeat in elections to the two chambers of Italy's Parliament, throwing Italy's austerity, Europe's recovery, and the euro's future all into doubt simultaneously. Mr Monti's defeat was underlined by the bizarreness of some of the other results, particularly that the unabashedly populist and agenda-free party headed by comedian Beppe Grillo won a full quarter of the votes.

Italy's populist backlash may well be replicated across the "Club Med" countries. After 15 months of Mr Monti's tax-and-cutback policy, the Italian economy continues to shrink and public debt is still 120 per cent of its gross domestic product. Poor economic performance holds true for Greece, Portugal and Spain as well, so it is not surprising that across the Mediterranean, leaders are reviewing the virtues of deficit-cutting austerity. In that sense, the manner in which politics in Italy, the euro zone's third-largest economy, plays out is critical. Italy's - and Europe's - problem is that the alternative route to recovery is as opaque as the election results. Pier Luigi Bersani's centre-left bloc Common Good has won a majority in the lower House. But the results for the Italian Senate are inconclusive, with Common Good and Silvio Berlusconi's coalition neck and neck. Horse-trading may mark the slow formation of a coalition; but one thing is already clear: the anti-austerity majority in the Senate will be able to block many economic measures. While many have focused on the simple fact that Mr Berlusconi has somehow managed to resurrect his career once again, the problem for the Italian left is that Mr Bersani does not inspire confidence. His economic programme sounds deeply inconsistent; and elsewhere in Europe, similar wishy-washy left-of-centre politics seems to have failed. For instance, France's Socialist Party president Francois Hollande has done little to boost growth there.

But can Europe's creditors take a much larger haircut than they think they deserve, simply because none of these debtor economies has been able to generate the growth or the savings to repay them? That idea brings its own raft of political problems with it. Given that the bulk of the debt is with German banks, German Chancellor Angela Merkel will finally have to face this harsh reality at a singularly inconvenient moment for her. She faces an election for a third term this September. The world markets have taken note, and are worried. For a while, the future of Europe and the euro has seemed secure, but the prospect of lengthy paralysis in Italy puts those concerns right back on the table. It might signal the beginning of another phase of global risk-aversion - with incalculable consequences for the Indian economy, increasingly dependent on foreign capital flows.